Why Nations Fail

1. Institutions shape nations' fates: Inclusive vs. extractive systems

Inclusive economic institutions, such as those in South Korea or in the United States, are those that allow and encourage participation by the great mass of people in economic activities that make best use of their talents and skills and that enable individuals to make the choices they wish.

Inclusive institutions foster prosperity. They provide secure property rights, unbiased law enforcement, public services, and a level economic playing field. This enables and incentivizes people to innovate, invest, and participate fully in the economy. Examples include the United States and South Korea.

Extractive institutions concentrate power and wealth. They are designed to extract resources from society to benefit a narrow elite. Examples include North Korea and many post-colonial African nations. Extractive systems discourage investment and innovation, leading to economic stagnation or decline.

Key features of inclusive economic institutions:

• Secure property rights

• Impartial rule of law

• Public services that provide a level playing field

• Free entry into markets

• Contract enforcement

• Key features of extractive economic institutions:

• Insecure property rights

• Barriers to entry in markets

• Regulations that prevent free exchange

• Lack of law and order

2. Geography and culture don't determine prosperity

There is no evidence that the climate or geography is the reason that the United States is more than twenty times as rich today as nations such as Mali or Guatemala.

Prosperity stems from institutions, not geography or culture. Many theories have tried to explain global inequality through factors like climate, natural resources, or cultural values. However, these don't account for stark differences between neighboring countries with similar geography and culture.

Institutional differences explain divergent outcomes. For instance, Nogales, Arizona and Nogales, Sonora share geography and culture, but have vastly different living standards due to the US-Mexico border dividing them. Similarly, South Korea and North Korea diverged dramatically after separation despite shared geography and culture.

Examples refuting geographic determinism:

• Botswana's success vs. neighboring countries' struggles
• Singapore's wealth vs. Malaysia's relative poverty
• Chile's growth vs. other Andean countries' stagnation

Examples refuting cultural determinism:

• China's growth after policy changes under Deng Xiaoping
• Divergence between East and West Germany during Cold War
• Japan's rapid development after Meiji Restoration

3. Critical junctures and small differences drive institutional divergence

Small institutional differences can matter, especially during critical junctures.

Critical junctures are historical turning points. These are periods of major socioeconomic or political upheaval that disrupt the existing balance of power. Examples include the Black Death in Europe, the opening of Atlantic trade routes, and the Industrial Revolution.

Small initial differences can lead to divergence. When societies with slightly different existing institutions face a critical juncture, their responses can set them on radically different paths. Over time, these paths tend to reinforce themselves through positive feedback loops.

Key historical critical junctures:

• Black Death (14th century)
• Discovery of the Americas (15th-16th centuries)
• Industrial Revolution (18th-19th centuries)
• Decolonization (20th century)

Examples of divergence:

• England vs. Spain after Atlantic trade opened
• Western vs. Eastern Europe after the Black Death
• North vs. South Korea after World War II

4. Virtuous circles reinforce inclusive institutions

Though still subject to significant contingency, virtuous circles enable the institutions' continuity and often even unleash dynamics taking society toward greater inclusiveness.

Inclusive institutions tend to persist and expand. Once established, inclusive political and economic institutions create a positive feedback loop. They distribute power and resources more broadly, empowering more people to participate in and defend the inclusive system.

Key mechanisms of virtuous circles:

1. Pluralism makes power grabs harder
2. Rule of law constrains elites
3. Free media exposes threats to institutions
4. Economic opportunities reduce incentives for extractive behavior
5. Broader participation increases demand for inclusion

Historical examples of virtuous circles:

• England after the Glorious Revolution
• United States after the Constitution
• Japan after the Meiji Restoration

Elements reinforcing inclusive institutions:

• Free press
• Independent judiciary
• Competitive elections
• Broad-based education
• Economic mobility

5. Vicious circles perpetuate extractive institutions

Extractive political institutions support these economic institutions by cementing the power of those who benefit from the extraction.

Extractive systems are self-reinforcing. Those benefiting from extractive institutions use their power and wealth to maintain the system. This creates a negative feedback loop that's difficult to break, even when leaders change.

The iron law of oligarchy. Even when extractive regimes are overthrown, new leaders often recreate similar systems because the institutional framework and incentives remain unchanged. This explains why many post-colonial and post-revolutionary societies struggle to develop inclusive institutions.

Mechanisms of vicious circles:

• Concentration of wealth and power
• Suppression of opposition
• Control of media and education
• Creation of dependent elite classes
• Economic barriers to upward mobility

Historical examples:

• Post-independence Sierra Leone
• Zimbabwe under Mugabe
• Democratic Republic of Congo after Mobutu

6. Creative destruction fuels progress but threatens elites

The response of Mugabe to the breakdown of his political control was to intensify both the repression and the use of government policies to buy support.

Innovation drives growth but disrupts existing power structures. Creative destruction – the process by which new technologies and methods replace old ones – is crucial for economic progress. However, it often threatens the economic and political power of established elites.

Fear of creative destruction leads to stagnation. Elites in extractive systems often block new technologies, education, or economic opportunities that might empower rivals. This preserves their power in the short term but undermines long-term economic development.

Historical examples of resisting creative destruction:

• Ottoman Empire banning the printing press
• Russian and Austro-Hungarian resistance to industrialization
• Luddite movement against mechanization in England

Signs of fear of creative destruction:

• Restrictions on education
• Monopoly grants to favored firms
• High barriers to starting businesses
• Suppression of disruptive technologies
• Rigid social hierarchies

7. Pluralism and rule of law are key to sustained growth

The ability of economic institutions to harness the potential of inclusive markets, encourage technological innovation, invest in people, and mobilize the talents and skills of a large number of individuals is critical for economic growth.

Shared power and consistent rules enable progress. Pluralistic political systems where power is broadly distributed and constrained by law create the stability and opportunity needed for sustained economic growth. This contrasts with extractive systems where unchecked power leads to arbitrary rule and economic uncertainty.

Key elements of pluralism and rule of law:

• Separation of powers
• Independent judiciary
• Protection of property rights
• Enforcement of contracts
• Equal application of laws
• Limits on government power
• Peaceful transfers of power

Historical examples of benefits:

• England's economic takeoff after Glorious Revolution
• U.S. economic dominance in 20th century
• Post-war growth in Japan and Germany

Contrasting examples of arbitrary rule:

• Economic decline in Venetian Republic after aristocratic takeover
• Stagnation in absolutist Spain and France
• Instability and poverty in many post-colonial African states

8. Colonial legacies impact modern institutional development

The economic institutions that made Carlos Slim who he is are very different from those in the United States.

Colonial strategies shaped post-independence institutions. Different colonization approaches led to divergent institutional legacies. Extractive colonial institutions often persisted after independence, while more inclusive colonial institutions provided a better foundation for development.

Types of colonial legacies:

1. Settler colonies (e.g., USA, Australia): More inclusive institutions
2. Extractive colonies (e.g., Congo, Peru): Highly extractive institutions
3. Mixed cases (e.g., India, South Africa): Some inclusive elements but still largely extractive

Factors influencing colonial strategies:

• Population density of native peoples
• Disease environment for European settlers
• Valuable extractable resources (e.g., gold, slaves)
• Timing of colonization

Examples of persistent colonial effects:

• Divergence between North and South America
• Differences in property rights systems in former French vs. British colonies in Africa
• Variations in educational institutions in former Spanish vs. British colonies

9. Centralized states are necessary but not sufficient for prosperity

Both new military and civilian regimes picked their own justices. But picking Supreme Court justices in Argentina was not an activity confined to transitions between military and civilian rule.

Effective states enable economic growth. A certain degree of political centralization is necessary to provide basic public goods, enforce laws, and create the stability needed for economic development. However, centralization alone doesn't guarantee inclusive institutions.

Centralization can enable extraction or inclusion. While some degree of state capacity is needed for any economic development, centralized power can be used to create either inclusive or extractive systems. The key is whether political power is constrained and broadly distributed.

Necessary functions of a centralized state:

• Monopoly on legitimate use of force
• Ability to tax and provide public goods
• Enforcement of contracts and property rights
• Standardization of weights, measures, and currency

Examples of centralization leading to different outcomes:

• England: Centralization under Tudors enabled later inclusive institutions
• Spain: Centralization reinforced absolutism and extraction
• China: Strong state capacity but largely extractive institutions until recent reforms

10. Resistance to inclusive institutions often leads to poverty

Inclusive economic institutions create inclusive markets, which not only give people freedom to pursue the vocations in life that best suit their talents but also provide a level playing field that gives them the opportunity to do so.

Fear of losing power drives opposition to inclusion. Elites in extractive systems often resist reforms that would create more inclusive institutions, even when these changes could drive economic growth. They fear losing their privileged position more than they value potential broader prosperity.

Failed reform attempts perpetuate poverty. When efforts to create more inclusive institutions are blocked, it often locks societies into low-growth paths. This explains why many resource-rich countries remain poor despite their natural wealth.

Common tactics for resisting inclusive reforms:

• Violent suppression of opposition
• Co-opting potential reformers
• Creating dependent elite classes
• Fostering ethnic or regional divisions
• Controlling information and education

Historical examples of blocked reforms:

• Russian resistance to emancipation of serfs
• plantation owners' opposition to education in U.S. South
• Saudi Arabia's limits on women's rights and political participation

Consequences of failed reforms:

• Brain drain of talented individuals
• Lack of innovation and entrepreneurship
• Overreliance on natural resource extraction
• Political instability and conflict

Last updated: July 21, 2024