Nobel Prize in Economics explains difference in the prosperity of nations

This year’s Nobel Prize in Economics awarded three researchers – Daron Acemoglu, Simon Johnson and James Robinson – who demonstrated that societies with a poor rule of law and institutions that exploit the population do not generate prosperity. On the other hand, social institutions with a regulatory role and promoting growth or change for the better are key to a country’s wealth.

Daron Acemoglu, was born in 1967 in Istanbul, Turkey. He has a doctorate from the London School of Economics and Political Science and is currently a professor at the Massachusetts Institute of Technology (MIT), in the USA.

Simon Johnson, born in 1963, is originally from Sheffield, United Kingdom. He has a PhD from MIT, where he also teaches. James A. Robinson, who was born in 1960, has a doctorate from Yale University and works as a professor at the University of Chicago, both in the USA.

This year’s Nobel Economics winners have developed theoretical tools that can explain why there are such vast differences in prosperity between nations. By examining the various political and economic systems introduced during the process of European colonization, his research demonstrates that there is a direct relationship between institutions, their maintenance, and prosperity.

Places where colonizers just wanted to extract resources and exploit the population tended not to develop as much. Other countries, where inclusive political and economic systems have been formed for the long-term benefit of migrants, have achieved different results.

Thus, even though the colony’s situation was initially poor, the creation of inclusive institutions resulted over time in a prosperous population. And the opposite is also valid. For this reason, former colonies that were once rich, but in which the exploitative system was promoted, became impoverished.

Some nations manage to break out of the exploratory cycle and create new institutions

The Nobel Economics winners also developed a theoretical framework that explains why some societies become trapped in “extractive institutions,” and why escaping this trap is so difficult.

According to his study, unlike inclusive institutions, which generate wealth and benefits for everyone, extractive institutions were created to provide only short-term gains for the people who hold power.

In these situations, as long as the political system ensures that the same group remains in charge, no one will trust their promises of future economic reforms. According to the laureates, this is why no improvements occur and the reason why certain countries have become tied to extractive institutions and, therefore, low economic growth.

However, the inability of governments themselves to promote positive change and their lack of credibility may also explain why democratization occasionally occurs.

According to research, when there is a threat of revolution, people in power face a dilemma: they seek to remain in their positions of command and try to appease the masses through economic reforms.

However, accustomed to exploitation and discredit towards politicians, the population is unlikely to believe that the new promises will not, in fact, lead to a return to the old system as soon as the revolt situation calms down.

For their part, those in power themselves do not believe that they will be rewarded by the population if they create a fairer system, based on the law. This is known as the commitment problem.

The difficulty in overcoming it means that societies become trapped in extractive institutions, mass poverty and a wealthy elite. In this way, the only possible outcome would be the transfer of power and the establishment of a democracy.

Even if the population of a non-democratic nation does not have formal political power, it outnumbers the ruling elite and, for this reason, can provoke revolutions to remove it from power, establishing a democratic government.

How colonist mortality affected the profile of the institutions created

According to research by Nobel Prize winners in Economics, the main explanation for the type of colonial institutions created is the number of permanent settlers in each colony. The more European settlers, the more likely they were to establish economic systems that promoted long-term economic growth.

Another factor that contributed to the establishment of different institutions was the severity of the diseases that spread throughout the colonies. The prevalence of deadly diseases varied greatly between colonized areas.

According to the study, in places where diseases were most dangerous for colonizers, extractive institutions were created. Currently, they are those where dysfunctional economic systems and the greatest poverty are found, as well as the greatest corruption and the weakest rule of law.

According to the Swedish Academy of Sciences, Acemoglu, Johnson and Robinson discovered a clear chain of causality that explains the wealth and poverty situation of nations.

Nogales, in Mexico, presents two distinct and simultaneous realities

In one of their works, the winners used the city of Nogales, on the border between the USA and Mexico, as an example. The city is cut in half by a fence, half of which is on American soil and the other on Mexican territory.

The part of Nogales that extends into Arizona, USA, is experiencing prosperity. Its residents are relatively wealthy, have a long average life expectancy, and most children receive high school diplomas. Property rights are secure and people know they will be able to enjoy most of the benefits of their investments. Free elections give residents the opportunity to replace politicians they are unhappy with.

In the southern portion of the city, located in the Sonora region, Mexico, the reality is different. Although this is a relatively wealthy area, the residents are considerably poorer than those who live on the north side of the fence. Organized crime makes starting and running businesses risky. Corrupt politicians are difficult to remove, even though the opportunities for doing so have improved since Mexico’s democratization some 20 years ago.

The researchers’ conclusion about the reasons for the differences between the two parts of the city, as they have similar geography and culture, falls to the institutions. People living north of the fence live in the US economic and political system, which gives them greater opportunities to choose their education, profession, and is guaranteed broad political rights.

South of the fence, residents live under different economic conditions, and the political system limits their potential to influence legislation. The conclusion of the laureates is that Nogales is not an exception. And this is a pattern that is even repeated across nations, and whose roots go back to the type of institution established in colonial times.

Nobel-winning model contains three variables that can explain other processes throughout history

According to the Academy, the model created by the Nobel Prize winners in Economics to explain the circumstances under which political institutions are formed and changed has three components.

The first is a conflict over the allocation of resources and who holds decision-making power in a society (the elite or the masses). The second is that the masses sometimes have the opportunity to exercise power by mobilizing and threatening the ruling elite; Power in a society is therefore more than the power to make decisions. The third is the problem of commitment, which means that the only alternative is for the elite to hand over decision-making power to the population.

The model is able to explain the process of democratization in Western Europe at the end of the 19th century and the beginning of the 20th century. Another example is the expansion of suffrage in Great Britain, carried out over several periods, each of which was preceded by general strikes and widespread protests.

It can also be used to explain why some countries alternate between democracy and non-democracy or why it is so difficult for countries that do not have inclusive institutions to achieve growth equal to those that do, and why ruling elites can sometimes benefit from lockdown of new technologies.

According to the Swedish Academy of Sciences, insights from Daron Acemoglu, Simon Johnson and James Robinson into the influence of institutions on prosperity show that working to support democracy and inclusive institutions is an important path forward in promoting economic development .

“Reducing the vast income differences between countries is one of the greatest challenges of our time. The laureates have demonstrated the importance of social institutions in achieving this,” says Jakob Svensson, Chair of the Prize Committee in Economic Sciences.

Since 1968, the Nobel Prize in Economics has been awarded by the Royal Swedish Academy of Sciences. Founded in 1739, the Academy currently has around 470 Swedish and 175 foreign members. It is the Academy that appoints members of the Prize Committee, the working body for electing laureates, for a three-year term.