Nobel Economics Prize: How Colonial History Shows the Importance of Strong Institutions – Expert Q&A

While announcing the award, Jakob Svensson, the chairman of the economics prize committee, said: “Reducing the huge differences in income between countries is one of our times’ greatest challenges”. The economists’ “groundbreaking research” has given us a “much deeper understanding of the root causes of why countries fail or succeed.”

The award, which was established several decades after the original Nobel prizes in the 1960s, is technically known as the Sveriges Riksbank prize in economic sciences. The academics will share the award and its 11 million kroner (£810,000) cash prize.

To explain their work and why it matters, we talked to Renaud Foucart, a senior lecturer in economics at Lancaster University in the UK.

What did Daron Acemoglu, Simon Johnson and James Robinson win for?

The three academics won the prize mostly for providing causal evidence of the influence of the quality of a country’s institutions on its economic prosperity.

At first glance, this may seem like reinventing the wheel. Most people would agree that a country that enforces property rights, limits corruption, and protects both the rule of law and the balance of power, will also be more successful at encouraging its citizens to create wealth, and be better at redistributing it.

But anyone following the news in Turkey, Hungary, the US or even the UK, will be aware that not everyone agrees. In Hungary for instance, cases of corruption, nepotism, a lack of media pluralism, and threats to the independence of the judiciary have led to a fierce battle with the European Union.

Rich countries typically have strong institutions. But several (wannabe) leaders are perfectly comfortable with weakening the rule of law. They do not seem to see institutions as the cause of their prosperity, just as something that happens to be correlated.

In their view, why does the quality of institutions vary across countries?

Their work starts with something that has clearly not had a direct effect on today’s economic prosperity: living conditions at the start of European colonialism in the 14th century. Their hypothesis is that, the richer and the more inhospitable to outsiders a place was, the more colonial powers were interested in brutally stealing the country’s riches.

In that case, they built institutions without any regard for the people living there. This led to low quality institutions during the colonial period, that continued through independence and led to bad economic conditions today.

All of this is because – and this is another domain to which this year’s laureates contributed – institutions create the conditions of their own persistence.

In contrast, in more hospitable and less developed places, colonialists did not take resources. They instead settled and tried to create wealth. So, it was in their (selfish) interest to build democratic institutions that benefited people living there.

The researchers then tested their hypothesis by looking at historical data. First, they found a “great reversal” of fortune. Places that were the most urbanised and densely populated in 1500 became the poorest by 1995. Second, they found that places where settlers died quickly from disease and could therefore not stay – while local populations were mostly immune – are also poorer today.

Looking at the colonial roots of institutions is an attempt to disentangle causes and consequences. It is also perhaps the main reason why the committee would say that even if this year’s laureates did not invent the idea that institutions matter, their contribution is worthy of the highest distinction.

Some have suggested the work simply argues ‘democracy means economic growth’. Is this true?

Not in a vacuum. For instance, their work does not tell us that imposing democracy from scratch on a country with otherwise malfunctioning institutions will work. There is no reason for a democratic leader not to become corrupt.

Institutions are a package. And this is why it is so important to preserve their different aspects today. Weakening even a little bit of the protections the state offers to citizens, workers, entrepreneurs and investors may then lead to a vicious circle where people do not feel safe that they will be defended against corruption or expropriation. And this leads to lower prosperity and more calls for authoritarian rules.

There may also be outliers. China is clearly trying to push the idea that capitalism without a liberal democracy can be compatible with economic success.

The growth of China since Deng Xiaoping’s reforms in the 1980s coincides with the introduction of stronger property rights for entrepreneurs and businesses. And, in that sense, it is a textbook version of the power of institutions.

But it is also true that Deng Xiaoping ordered the crushing by the military of the Tiananmen Square protests for democracy in 1989. China today also has a clearly more authoritarian system than western democracies.

And China is still much poorer than its democratic counterparts, despite being the world’s second-largest economy. China’s GDP per capita is not even a fifth of that of the US, and it is facing major economic challenges of its own.

Actually, according to Acemoglu, Xi Jinping’s increasingly authoritarian regime is the reason why China’s economy is “rotting from the head”.

What trajectory are democratic institutions throughout the world currently on?

Acemoglu has expressed concern that democratic institutions in the US and Europe are losing support from the population. And, indeed, many democracies do seem to be doubting the importance of protecting their institutions.

They flirt with giving more power to demagogues who claim it is possible to be successful without a strong set of rules that bind the hands of the rulers. I doubt today’s prize will have the slightest influence on them.

But if there is one message to take home from the work of this year’s laureates, it is that voters should be cautious not to throw the baby of economic prosperity with the bathwater of the sometimes frustrating rules that sustain it.

Renaud Foucart, Senior Lecturer in Economics, Lancaster University Management School, Lancaster University

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