The unprecedented economic crisis that Sri Lankans experienced two years ago has prompted many in the country to explore the principles underlying the science of economics. During the recovery period, interest was mainly focused on topics related to economic stability. Having witnessed how sound economic policies can steer a nation away from crisis and toward stability, many are now curious about how the country can accelerate its growth trajectory.
Three days ago, the Royal Swedish Academy of Sciences
announced its decision to award the 2024 Sveriges Riksbank Prize in Economic
Sciences in Memory of Alfred Nobel to Daron Acemoglu, Simon Johnson, and James
A. Robinson. These three laureates have provided a scientific answer to the
complex question of how a country can achieve faster growth toward prosperity.
In their influential work, Institutions as a Fundamental
Cause of Long-Run Growth, economists Daron Acemoglu, Simon Johnson, and
James A. Robinson argue that differences in economic institutions are a primary
driver of long-term economic growth and development. The paper is part of a
broader body of literature that seeks to explain why some countries are wealthy
and developed, while others remain poor and underdeveloped. Their central
argument is that economic institutions, which shape incentives for economic
actors, are fundamental determinants of economic performance.
1. Background and Motivation
The authors begin by exploring why economic performance
varies so drastically across countries. For instance, they highlight the vast
differences between wealthy countries like the United States and poor countries
like Haiti. Despite similar access to technology and resources, these
disparities persist, suggesting that something beyond geography or culture
plays a significant role in explaining these differences. They argue that
institutions—rules and norms governing economic activity—shape the incentives for
production, investment, innovation, and ultimately, long-term growth.
2. The Role of Institutions
Acemoglu, Johnson, and Robinson define economic institutions
as the rules and constraints that structure economic interactions, including
property rights, legal systems, contract enforcement mechanisms, and government
policies. These institutions influence how resources are allocated and whether
economic actors (firms, individuals, and the government) have the incentives to
engage in productive activities like innovation and investment.
Good institutions, the authors argue, protect property
rights, ensure that contracts are enforced, and provide a stable environment
where individuals and firms feel secure in their investments. Poor
institutions, on the other hand, may lead to expropriation, corruption, and
inefficient use of resources, which stifles economic growth.
3. Why Institutions Matter for Economic Growth
The authors argue that differences in institutions explain
why some countries experience sustained economic growth, while others stagnate.
Their argument is grounded in historical evidence that shows how institutions
influence economic outcomes.
For example, the authors point to the experience of
colonization as a natural experiment in institutional differences. European
colonial powers implemented vastly different institutions in different
colonies. In regions where they could settle (such as North America), they
established institutions that protected private property and promoted
investment. However, in regions with unfavorable conditions for settlement
(like much of Africa), they established extractive institutions that
concentrated power and wealth in the hands of a few, while failing to provide
incentives for broader economic participation.
4. Inclusive vs. Extractive Institutions
A key distinction made in the paper is between inclusive
and extractive institutions:
- Inclusive
institutions are those that provide broad access to economic
opportunities, protect property rights, and create incentives for
innovation and investment. These institutions allow a large part of the
population to participate in economic activities, which promotes growth.
- Extractive
institutions, on the other hand, concentrate power and wealth in the
hands of a small elite, stifling innovation, reducing investment, and
limiting economic growth.
The authors argue that the countries that developed
inclusive institutions have been able to sustain long-term economic growth. In
contrast, countries with extractive institutions have seen limited growth, as
elites use their power to extract resources from the rest of the population
without creating incentives for broader economic participation.
5. Historical Evidence and Empirical Support
To support their argument, Acemoglu, Johnson, and Robinson
present historical and empirical evidence linking institutions to long-term
economic performance. A significant part of their argument is based on what
they call the "colonial origins" of current institutions. They
present evidence showing that European colonialism had long-lasting effects on
the economic institutions of many countries.
For example, in places like North America and Australia,
where European settlers were able to establish inclusive institutions, these
countries went on to experience sustained economic growth. However, in regions
where colonizers established extractive institutions (such as much of Africa
and Latin America), growth has been limited, and these countries continue to
suffer from the legacy of poor institutional frameworks.
In addition, the authors argue that geography and culture
are less important determinants of long-term growth compared to institutions.
While geography might affect short-term economic performance, it does not
explain the sustained differences in economic growth over long periods.
6. The Role of Political Institutions
The paper also emphasizes the role of political institutions
in shaping economic institutions. Political institutions determine who holds
power in society and how that power is used. Inclusive political institutions,
where power is distributed broadly and checked by different groups in society,
tend to lead to the development of inclusive economic institutions. In
contrast, extractive political institutions, where power is concentrated in the
hands of a small elite, tend to result in extractive economic institutions.
The interaction between political and economic institutions
is critical for understanding long-term economic growth. Countries with
inclusive political institutions are more likely to develop inclusive economic
institutions, which promote growth. Conversely, countries with extractive
political institutions are likely to develop extractive economic institutions,
which stifle growth.
7. Path Dependence and Institutional Persistence
Another important concept discussed in the paper is path
dependence. Once institutions are established, they tend to persist over
time, even if they are inefficient. This is because institutions create vested
interests that benefit from maintaining the status quo. For example, elites in
countries with extractive institutions have little incentive to change the
system, even if it leads to poor economic outcomes for the majority of the
population.
This persistence of institutions helps explain why some
countries remain trapped in a cycle of poverty and underdevelopment. Even if
these countries have the potential for growth, the existing institutional
framework prevents them from realizing that potential.
8. Policy Implications
The authors conclude by discussing the implications of their
findings for policy. If institutions are the key determinant of long-term
economic growth, then policies aimed at reforming institutions are crucial for
promoting development. However, institutional reform is difficult, particularly
in countries with extractive institutions, where elites may resist changes that
threaten their power.
Successful institutional reform requires both political will
and a broad coalition of support. The authors suggest that international
efforts to promote good governance and institutional reform can play a role in
fostering economic development, but they caution that such efforts must be
tailored to the specific context of each country.
9. Criticism and Alternatives
While the paper has been highly influential, it has also
faced criticism. Some scholars argue that the authors place too much emphasis
on institutions and downplay other factors, such as geography, culture, or
external economic shocks, that can also influence long-term growth. Others
argue that while institutions are important, the process of institutional
change is complex and cannot always be easily influenced by policy
interventions.
Conclusion
Acemoglu, Johnson, and Robinson make a compelling case that institutions are a fundamental cause of long-term economic growth. By shaping the incentives for investment, innovation, and economic participation, institutions play a crucial role in determining whether countries experience sustained growth or remain trapped in poverty. Their work has had a profound impact on the field of development economics, highlighting the importance of institutional reform for promoting economic development.
