Why Some Countries are Rich while Others are Poor?

Traditionally, economic models emphasize that economic growth rests on the accumulation of factors of production, namely, labor, capital, and technology that enhance productivity and efficiency. In other words, the greater the capital stock per worker and the more productive and efficient its use, the richer a country would be. The obvious question that it raises is: Why did some countries accumulate more of these factors of production and grow richer than others?

This year’s winners of the Sveriges Riksbank Prize in Economic Sciences, awarded in memory of Alfred Nobel, “for studies of how institutions are formed and affect prosperity”—Daron Acemoglu, Professor at MIT, Cambridge, US; Simon Johnson, Professor at MIT, Cambridge, US, and James A Robinson Professor at University of Chicago, US—argue that accumulation of factors of production in a country depends on the quality of its institutions/government.  

In 2001, these three Laureates published a paper, “The Colonial Origins of Comparative Development: An Empirical Investigation”, that became one of the most cited papers in economics. This paper examined the long-lasting effects of colonialism on the economic development of countries. Employing a range of empirical methods, including regression analysis, and analysing the colonial experiences of various countries and their current economic performance using historical data, the authors have shown a clear correlation between the type of institutional patterns established during colonialism and present-day economic outcomes. 

According to them, colonizers had established two kinds of institutions in the colonies: One, extractive institutions, and the other inclusive institutions. Extractive institutions are designed to exploit the resources and labor of a colony such as Congo, etc., for the benefit of the small elite, i.e., the colonizers. Such institutions helped colonizers retain control and thereby enjoy short-term gains. On the other hand, inclusive institutions promoted broad participation including locals in the economic process and provided secure property rights, which ultimately fostered investment and innovation. This kind of institutional pattern had a lasting impact on the economic prosperity of the colonies such as North America, Canada, Australia, and New Zealand, leading to flourishing economic growth. 

This phenomenon of establishing different institutions in different colonies gave the Laureates a “natural experiment” to analyze and unearth the underlying criteria for the creation of different institutions in different colonies. The authors hypothesized that the said colonization strategy was in part determined by the feasibility of European settlement in the colonies. In support of this argument, they, cleverly using the historical data about the mortality rates of settlers in different colonies, inferred that those countries with low mortality rates had become attractive for colonizers to stay for long, and as a result, they built inclusive institutions allowing the colonized to share in the wealth produced through private property and free markets. 

Contrarily, in colonies such as in Africa and South America, where mortality rates of Europeans were high, colonizers tended to develop extractive institutions, for they had less incentive to settle there for long and build lasting governance structures. They finally concluded that these institutions by virtue of their persistence to the present continue to impact their economic performance. Their results also indicate that “reducing expropriation risk would result in significant gains in income per capita but do not point out what concrete steps would lead to an improvement in these institutions”. 

Some economists, however, argue that the data for the key variable, namely, “settler mortality” on which their very argument rests is flawed and selectively chosen to flatter their hypothesis and hence their empirical findings are not robust. They also commented that their style of inferring causation is debatable, for it cannot distinguish between the places that the colonizers went to and the human capital they brought along with them.  

Nevertheless, this paper was found to have greatly influenced several disciplines such as economic development, political science, economic history, institutional studies, etc. It also highlights the importance of historical specificity in understanding economic growth, and in that sense, it moved development economics away from traditional growth models.

Interestingly, way back in 1997, Jared Diamond argued in his trans-disciplinary non-fiction book Guns, Germes, and Steel: The Fates of Human Societies that it was the geography of European countries that led to early economic growth. Moving a bit beyond Diamond’s assertion, current year’s Nobel Laureates in economics, argued that it was the kind of institutions built by the colonizers in colonies—defined by mortality rates linked to the region’s geography—that ultimately influenced economic growth.

Indeed, two of the Laurates, Acemoglu and Robinson, taking the chain of causation one step further, argued in their best-selling book, Why Nations Fail, that political institutions as determinants of economic institutions led to long-run development. This argument, however, fails to explain how China with that kind of political institutions could grow economically so well, while India despite its democratic setup could not grow that well.

Nonetheless, the Nobel Laureates’ exploration to find an answer to the question as to why some countries are rich and others poor, has certainly laid a foundation for later generations of economists to build fresh knowledge over it. That aside, their paper also suggests strengthening property rights, encouraging political inclusivity, and promoting good governance for fostering economic development in post-colonial countries. Simply put, the Nobel Laurates argue for a genuine commitment of governments of the erstwhile colonies to build institutions that promote inclusive economic growth.   

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