Wednesday, May 9, 2012

Why Nations Fail

I recently read "Why Nations Fail" by Daron Acemoglu and James A. Robinson. Through the first half of the book I kept trying to decide whether it was one of the most intelligent books I have read in the last thirty years or another example of the common academic conceit of claiming great insight when all that has been done is to invent new nomenclature. I finally decided it was the former, despite the latter.

The nomenclature in the book is "extractive" political and economic structures and institutions versus "inclusive" ones.

Extractive economy institutions are designed to reinforce the ability of a small self-perpetuating proportion of a society to benefit at the expense of the rest, and extractive political institutions concentrate political power in a small group and exclude from power the others. Some extreme examples of societies with extractive economic and political institutions are present-day North Korea, pre-revolutionary France and the US South during both the antebellum and "jim crow" periods.

Inclusive institutions create opportunity for economic and political participation of the great majority.

The book is a slog because it follows the standard advice to speakers, namely "tell them what you are going to tell them, then tell them what you are telling them and finally tell them what you have told them" nested in a fractal like structure of repetition.

None the less, it is an extremely important book. Aside from the central ideas, the great strength of the book is the authors' broad grasp of economic and political history, which allows them to mine it for numerous examples to illustrate their ideas.

Although never stated this way in the book, its essential syllogism is as follows:

1. National prosperity is a function of continuous wealth creation activity (the longer the better).

2. Wealth-creation activity is a function of risk-taking entrepreneurial activity and technological innovation.

3. A society's level of entrepreneurial activity and technological innovation is a function of:

a) the proportion of the population permitted to engage in such activity (e.g. slaves and serfs (and jews in many parts of Europe during different periods) were not),

b) the existence (and reliability of) essential supporting structures (e.g. private property and contract rights, a just rule of law, and a functioning capital market) and

c) the absence (or minimization of) impediments such as corrupt public officials, prohibitive regulations, confiscatory taxing policies and politically protected (or created) cartels or monopolies.

4. Entrepreneurial and innovative activity results in "creative destruction" which as economically and politically adverse to those who are currently at the top of the political and economic heap (elites).

5. Therefore, political and economic elites will tend to seek to shape political and economic institutions (if permitted) so as to discourage entrepreneurial activity and the introduction of technological innovations in order to avoid creative destruction.

6. Inclusive political and economic institutions are mutually and self- reinforcing (virtuous circle) as are extractive institutions (vicious circle).

7. Other than as a result of 6 above, there is no historical, cultural or geographic destiny or imperative or immutable law governing the economic trajectories of nations. (The book is a very effective refutation of Jared Diamond's theories).

8. Counter-intuitively (to the central idea), nations with extractive institutions can engineer bursts of strong economic activity by importing technology but they cannot sustain the high rates of growth when further advances require risking creative destruction of the economic base that sustains the extractive institutions.

Oddly enough, the book utterly fails to address the current crisis in Europe or the coming one in the US. More on that in the next posting.

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