The Real Reason Why Some Nations Are Rich and Others Poor

We live in an unequally prosperous world. The average citizen of the United States is 10 times wealthier than counterparts in Central America, and 40 times wealthier than residents in Africa’s poorest countries. Why is this the case?

When I studied international economics in the 1960s, the explanations offered were along the lines of geography, climate, soil fertility, resource endowments, culture, religion, work ethic, ignorance of economic principles and more. However, these hypotheses fail to satisfactorily explain the patterns of poverty and prosperity in today’s world. Modern scholarship points in a different direction.

In their landmark work, “Why Nations Fail,” Daron Acemoglu and James A. Robinson show convincingly that a nation’s economic problems are fundamentally caused by a lack of inclusive political rights. Poor countries are poor because they are ruled by narrow elites that organize society for their own benefit at the expense of the citizenry.

Political and economic institutions shape the incentives of individuals, politicians and businesses. And whereas economic institutions shape economic incentives, it is the political institutions that determine what economic institutions people will labor under.

That is, the political process determines what economic institutions a country will have. Plainly put, poor countries are poor because those that have power make choices that create poverty. The new paradigm for the success or failure of nations centers on the inclusiveness of political and economic institutions and their interactions.

Inclusive economic institutions are those that allow and encourage participation by all in economic activities. They feature secure private property rights, the rule of law, the entry of new businesses, and a level playing field in which people can freely exchange and contract.

Inclusive economic institutions are necessary for the economic prosperity of a nation, but it is the political institutions that determine the economic institutions. In totalitarian countries like North Korea and Cuba, political institutions are extractive rather than inclusive. This condition of extractive institutions holds, in differing degrees, for most poor countries today.

Extractive political institutions concentrate power in the hands of narrow elites with few constraints on the exercise of their power, and create extractive economic institutions designed to enrich the power holders at the expense of society. The tools of extractive economic institutions include abolition or severe limits on private property, state-run enterprises, excessive regulation and taxation, and more.

On the other hand, inclusive political institutions are those that distribute power broadly in society and are constrained by the citizenry. Inclusive political institutions do not tolerate extractive economic designs that benefit only a few.

Economic prosperity springs from inclusive political and economic institutions. Extractive institutions typically lead to stagnation and poverty. Thus, whether a country becomes rich or poor is largely a function of its institutions.

Acemoglu and Robinson acknowledge that, under some conditions, growth can occur under extractive political institutions as in the case of China. But they argue that growth generated under extractive institutions is ultimately unsustainable unless the nation shifts to inclusive institutions. Unfortunately, extractive political and economic institutions form a strong feedback loop in support of each other and tend to persist in a vicious circle.

Rich nations are rich today, largely because they managed to develop inclusive institutions at some point during the past 300 years. This contradicts the claims of the theories studied in the 1960s. And it refutes the prevailing U.S. foreign policy approach that deems that economic growth, even under authoritarian regimes, will lead to democracy or inclusive political institutions.

Our understanding today is that economic growth without political empowerment tends to lock into place the repressive political elites. Without changes in the political institutions, there is little chance that economic growth will be inclusive, or that it will lead to political inclusivity.

Sustained economic growth depends on inclusive political institutions to support inclusive economic institutions. U.S. foreign policy must thus aim to foster political systems open and responsive to the aspirations of society. The path to prosperity is not support for tyranny, but the political articulation of the citizenry.