The power of institutions: Economics Nobel rewards deepest questions

The economics Nobel for this year went to three academics who specialise in asking a very simple question: What makes countries rich? They are not all academic economists in the traditional sense. Daron Acemoglu is certainly one of the most respected such professors of his generation. But Simon Johnson is a professor of entrepreneurship at a business school and a former chief economist at the International Monetary Fund. And James A Robinson has long been at political science and public policy departments. A question as deep as the success and failure of nations presumably required three quite different approaches to be melded in order to succeed.

The motivation with which Professors Acemoglu, Johnson, and Robinson (or AJR) began their investigation was simple: Why were some countries rich in the medieval period but poor today, while others that had been poor had become rich? Was there something causal or mechanistic that underlay this “great reversal”? Their answer was deceptively simple: “Institutions”. That word is now thrown around a great deal — partly because of AJR’s work —without a clear understanding of what precisely is meant. By “institutions”, they meant direct and enforceable constraints on the exercise of power. Ideally, institutions evolved to balance the exercise of power between various groups, to limit the overuse of power, and to ensure that in the long run such growth-enhancing mechanisms as property rights were protected. This would allow investment, entrepreneurship, and growth to thrive.

AJR’s original paper more than two decades ago demonstrated this effect through a clever instrument. The question was how to demonstrate that institutions caused growth, and not that institutions grew up alongside or because of growing wealth. One way to make the case would be to identify institutions that emerged for reasons other than wealth and then check if countries with those institutions did better. To do that, AJR — one of whom is Turkish, and two of whom are English — turned naturally to colonialism. They made the quite defensible assumption that places during the colonial era where Europeans remained healthy attracted more European settlers; and that if a colony had more European settlers than indigenous subjects, their institutions were less likely to be designed to be purely extractive and unrepresentative. They then used this to demonstrate that places where European settlers happened to survive performed better over time. In fact, once “differences in European mortality rates” centuries ago were controlled for, “countries in Africa or those closer to the equator do not have lower incomes”. The “colonial origins of comparative development”, as they put it, were a remarkable insight into the power of institutional strength.

Since then, they have expanded their analysis into multiple fields, including agrarian tenure, the extension of the right to vote, and the persistence of elite power across generations. But the central argument — that institutional choice, not destiny or genetics — that AJR make for economic success has remained the same. It is an optimistic view of the world, and one that some in India should examine with care. The basic structure of liberal economic reform that has been argued for in this country for decades now is one, essentially, of institutional change. A state that reduces entrepreneurial risk, preserves property rights, creates independent regulators, dispenses justice swiftly, and does not monopolise savings is one that will ensure long-term prosperity.