Representative image showing wealth disparity
Credit: iStock Photo
This year’s Nobel Prize in Economics was awarded to Daron Acemoglu, Simon Johnson, and James Robinson (AJR) for providing new insights on differences in prosperity between nations. Their studies demonstrated the relationship between institutions and prosperity and highlighted the causes why some countries are rich and many others poor. Though poor countries are becoming richer in the last few decades, the income gap between rich and poor countries is increasing. AJR found new and convincing evidence for the explanation for this persistent gap and stated that this was due to the differences in society’s institutions. One could easily argue that since rich countries are already prosperous, they have robust institutions, and hence may not necessarily mean that one is the cause for the other. Establishing the correlation between institutions in a society and its prosperity was not an easy task for the Nobel laureates. The press release by the Nobel Prize committee states that “the laureates have shown that one explanation for differences in countries’ prosperity is the societal institutions that were introduced during colonisation”. Paradoxically, the places that were, relatively speaking, the richest at their time of colonisation are now among the poorest. India is a classic example.
AJR developed a theoretical framework that explains why some societies are trapped in what they call “extractive institutions”, and why escaping from this trap is so difficult. They use the city of Nogales on the United States-Mexico border in one of their works as an example. Nogales is cut in half by a fence. Residents of Nogales on the US side are relatively well off, have longer average lifespans, and their children receive high school diplomas. Property rights are secure, and free elections provide residents with the opportunity to choose their politicians. However, residents of Nogales, in Sonora, Mexico, are considerably poorer, although this is a relatively wealthy part of Mexico. Organised crime makes starting and running companies risky. Corrupt politicians are difficult to remove, even if the chances of this have improved since Mexico democratised just over 20 years ago. Though the language, culture, and climate were the same across the two parts of Nogales, the difference in living standards was due to the difference in political and economic systems between the US and Mexico.
When Europeans colonised large parts of the world, their intention was to exploit the indigenous population and extract natural resources. The places where they built inclusive political and economic systems fostered growth. Places like Australia and New Zealand, which were more sparsely populated, offered less resistance to the colonisers and less labour to exploit, so more European colonisers moved to these sparsely populated places and established economic systems that promoted long-term economic growth. AJR’s work has had a decisive influence on continued research in both economics and political science. Their insights regarding how institutions influence prosperity show that work to support democracy and inclusive institutions is an important way forward in the promotion of economic development in different countries of the world.
Claiming that there is a correlation between institutions and prosperity is one thing. Claiming that the institutions established by colonial powers led to prosperity is another. What could not be explained by the research of AJR is the disparities in income between citizens of India and Pakistan. The colonial power in the undivided India was the British. They established institutions in undivided India. But what happened after partition? India today has a vibrant democracy, an independent judiciary, and is the fastest-growing economy in the world. Pakistan has lagged behind. The research work of AJR fails to explain why many countries in Africa have dysfunctional economic systems, abject poverty, high levels of corruption, and weak or no rule of law, though they were also colonised by Europeans. The findings also cannot explain the differences in prosperity between North and South Korea. Korea was colonised by Japan during the late 19th century, not by Europeans. Korea was divided into North and South Korea after the second world war. The culture, climate, and ancestors are the same for both of them. While North Korea is a communist economy, South Korea is capitalist and a developed nation. Its citizens enjoy a better standard of living and freedom. In fact, South Korea has become a soft power by exporting its pop music, cinema, and dramas. The research also does not mention the exploitation and looting of natural resources by Europeans in different parts of the world. But then global issues, whether historical or current, and what is right or wrong is looked at through the lens of western powers only. It is also debatable why the Nobel Prize in economics is awarded almost always to American economists.
(The writer is a CFA and former banker)