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Why are some countries rich and others poor? It’s among the most important questions in economics—in all the social sciences—and one at the heart of the work for which MIT’s Daron Acemoglu and Simon Johnson and University of Chicago Harris School of Public Policy’s James A. Robinson won the 2024 Nobel Prize in Economic Sciences.
Even in the 21st century, life remains a lottery, with the country in which one is born playing an often decisive role in one’s life chances. Understanding why some countries have developed thriving, prosperous economies and others have not is as vital as ever. For Acemoglu, Johnson, and Robinson, the answer is to be found in institutions.
When economists and other social scientists talk of institutions, they tend to use the term in a somewhat different sense to laypeople. The police department of a city is, economists and noneconomists can definitely agree, surely an institution. It is an organization with staff, rules, procedures, and a physical location. Economic institutions refer not only to such organizations with a door one can knock on or a website one can visit, but to a wider set of well-established arrangements and structures that govern how an economy—and indeed a society—function. The police department is the organization that will respond if you steal from a supermarket; it is definitely an institution. But so too is the notion that, in general, one should not steal from a supermarket regardless of whether the police department will respond in time to intervene.
Institutions might be thought of as the rules of the game for how an economy is run, as Acemoglu wrote in response to a poll of economists by Chicago Booth’s Kent A. Clark Center for Global Markets in October, “Summary of my view: Constitutions, laws, and institutional practices provide the framework within which other decisions are made.”
The institutional framework in this case is more than just a collection of organizations with websites and constellations of laws and rules. It also brings in a set of expected and customary behaviors.
Economists have long recognized that such frameworks matter. Douglass North and Robert W. Fogel won the economics Nobel in 1993 for their own work on the role of institutions in explaining long-term growth. But one can go back much further to find economists writing of the role of institutions in development. Adam Smith was, to a modern economist, thinking in institutional terms when he argued that “peace, easy taxes, and a tolerable administration of justice” were the ingredients needed for a sound economy.
The institutions on which the rich world’s success has been built developed slowly over decades and centuries. There is a risk that they are sometimes taken for granted.
The work for which Acemoglu, Johnson, and Robinson won their Nobel goes beyond merely pointing out that institutions play a crucial long-term role. That much was already recognized. Their 2001 study, “The Colonial Origins of Comparative Development: An Empirical Investigation,” which has gone on to become one of the most-cited economics papers of all time, goes much further.
The researchers argue that European colonizers developed different kinds of institutions in their various overseas holdings. In countries where mortality rates for Europeans were high, they generally employed extractive institutions that sought to exploit local populations and take out economic wealth. By contrast, in colonies where the climate was more suited to Europeans, they often employed more inclusive institutional structures to attract European settlers by offering them a chance to share in the colony’s economic development. The pattern of colonial rule, and the institutions associated with it, looked rather different in Canada and Australia, say, to those found in Spanish South America or in the Belgian-run Congo.
These colonial roots can run deep, as the Nobel committee explained in its announcement of the 2024 prize:
This is an important reason for why former colonies that were once rich are now poor, and vice versa.
Some countries become trapped in a situation with extractive institutions and low economic growth. The introduction of inclusive institutions would create long-term benefits for everyone, but extractive institutions provide short-term gains for the people in power. As long as the political system guarantees they will remain in control, no one will trust their promises of future economic reforms. According to the laureates, this is why no improvement occurs.
However, this inability to make credible promises of positive change can also explain why democratisation sometimes occurs. When there is a threat of revolution, the people in power face a dilemma. They would prefer to remain in power and try to placate the masses by promising economic reforms, but the population are unlikely to believe that they will not return to the old system as soon as the situation settles down. In the end, the only option may be to transfer power and establish democracy.
The European and US economists polled by the Clark Center strongly agreed that institutions play a crucial role in economic outcomes. Perhaps more interestingly, they also agreed that “countries where democracy and the rule of law are weakened are likely to experience measurable damage to their economic performance.”
Few economists nowadays would disagree that the institutions on which the rich world’s success has been built developed slowly over decades and centuries. There is a risk that they are sometimes taken for granted. Of course, just as the benefits of any institutional structure can take years to have any real impact on economic performance, so too can the damage done take a long time to show up.
Duncan Weldon is an economist, journalist, and author who regularly writes for the Financial Times, New Statesman, and other publications. This is an edited version of a column that ran on Booth’s Clark Center website.
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