Saturday, February 22, 2014

Book Review (#20 of 2014) Why Nations Fail by Daron Acemoğlu and James Robinson

Why Nations Fail: The Origins of Power, Prosperity, and Poverty

This is one of the most complete books I have ever read. It is worth all the accolades. The authors maintain a blog to continue the research and discussion. 

This is a great book for an economic overview of world history. The Acemoğlu-Robinson thesis is this: Countries are poor (or become failed states) not because of geography or culture, but because of the legacy of "extractive" institutions. Extractive political institutions set up extractive economic institutions in order to enrich the rulers at the expense of the greater society. The ruling group then sets up protections to this way of life, removing property rights and incentives for the general population to produce and innovate. This creates poverty and inequality. The "Iron Law of Oligarchy" prevails; revolutions tend to replace who are in power, but not unwind the extractive institutions. 

The book is a critique of Jared Diamond's Guns Germs and Steel in which he argues the inequality among nations we see today are artifacts of developments that took place due to relative endowments of climate and agriculture. Diamond's thesis may explain the initial rise of technologies and kingdoms, but not their perpetuation. Why do North and South Nagales and Laredo have such differing standards of living? North and South Korea? (Formerly) East and West Germany? I consider Why Nations Fail to be similar to Diamond's sequel Collapse, it just tells the rest of the story for many more cultures than Diamond discusses. (I read Diamond's books in 2005 but apparently didn't write reviews for them?) The authors argue that "history is contingent;" there was no way to predict that Western Europe would develop democracy coming out of the Black Plague period and launch the Industrial Revolution. There was no way to predict that Botswana would be the positive outlier in Africa. There was no way to predict that Peru, whose Mayan kingdom was once more wealthy and technologically advanced than those cultures in North America, would not grow faster than the rest of the world.

The authors go through lengthy histories of countries and tribes on every continent for hundreds of years, including well-known modern examples. The majority of human history has been lived under absolutism. (This is much different than the 99% argument the Occupy movements make, under absolutism there is slavery and essentially no innovation or upward mobility.) Extractive economic  institutions stifle progress by eliminating the incentive of people to innovate or be productive-- why plant a tree when you won't get its fruit? This maintains power in the hands of a few, on whom the serfs, slaves, and majority population then have to rely.

Wherever there are vested interests, they will stand against the forces of "creative destruction." Writing was outlawed in Somalia as it was seen as subversive to ruler's self-interest to have the masses educated and able to communicate. The printing press was initially forbidden to print in Arabic in the Ottoman Empire because it put over 600 scribes loyal to the Sultan at risk. The Ming Dynasty in China forbid shipping, and forced residents to move inland 17 miles from the coast in order to keep out exports and maintain their local monopolies and keep innovation from happening. I think about Cyrus Hamlin's account of Turkey opening up for trade in the mid-1800s, how once-protected Turkish artisans were suddenly faced with much higher-quality foreign goods and had to adapt.When innovation would simply lead to greater extraction, as in pre-industrial Congo, people don't innovate.Why plant a tree or use a better tool when the King will simply take the fruit or the crops? Creative destruction is difficult, but necessary for productivity and incomes to increase-- where monopolies decrease, creative destruction increases productivity, incomes, and standard of living for entire populations instead of a relative few.

Spaniards conquering South America deliberately set up systems designed to exploit the natives as slaves mining the gold that would enrich the elite Conquistadors. Their systems essentially lasted for more 400 years and led directly to Latin America's great inequality today.

It took the Glorious Revolution of 1688 in England to create a system of property rights and incentives for new products to launch the Industrial Revolution. It would take wider political reforms demanded by a majority of citizens for political power to be widespread enough to remove the Corn Laws in the early 1800s. Western Europe grew rapidly as political reforms were adopted and rights expanded beyond the ruling class, whereas the Russians and Ottomans who maintained their extractive institutions (including serfdom and slavery) fell behind. A little bit of economic inclusiveness tends to lead to more political inclusiveness, and a "virtuous cycle" of greater inclusiveness ensues. See Europe or America today.

The authors maintain that one cannot manage economic growth-- macroeconomic policy changes encouraged by the IMF and World Bank err in that they do not change the extractive political institutions of countries which are what impede long-run economic growth. Funding massive projects to build capital (better farming practices, dams, highways, electric grid) help economic growth little because the extractive political institutions make sure the gains from progress go to a select few. Likewise, international aid (of which only about 20% reaches its intended target) does nothing to solve the underlying political problem. This seems to jive with Bill Easterly's critiques of Jeff Sachs' proposals.

The authors predict that China will eventually reach the limits of its "authoritarian growth" and argue that the authoritarian growth model should not be advocated by the world as a response to the 1990s "Washington Consensus." The gains from Chinese growth are increasingly going to the elite, as many of the corruption scandals illustrate. Property rights are still not protected and China will not maintain sustained growth until its political structure becomes inclusive. Brazil serves as a counterpoint, its growth since the 1970s had nothing to do with international aid or macroeconomic policies, but is an outgrowth of inclusive political and economic reforms.

Acemoğlu and Robinson are likewise ambivalent greater liberalization of extractive economic institutions eventually leading to liberalization politically-- often used when talking about China (and often cited as Gorbechev's mistake for also liberalizing politically in the 1980s). Instead, history seems to say that it will simply enrich the ruling class and prolong the inequality.

Anything in the book about America? 
The Virginia Company looked to exploit the New World via Jamestown, hoping to extract riches like the Spanish were. When exploiting the Natives didn't work, they instead tried to exploit the colonists themselves with forced labor and susbsistence wages. This destroyed the colony, and the Virginia Company instead turned to incentives-- granting land to colonists, the right to keep their house, and setting up councils where the men could have a say in making laws: hence, free-market democracy and colonial life flourished.

In the South, extractive institutions remained strong until the 1960s. Since a large part of the population (slaves) were forbidden to own land, be educated, or vote, wealthy white landowners (monopolists) had a strong extractive institution. Thus, the South was poorer (measured by output and income) and less innovative (as measured by patents) than the North. When the political institutions were threatened, war ensued and more inclusive political institutions had to be formed at gunpoint. But the Iron Law of Oligarchy kept hold through disobedience to the law, the Ku Klux Klan, and Jim Crow laws until more forced reforms in the 1960s. Only now do we see economic growth in the South now that the benefits are more widespread, although poverty still remains strong due to the amount of time it takes to catch up.

In the early 1900s, the "Robber Barons" of industry owned an increasingly large part of the U.S. economy. The U.S. enacted trust-busting legislation partly in response to the increasing influence seen by the oligarchs on politics. FDR made trust-busting a central part of his early days in office (though as I've read a few books on the Great Depression lately, I think this is a bit of stretch) but was himself curtailed in his quest to gain more power to the state by the inclusive nature of our Constitution-- the Supreme Court checked his power.

Could Tyler Cowen's Great Stagnation be evidence that economic and political power is too extractive in America? Some argue as such-- large companies have armies of lawyers to protect patents, our financial institutions are increasingly consolidating, and large players in certain industries have huge sway over elected officials through campaign donations and Super PACs. We negotiate trade deals that do nothing to chip away at the protections enjoyed by the wealthier and more politically powerful-- doctors, engineers, lawyers, etc. -- at the expense of the less-wealthy, like unskilled labor. 

As a Christian, my thought is that it is in our sinful human nature to want to see power centralized, or to enrich ourselves when given an opportunity-- and absolute power corrupts absolutely. Did God not warn the Israelites about desiring such extractive political and economic institutions (1 Samuel 8:10-22)?
(H)e will take your sons and place them for himself in his chariots and among his horsemen and they will run before his chariots. 12 He will appoint for himself commanders of thousands and of fifties, and some to [b]do his plowing and to reap his harvest and to make his weapons of war and equipment for his chariots. 13 He will also take your daughters for perfumers and cooks and bakers. 14 He will take the best of your fields and your vineyards and your olive groves and give them to his servants. 15 He will take a tenth of your seed and of your vineyards and give to his officers and to his servants. 16 He will also take your male servants and your female servants and your best young men and your donkeys and [c]use them for his work. 17 He will take a tenth of your flocks, and you yourselves will become his servants. 18 Then you will cry out in that day because of your king whom you have chosen for yourselves, but the Lord will not answer you in that day.”

Yet, the Israelites demanded it because they envied other nations who had it. Is this the arc of history?
This seems to repeat itself today, there's an idea that centralized control can get the economy moving. Biblical prophecy seems quite glum on the prospect of more inclusive institutions in the future.

Acemoğlu looks at the USSR as one oft-cited example (like China today), popularized in the early 20th century. Stalin simply replaced the Tsar as the extractive political ruler. He diverted resources from agriculture to manufacturing at the expense of famine, millions of lives, political murders and imprisonment, and lost productivity (and population). Towards the end of his life, Stalin himself undid some of these efforts because he saw their counterproductivity-- a similar conclusion reached by Lenin before his death.

As Acemoglu points out, even a benevolent dictator swept in by popular grievances over economic hardships has to do things to maintain his power-- namely enrich his allies. Whatever benevolent ideas he had about helping his nation, these get lost as policies are enacted that will perpetuate the cycle of enriching the few at the expense of the many. What leads to his ouster is simply another group becoming strong enough to take that power, and the cycle continues. He details several South American and African examples.

How do I relate this to today? Well, I grimace when I see a Comcast-Time Warner Cable merger plan-- concentrated power over a vital economic resource (broadband). When I see one political party trying to establish a "permanent majority," or a U.S. President take unilateral action to circumvent a check on his power (Congress, the Supreme Court).

The one thing the book lacks is a look at the environment. Perhaps environmentalists today would argue we need less creative destruction as greater economic growth puts a strain on resources. The counter-argument is that greater productivity leads to getting more with fewer resources. England has more trees and today than it did before the Industrial Revolution. It seems perverse to argue that poor countries need less economic growth. But these issues go unaddressed in the book.  

This is a 5 star book that everyone should read.I would recommend reading Jared Diamond's books, Joseph Stiglitz's books, as well as Yergin and Stanislaus's Commanding Heights and Thomas Friedman's The World is Flat along with this.
Why Nations Fail: The Origins of Power, Prosperity, and Poverty

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