In their groundbreaking bestseller, Why Nations Fail: The Origins of Power, Prosperity, and Poverty, MIT’s Daron Acemoglu and Harvard’s James Robinson make the case for “inclusive institutions” as the driver of economic prosperity. Inclusive institutions guarantee secure property rights, effective education, open markets, democratic pluralism, and so on. Alternatively, “extractive institutions” are the causes of the demise of many nations. These are essentially the opposite of inclusive institutions and include oligarchies, single-party rule, crony capitalism, weak property rights, and so on. Chapter 13 of their book, aptly titled Why Nations Fail Today: Institutions, institutions, institutions, implies that, if low-income countries had better institutions, millions of people would be catapulted to prosperity. It is quite compelling.
There is little doubt that inclusive institutions incentivize better behavior and promote investments. In 2015, almost $1.2 trillion the total $1.63 trillion of global Foreign Direct Investment (FDI) flowed to the richest countries in the world, that is, the 35 member countries in the OECD. In its attempt to build better institutions in poor countries, the World Bank spent more than $8 billion in 2015. However, we must ask two questions. First, how (and why) did rich countries transform their extractive institutions to inclusive institutions? And second, can we really push inclusive institutions onto societies whose instinctive reaction is to reject them?
To answer the first question, consider the difference between the 1688 Glorious Revolution and the 2011 Arab Spring. Why did the 1688 Glorious Revolution—an event that caused the overthrow of King James II of England and catalyzed the evolution to democracy in the region—bring glory to many in England, and the 2011 Arab Spring—a revolution which caused the overthrow of many governments in the Middle East—not bring spring to many in Egypt, Libya, or Yemen?
On the surface, both events forced considerable change in the political make-up in their respective regions. The Glorious Revolution, for instance, made way for the Bill of Rights which accelerated the transfer of power from the Crown to the people. Many experts posit that the ensuing political changes caused an amplification of the Industrial Revolution in the region.
The Arab Spring was supposed to be, for many countries in the Middle East, what the Glorious Revolution was for England—a turning point of sorts. There was hope in the air. In fact, Acemoglu and Robinson begin their book by referencing the Arab Spring, and suggest that the political transformation that is “required for a poor society to become rich… may be happening in Egypt.” Unfortunately, no such transformation happened. Egypt is currently ruled by a former general in the Egyptian army; Libya has been in chaos since the uprising; and Yemen is in conflict, with 70% of the population in need of some form of aid. Why is this the case?
The subtle difference lies in the fact that market-creating innovations were at the core of the Glorious Revolution, but not the Arab Spring. These innovations are so powerful because they create new markets that are worthy of being preserved by those responsible for their emergence. This invariably leads to a fundamental change in the societal dynamics of a region.
In other words, inclusive institutions are pulled into the society by people who want to preserve their wealth and the markets their innovations create. This is what spurred, and funded, the successful Glorious Revolution which led to the Bill of Rights. All too often, inclusive institutions are pushed onto low-income countries because “it is the right thing to do.” But they are hardly sustained because the fundamental dynamics of the society have not changed.
A similar occurrence, of increasing incomes leading to institutional change, can be observed in the Netherlands, another early developer. In a seminal paper, The Rise of Europe: Atlantic Trade, Institutional Change, and Economic Growth, Acemoglu et al write, “Critical was the Dutch merchants’ improving economic fortunes, partly from Atlantic trade [an innovation at the time], which were used to field a powerful army against the Habsburg Empire… Overall, both the British and Dutch evidence, therefore, appears favorable to our hypothesis that Atlantic trade [innovation] enriched a group of merchants who then played a critical role in the emergence of new political institutions constraining the power of the crown.”
Writing more broadly about the development of institutions in Europe, Harvard University’s Robert Bates notes in his book, Prosperity and Violence, “Economic growth led to increased demands for an official system of justice and a willingness to pay for it. The court fees collected by the king more than covered the costs of the legal system, and fees from the provision of justice soon grew into a major source of government revenues.”
Innovations that create markets, it seems, precedes institutions.
Can we successfully push inclusive institutions onto low-income countries?
No. Pushing institutions does not cause people to change behavior. It is only when these institutions make sense contextually that they are adopted. This is because institutions are simply a representation of the culture of a region. MIT’s Edgar Schein defines culture as “a pattern of basic assumptions—invented, discovered, or developed by a given group as it learns to cope with its problems of external adaptation and internal integration—that has worked well enough to be considered valid and, therefore, to be taught to new members as the correct way to perceive, think, and feel in relation to those problems.”
Using that definition, it is impossible, except by coercion, to successfully push institutions onto a society. Over time, every society adapts to solve its problems a particular way, and unless there is a compelling reason to change—like innovations that create new markets—institution pushers will spin their wheels.
The funders of the revolutions that led to a change in institutions in Europe were largely innovators seeking to preserve the new markets their innovations were creating. The funders of institution change in poor countries must be innovators as well, seeking to do the same. Anything short of this will cause impractical and expensive institutions to be implemented with underwhelming results.
If poor countries cultivate market-creating innovations, inclusive institutions will emerge. However, if they continue to overwhelmingly promote inclusive institutions, neither market-creating innovations nor institutions are likely to emerge.