Book summary: Why Nations Fail

Why Nations Fail

The book is a good read on why some nations are rich today while others are poor. While the book Breakout Nations provides useful information on the current situation in many countries, Why Nations Fail offers valuable historical lessons on critical aspects of economy and politics that have shaped countries around the world. The theme of this book includes:

 

  1. Inclusive vs. Extractive Economic and Political Institutions
  2. The Myth of Geography/Culture
  3. Path-dependence of the Past
  4. Centralization of Power
  5. Creative Destruction
  6. Critical Junctures
  7. Defending Prosperity

Inclusive vs. Extractive Economic and Political Institutions

Rich nations have inclusive institutions that respect the property rights of individuals, have independent judiciaries, and generally enforce the rule of law. On the other hand, poor nations have extractive economic institutions, where a small number of elites tries to extract wealth from the rest of the population. The elite class also controls political institutions, which ensures their control over economic institutions. As there is much to be gained by having control over the extractive institutions, in poor nations, coups are the norm. Since most of the benefits go to the elite, such extractive institutions discourage the general public from investing in the productivity of their country. However, initially, authoritative political institutions can clear up labor inefficiencies and can produce rapid growth, which was the case, for example, in the Soviet Union between 1950 and 1980. Nonetheless, authoritative regimes soon run out of steam, since, the citizens have no real incentive to work for the betterment of their country.

Inclusive economic institutions under extractive political institutions are unstable. They produce new winners and losers. And those winners demand more political rights.

In most parts of the once-colonized world, extractive institutions still exist despite these nation’s’ independence.

Spain took over much of the Caribbean and South America, replacing the Aztecs, the Incas, and others, to set up even stronger extractive institutions. Britain’s first colony in the Americas was in Virginia because the extractive parts of the Americas were already under the control of different European powers including Spain. The English colonies had no mining-worthy areas, and the native population density was too low to enslave. Therefore, over time the men and women sent to these colonies had to work on their own, unlike their Spanish counterparts who took indigenous peoples as slaves.

The myth of Geography Hypothesis

The geography hypothesis states that “Tropical geographies are poor because people in these climates tend to be lazy and suffer from diseases like Malaria.” This hypothesis is incorrect, of course, as, historically, India was more prosperous than most of temperate Europe. Additionally, the tropical areas in the Americas were richer and had more advanced civilization than the more temperate parts of these two continents. Further, this hypothesis fails to explain the success of modern-day Singapore, or why South Korea is ten-times more prosperous than the communist North.

Centralization of Power

Too much decentralization of power is bad for a country’s economy. One needs a central authority to levy taxes and build common projects like roads, as well as to maintain law and order. Many African nations, where power is split into the hands of individual tribes lack the incentive to invest in country-level infrastructure.

Creative Destruction

Economic processes produce not just new winners but also new losers. Inclusive institutions can accept this. In extractive institutions, if an economic change might harm the current elites, the elite class tries to get it outlawed. Railways were prohibited in many parts of Eastern Europe and Russia for this very reason.

Additionally, in the 17th century, the Caribbean islands, heavily engaged in sugar production, were one of the wealthiest places on earth. Their political institutions were extractive, but growth happened since most of the (slave) workforce was directed to work in the sugar plantations. Once there was a need to shift to new economic activities, the island’s growth began to stagnate since such a change would have threatened the elite class. The same happened in the USSR during the Stalin’s regime where people were moved from an economy based on agriculture into one economy based on industry, to increase the country’s economic output, but this economic shift eventually fizzled out. History is full of such examples, for instance, when the printing press was initially developed, it was forbidden in many parts of Europe, since the elites did not want to let go of the control of knowledge. Thus, we see that sustained economic growth is not possible without creative destruction.

Critical Junctures

Sometimes nations encounter critical junctures, and the paths they choose have long-term consequences. For example, the bubonic plague wiped out a big chunk of the population in 13th century England, creating a situation where labor was scarce; from this, a free-market for buying and selling labor emerged. The same plague had the opposite effect in Eastern Europe, where the existing landowners bought even more of land and began to maintain even stronger control over the serfs. Meanwhile, back in England, when the king tried to fix wages, a riot broke out, and wage fixing was never enforced after 1381.

All societies are different, and even small differences can produce drastically different outcome when a critical juncture is encountered. China and Japan both faced critical junctures when, respectively, Great Britain and the United States tried to colonize them. China responded negatively and entered a death spiral while Japan modernized itself and became a major international power. Similarly, going back several centuries, once the new riches in the 13th century decided to make the institutions closed to outsiders, Venice went from a prosperous trading city with a strong economy to a modern-day museum.

Defending Prosperity

A nation cannot enforce property rights unless it can protect itself. South-east Asia’s wealthy, prosperous trading communities failed to survive after the Dutch East India Company enslaved local populations. From forced treaties to genocides, the Dutch East India Company did everything it could to take full control over the spice trade. In response, many islands stopped growing spices to avoid the Dutch armed forces.

In Africa, the effort was on the slave trade, where prisoners of war were captured by the rivaling tribes and then sold to European traders. When the slave trade was abolished, many of these African turned slaves to forced labors. In South Africa, between 1840 and1890, native Africans adopted modern laws following the rules put forward by the white Afrikaners and became more prosperous. Then, to get cheap labor for mining and to eliminate competition, European Afrikaners introduced apartheid where the government disproportionately allotted the land to whites and prohibited the blacks from certain jobs. The British East India Company did much the same in India, where they destroyed existing institutions and replaced them with their own in order to extract greater wealth for Britain.

What Does Not Work

  1. Authoritarian growth – China seems to be the model example of growth under authoritarianism, roughly similar to the growth experienced in the USSR in the 1950s and 1960s. Once enough of the inefficiencies have been eliminated, the growth will stop.
  2. Engineering prosperity – Even when the IMF and the World Bank set specific targets, the gaming of those targets happens to benefit the elite class ruling the country. Therefore, the poor do not benefit sufficiently.
  3. Foreign aid – Foreign aid mostly gets consumed by NGOs and corrupt leaders.

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