Over the winter holidays, I had the leisure to read the book “Why Nations Fail: The Origins of Power, Prosperity, and Poverty” by MIT economist Daron Acemoglu and Harvard political scientist James A. Robinson (Crown Business 2012, 544 pages, Hardcover $20.00). Both authors are very eminent – one would not be surprised if Acemoglu, a Turkish-born Armenian and the most frequently cited contemporary economist, would receive the Nobel Prize in economics somewhere down the road.

After reading the book, I was rather disappointed, because it appeared to me as if its message bordered on triviality. Didn’t the authors just say that dictators who oppress and exploit their populations are bad, while inclusive democracies that abide by the rule of law are good?

Well, the longer I think about their theory, the more I find it appealing, in particular as I can nicely connect it with my experiences as an economist living in Georgia.

... while other societies are rich? (Source: Wikimedia Commons)

CREATIVE DESTRUCTION

Acemoglu and Robinson draw on an idea put forward by Joseph Schumpeter (1883-1950). According to Schumpeter, the driving force behind economic progress is what he calls “creative destruction”, namely the replacement of old business models by new ones, of old products by new products, and of old professions by new professions. Instead of emphasizing the positive, constructive role of entrepreneurs (“building up a business”), he focuses on the fact that new developments in the economy usually go at the expense of existing sectors and industries. Yet Schumpeter believes that this destruction is at the core of economic progress, and that without it there would be just stagnation and incrustation. Indeed, it is easy to find examples for the beneficial role of creative destruction. For instance, at the beginning of the 20^th century, entrepreneurs producing pneumatic tires have replaced those who made wooden wheels, but the frequent English name “Wright” indicates that wheelwright was an important profession in the past. Despite the destruction of the wheelwright profession, everybody would agree that the replacement of wooden wheels by pneumatic tires was part of the economic progress of humankind.

As a matter of fact, those who control the economy are usually also politically powerful. Yet if this is so, Acemoglu and Robinson ask, why should economic-political rulers allow creative destruction to happen, as this destruction threatens the very basis of their economic and political power? And indeed, as they show, creative destruction was and is frequently suppressed by those who possess power.

Supported by a plethora of interesting, sometimes curious and funny examples, the authors interpret economic history as a fight between those who want to preserve existing “modes of production” (to use a Marxian term) against those who come up with fresh ideas for unlocking new technologies and new markets. Putting it simple, Acemoglu and Robinson claim that when the conservative forces prevail, there is poverty, while it leads to progress and development when the forces of creative destruction are unleashed.

One of the most convincing examples in support of their viewpoint is the fact that there were various inventions of weaving machines and even of steam engines all over Europe before the industrial revolution. But these novelties were seen as threats to the existing economic order and were thus successfully suppressed by the ruling elites.

But why did industrialization pick up in England then?

EXCLUSIVE AND INCLUSIVE INSTITUTIONS

The authors not only describe the struggle between preservers and creative destroyers, but they also try to explain what determines the winner of this struggle. Here their concepts of “inclusive institutions” and “exclusive institutions” come into play.

Acemoglu and Robinson classify the economic and political institutions of a society on a scale of “inclusiveness”. The more inclusive institutions are, the more they reflect the economic interests of many members of the society (as opposed to the economic interests of just a small elite). In its most mature form, inclusive institutions are governed by a legal system that does not favor anybody, but treats everybody’s economic interests equally. Exclusive institutions, on the other hand, are directly controlled by a despot or by laws that foster the interests of the existing elite at the expense of the interests of those excluded from power.

The theory has many facets and twists that cannot be described here, but the above argument is what I would consider to be its centerpiece. To my mind, one can rightfully criticize the breadth of the domain to which this theory is applied, namely all societies throughout geography and time. Certainly, there were societies in history with institutions that were neither exclusive nor inclusive in the above sense. However, the general framework Acemoglu and Robinson propose is, despite its simplicity, amazingly powerful for interpreting history and even for making predictions.

For instance, Acemoglu and Robinson have a clear opinion about the future of “Chinese Capitalism”. Many economists are impressed by the Chinese achievements of the last twenty years, where mega-projects like airports and large water dams are carried out in breathtaking speed, and they believe that China will sooner or later overtake the West. Acemoglu and Robinson disagree. While also the exclusive institutions of China can generate some growth (otherwise there is nothing that can be exploited by an elite), they claim that in the middle-run these institutions will not allow for creative destruction. So, they predict, Chinese economic development will slow down. Already now, though generating high growth rates, the transformation of China neglects the economic interests of many members of the society, potentially causing unrest and upheaval – a negative side effect of exclusive institutions. After publication of their book, it was revealed that the elite of the Chinese communist party has accumulated huge riches, and just this week it became public that much of this money was harbored abroad. To my mind, this illustrates the exclusive character of the Chinese model.

For Acemoglu and Robinson, an open, democratic, and free society is not an impediment to long-run economic development, but rather its most important precondition.

AND GEORGIA?

If we subscribe to this theory, we should believe that Georgia has a bright future. Since the Rose Revolution of 2003, Georgia has done amazingly well in establishing inclusive institutions. These were so strong that the rulers who set up these institutions finally lost the elections and had to step down. Yet also the new political leaders of Georgia abide by the rules of democracy. While initially there were some calls to persecute the representatives of the old government, by and large a policy of revenge has been avoided.

Even more importantly, on the level of experts, technocrats, and bureaucrats, able people affiliated with the old government were not ousted. Almost all judges were left in office, maintaining an independent judiciary system, a crucial component of a system of “checks and balances”. In contrast, Acemoglu and Robinson describe how in South American countries the first act of new rulers is always to replace the judges at courts. Even President Roosevelt in the USA tried to get rid of a critical supreme court in the 1930s (to no avail). Though being democratic just since about 10 years, Georgian institutions seem to be very mature and much more inclusive than what can be seen in most of South America.

Therefore, after reading the book, I am now more optimistic about Georgia. If institutions determine the long-run economic success of a society, then Georgia is on the right track.