This post is really a comparison of three books: Peter Leeson’s The Invisible Hook, Douglas Allen’s The Institutional Revolution (review), and Daron Acemoglu’s and James Robinson’s Why Nations Fail. All three talk about institutions, and the latter two talk about institutions in the context of economic growth. I sense a friction between the Acemoglu–Robinson and the Leeson–Allen narratives. Leeson and Allen tell us that we have to look at institutions in the context of constraints. Acemoglu and Robinson look at various institutions, historically and internationally, and try to compare them directly, but they don’t consider constraints. I wonder whether the Acemoglu–Robinson narrative tells us less than they think it does.

Allen’s and Leeson’s books share a similar purpose. The Institutional Revolution attempts to explain various customs by looking at the rules of the game and what ends these rules seek to accomplish. Specifically, Allen explains a set of the institutions of ~1600–1850 England, including several aspects of the institutions of governance. Leeson, in the Invisible Hook, does much of the same, but focuses on the golden age of piracy. They both find that the institutions they look at make sense within the context of the ends of the agents and technological (exogenous) constraints. In the real world nothing is perfect, but we could think of these institutions as optimal. Replacing them with an alternative set of institutions, even if this set works well in certain situations (e.g. the institutions of governance of the modern developed world), would most likely lead to inferior outcomes.

In their book, Acemoglu and Robinson look at global income inequality between nations and argue that institutions are the cause of this inequity. They look at, for example, North and South Korea, two countries with similar cultures and geography, and explain the divergence in income growth through institutional comparison. North Korea is governed by an extractive dictatorship, while South Korea is an inclusive democracy (nevermind that this political dichotomy was probably not so clear in the late 1950s and 1960s). Their general argument is that extractive regimes slow income growth and inclusive (plural) regimes promote growth. An easy policy recommendation, then, is that developing nations should embrace inclusive institutions of governance.

Is economic growth as easy as embracing inclusive politics? The Leeson–Allen narrative warns us against settling for the easy answer. Oftentimes, institutional sets are not directly comparable. Suppose, for the sake of argument, that North and South Korea have two different sets of exogenous constraints. If this is the case, then it’s much harder to argue that the South’s political institutions are responsible for the income disparity. Replacing the North Korean state with that of the South may lead to another sub-optimal outcome, and not to the growth that Acemoglu and Robinson predict.

I’m not going as far as to argue that, given North Korean constraints, the current state is optimal. In fact, I think the opposite is true. Still, the optimal set of political institutions in North Korea could be very different to those of South Korea. This means that South Korea tells us very little about North Korea, and that direct comparison of institutions is misleading.

Do institutions explain global economic growth since the mid-19th century? They may, but perhaps not in the way Acemoglu and Robinson predict. Consider The Institutional Revolution. If Allen is right, modern political institutions just would not have worked out in premodern England, because the constraints were so that modern institutions just wouldn’t fit. He argues, for instance, that modern bureaucracy was made possible because of technological changes during the 19th century that allowed organizations to monitor their employees and offer them a wage based on the marginal value of their labor. Before these technological changes, it made sense to develop an aristocracy based on the accumulation of capital, which was invested into illiquid assets — assets that lost their value if aristocrats did their job poorly and were removed from office. These were the institutions in place when England went through the first industrial revolution, in the late 18th century.

The implication is that Robinson and Acemoglu might be looking at a symptom of economic growth, mistaking it for a cause. The transition to modern democracy may not have been an issue based only on the distribution of power; the emergence of modern democracy may have more to do than just the withering of extractive regimes. It might have required other things to come into place, as well, including technological developments and changes in the preferences of society. Typically, we relate technological advancement with economic growth, which implies that there is an element to growth that is independent of institutional transition.

I like the argument made in Why Nations Fail. I think there is something to the theory that extractive institutions restrain growth and inclusive institutions promote growth. My interpretation of these terms is that inclusiveness refers to the degree of plurality. Plurality is important, because the greater the fraction of society whose preferences are communicated through the political process, the smaller the externalized costs of governance (see Buchanan and Tullock, The Calculus of Consent1). If the current U.S. government were replaced by a dictatorship, I think the most likely outcome is a reduction in the rate of growth of our well-being. But, this theory loses explanatory power when we are making comparisons between institutions that exist within different sets of constraints.

Admittedly, despite my affinity for them, the terms “extractive” and “inclusive” lose concreteness. Suppose we think about these terms in the context of a spectrum, where extractive and inclusive are polar opposites — extractive on the left end, inclusive on the right. Can we put, for instance, modern U.S. democracy to the right of premodern English aristocracy? If we do, we have to accept that a more inclusive system of governance might have made premodern England worse off. If we say that the degree of inclusiveness is not directly comparable, we arrive at the problem I’ve been trying to explain throughout this post: direct institutional comparisons oftentimes tell us very little about why one society is poor and another very well-off.

The Acemoglu–Robinson narrative, however, might say a lot in certain situations. Above, I used the example of North and South Korea. I was trying to illustrate a point. I don’t know if the constraints on each country are different. If they aren’t, then directly comparing institutions might tell us something useful. In fact, I think that much of North Korean poverty is directly explained by their institutions of governance. The North Korean state is a perfect example of what Acemoglu and Robinson mean by extractive institutions. I think it also fits the model (“Why Not a Political Coase Theorem“) Acemoglu built to explain why political institutions remain extractive: North Korean leaders are afraid that economic growth will threaten their hold on power. I am not arguing that the story in Why Nations Fail explains nothing; it probably explains quite a bit, but only if we restrict institutional comparison in accordance with variations in the relevant constraints.

In a nutshell, the point I am making is as follows: which set of institutions are optimal depends on the relevant set of constraints. Therefore, a government that is optimal in one situation may be sub-optimal in another. If this is the case, the straightforward comparison between inclusive and extractive institutions does not lend us much help in pinpointing the causes of global wealth inequality. An inclusive institution that correlates with high growth in the U.S. may correlate with low growth in Laos, and the optimal set of institutions in Laos may look relatively extractive on a simple extractive–inclusive spectrum. The implication is that there is quite a bit to long-run economic growth that the narrative in Why Nations Fail can’t explain, and it may be that this aspect to growth is only indirectly related to institutional change — this change may come as a result of growth, as opposed to being a cause of it.

__________________

1. To relate The Calculus of Consent directly, Buchanan and Tullock model two sources of costs to governance: the externalized costs of imperfect plurality and decision-making costs, which increase as the number of people involved in the decision-making process rises. They come up with a combined cost curve that looks like a parabola that opens upwards, where the x-axis plots cost and the y-axis plots the number of individuals involved in decision-making. Optimal plurality is where costs are minimized, which is not necessarily 100 percent plurality. Changes in the mapping of the curve can about with technological changes, and this may push optimal governance towards a greater degree of plurality, but without these technological changes it doesn’t make sense to advocate for a more inclusive government than what’s optimal.