Why Nations Prosper
A paper presented to the International Economics & Law Conference, 2016, by Peter Bowman
Why is it that some nations have prospered economically providing a good standard of living for their citizens whereas others linger in poverty and appear unable to raise themselves out of it? Why is it that in the globally connected world of today there persists such huge disparities between the richest and poorest countries?
A satellite image of Korea at night provides a stark image to show the disparities. The south is a blaze of light, particularly around the capital city Seoul but to the north of the border it is so dark that the land is almost indistinguishable from the surrounding sea. There is just a faint glimmer around the capital
One way this question has been tackled it to look for deterministic answers. Some have argued (e.g. Jared Diamond) that it is the effect of externals factors such as climate or topography. Others (e.g. Max Weber) that it is due to cultural factors such as the “Protestant work ethic.” Still others suggest it is due to the presence rather than the absence of knowledge. However, it is difficult to apply these ideas to Korea where the north and south share the same geography, climate, language culture and up to sixty years ago the same history.
According to Daniel Acemoglu and James Robinson in their recent book, Why Nations Fail, the key to the differences is in the man-made institutions. What is behind the huge difference in prosperity between North and South Korea is the difference in the political institutions that have evolved in the two halves of the peninsular since it was divided at the end of the Second World War.
The “hierarchy diagram” presented in the Economics Courses indicates that the conditions prevailing in the lower levels, 1,2 & 3, the levels of the economy are determined by what is operating at level 4, the level of government, which in turn is influenced by the highest levels.
Humanity
Civilisation
Culture
Nation – level of Government
Society
Community } economy
Family
Surveying the broad scene of world history since Neolithic times Acemoglu distinguishes two broad categories of economic arrangements. One, he terms “inclusive” and the other “extractive.” For our purposes, we could correlate these with “just” and “unjust” arrangements respectively.
An inclusive economic arrangement is one in which participation in both production and consumption of the wealth produced is encouraged for the great majority of the adult population in economic activities that make best use of their talents and abilities and under circumstances where they are free to make choices both of what they contribute and what they consume.
For these circumstances to pertain four institutions need to be in place.
Firstly, the rule of law needs to be established. This means a legal system which is independent and unbiased and which everyone in the society including the executive is subject to.
Secondly, there needs to be secure property rights. There needs to be a recognition that everyone has an entitlement to the fruit of their labour. This enables the possibility of fair trade and exchange. It also gives actors in the economy the confidence to invest and innovate in the knowledge that the fruits of that investment can be retained and will not be taken away. There is a rather fundamental issue here relating to the extension of property rights beyond what has been earned to such things as land and the other provisions of nature which needs to be noted in passing.
The third requirement is for the provision of public services. Even if these are not provided directly by government they need to be facilitated by government. The necessary services include physical infrastructure such as roads and other transport networks, and also social provision such as education and health services.
The fourth requirement is for a market that provides equality of opportunity for exchange and contract permitting the appearance of new businesses and new innovations.
On the other hand, extractive or unjust economic arrangements are ones in which the principle that each should retain the full fruit of their labour is not applied. Under these circumstances a significant proportion of the wealth produced is extracted from one section of the community for the benefit of another section. There are four institutional arrangements that would enable this.
Absence of the rule of law so that one section of the community is effectively above the law and so has arbitrary powers to make laws for its own benefit.
The absence of secure property rights, so one section of the community can appropriate the property of another section and use it for its own benefit.
Arrangements which fail to induce government to provide necessary infrastructure including the absence of the provision of health and education services for all.
Fourthly a restriction of opportunities to participate in the economy to a privileged few with the remainder excluded.
All these four factors depend upon the organization of the state. They are dependent upon the political arrangements that are in place. Politics is the process by which a society chooses the rules that govern it.
Hence to understand why nations prosper one needs to look at political arrangements. In this context one can distinguish two essential two essential political arrangements, one described as inclusive, also pluralistic or simply just and the other extractive, absolutist or simply unjust.
In simple terms the absolutist or extractive political regime is narrow and unconstrained. Power is confined to a small elite who use it for their own ends.
Examples would be: Hapsburg Spain and the Spanish colonies in South and Central America, Bourbon France, later Roman Empire, the Caribbean slave colonies, Congo and other European colonies in Africa, Soviet Russia, China under the Qin Dynasty and Maoist Regime.
The alternative is a pluralistic regime where power is distributed broadly and there are sufficient checks and balances in place to prevent any particular faction taking overall control.
What is required in addition is a sufficiently centralized state so that institutions are in place to maintain law and order and provide necessary public services.
Examples are Britain post 1688, the US post the civil rights movement, early Medieval Venice, Botswana, modern Brazil, Denmark, Ecuador, and Singapore.
What is all important for the question of why nations prosper is the relationship between the two types of political and economic regimes. The basic premise is that absolutist political regimes give rise to extractive economic regimes whereas inclusive, pluralistic regimes give rise to inclusive economic regimes or in simple terms unjust political regimes will give rise to unjust economic regimes and just political regimes will give rise to just economic arrangements.
The external form of the government is here not the most important issue. There may be the appearance of a democracy with the formalities of elections whereas the reality is that power is in the hands of a powerful elite. The opposite could also be true. Power may be conferred in an Absolute Monarch who governs not for his own self -interest but for the well-being of the people as a whole and so be inclusive.
Pluralistic political arrangements will give rise to inclusive rather than extractive economic arrangements. Checks and balances will prevent one section of the community exploiting the rest and the four institutions described earlier to enable inclusive economic activity can be put in place. There is likely to be a synergy between the two leading to a virtual circle facilitating economic growth and widely shared prosperity.
Absolutist political regimes will give rise to extractive economic arrangements since to maintain power and then use it to meet its own ends an absolutist political regime will need to divert or subvert the economy to meet its own ends by expropriating a good proportion of the wealth produced to itself.
When members of the community have a considerable portion of the wealth they produce expropriated from them there is no incentive for them to improve productivity or innovate. This is likely to lead to a vicious circle with decreasing productivity followed by increased expropriation. It is also likely to lead to political instability. As power is held narrowly it lead to competition by challengers to overthrow power. However, the replacement of one regime by another whether peacefully or violently is unlikely to change the economic arrangements since the new regime gaining power is likely to take over the fruits of the exploitive system to enjoy their success and maintain power. This is what Acemoglu calls the iron law of oligarchy. Examples include the replacement of the Russian imperial regime by the Soviet system, in Mexico Spanish rule replaced by Iturbide and the 1824 to 1867 when they had 52 presidents, the Mugabe regime which followed the apartheid regime in Zimbabwe/Rhodesia, the Congo in the move from the Kongo Kingdom, the Belgian Congo colony and independent Congo.
But why could there not be sustained growth under an Absolutist political regime? Surely that would be what the ruling elite would want since it would provide additional wealth for them to extract.
In extractive regimes there is no incentive for individuals to improve productivity or innovate since the extra wealth they would produce would simply be taken away from them. Also, typically the public services needed to support productivity not in place including provision of education. In addition, law and order may not be well enough established to make it easy to do business and often it is the government itself that is the biggest crook!
Institutions that create incentives for economic progress such as a free and open market may simultaneously redistribute income and hence also power. For a predatory dictator, this would be a threat since it would erode their economic power base.
Economic development creates both winners and losers. When new innovations appear, and are established, they must replace existing arrangements. Consider the textile industry: factory production replaced cottage industry, there was fierce competition between wool and cotton and more recently man-made fibres have come in to compete with both these natural fibres. This is what the Austrian economist called creative destruction. Inclusive economic and political institutions have the openness to facilitate these disruptive changes.
Take England in the nineteenth century. The powerbase shifted from rural landowners to industrialists with the Corn Laws a particular focus of contention. At the same time the elites of the Austro-Hungarian and Russian Empires, and also in China were blocking industrial development such as the building of railways as they saw this as a threat to their power.
It is not that under extractive regimes growth cannot take place. One way it can happen is when the ruling elite diverts resources to the high productivity activities it has under its control. This was the case with the Caribbean sugar plantations in the 16th to 18th centuries. Here there was high productivity and growth and fortunes were made for the wealthy elites who were in control but not for the whole society. It was not a sustainable arrangement. With the end of slavery the system came to an end.
Another example is the Soviet industrial expansion in the early twentieth century. Although this took place rapidly the technical innovation was limited and the fruits were limited to a small ruling elite rather than being enjoyed by the population as a whole. This system was also not sustainable and eventually crumbled and declined.
Given the propensity for extractive political regimes and associated extractive economics regimes the question for those in search of justice in economics is how are inclusive economics regimes and the inclusive political regimes on which they depend established.
This is no easy matter, to transform a nation from being under an extractive regime to an inclusive one can be a long and hard road.
The flow of history is punctuated by critical junctures, significant turning points which can disrupt existing political structures and provide opportunities for evolution towards more inclusive institutions (or the reverse).
Britain provides an example of a relatively inclusive economy based on relatively inclusive political institutions. These have developed over several centuries in a step-by-step move away from extractive absolutism passing through a number of critical junctures.
The England of William the Conqueror with its feudal system in place was strongly extractive with the king having absolute power. An early critical juncture was the baronial revolt against King John with the Magna Carta establishing a distinct step towards the restraint of monarchial power, the establishment of the rule of law and a move towards more inclusive government even if this was limited to the nobility.
A second significant event that proved to be a critical juncture was the Black Death of 1346. This plague was hugely disruptive across the whole of Europe with different consequences in different places. In England the significant reduction in the working population raised the status of workers and provided an impulse for the freeing of the labour force from feudal servitude.
Another critical juncture was the discovery and colonization of America which provided huge opportunities to the European nations to expand overseas trade. In France, Spain and Portugal this trade was largely under the control of monarchy and so let to strengthening of their extractive absolutist regimes. By contrast in England much of the trade was independent of the monarchy and so served strengthen anti-royalist factions.
The English Civil War was a direct confrontation between the absolutist monarchial regime and the forces in opposition which were demanding a wider spreading of power, particularly amongst the capitalist gentry farmers, the traders and merchants. There was also a strengthening of the notion of rule of law in opposition to the idea of absolute monarchy.
The immediate consequence of the Civil War was the replacement of one authoritarian regime by another led by Oliver Cromwell, followed within a generation by the re-instatement of the monarchy in 1685.
The new and quite radical alignment of power came with the Glorious Revolution in 1688 three years after Charles II death. The Stuart dynasty was disposed and William of Orange with his Stuart wife was invited to become king but now under a new dispensation with the monarch’s power considerably curtailed and the power of parliament correspondingly enhanced.
The pressure for change had come from quite a broad coalition of farmers, traders, lawyers and aristocrats under the Whig banner and with no particular party dominant. There was also an opposition political force that remained active becoming the Tory party and also an independent judiciary. This unusually broad-based sharing of power laid the political basis for the agricultural and industrial revolutions and expansion of overseas trade that followed in the eighteenth century. Secure property rights were established and that encouraged innovation as inventors such as James Watt as they were confident they would retain the fruit of their labours.
A weakness of the new arrangement was the way that property rights were extended to include land. The legally sanctioned enclosure of land led to the expulsion of large numbers of peasants leading to abject poverty of exploitive industrial labour.
Hence although the Glorious Revolution had spread power it was certainly not fully shared. Nevertheless, a direction had been set and over the course of the nineteenth century further step by step progress was made further widening the sharing of political power and hence leading to more inclusive economic arrangements.
Bibliography
Acemoglu, D. and Robinson, J. (2012). Why Nations Fail: The Origins of Power, Prosperity, and Poverty. 1st ed. New York: Crown.