Inclusive Institutions Key for Economic Growth

The key to a nation's prosperity or failure is institutions, rather than culture, education or geography. But institutions come in different flavours, argues economist Daron Acemoğlu in an interview at the last St. Gallen Symposium.

By Julia Kramer

Why are some countries wealthier than others? This question attracted Daron Acemoğlu, Elizabeth & James Killian Professor of Economics at the Massachusetts Institute of Technology, to the field of economics. During the course of his studies, Acemoğlu realised that he could not answer this question without taking politics into consideration. Together with James A. Robinson, a political scientist at Harvard University, he decided to blend these two academic disciplines. After fifteen years of extensive research, their book "Why Nations Fail" (2012) challenged conventional economic wisdom by introducing empirical evidence showing that the economic success of nations depends on functional economic and political institutions.

The importance of inclusive institutions

"It is all about incentives and opportunities," says Acemoğlu. The Turkish-born professor does not reject the idea that cultural or geographical factors matter for understanding why countries in Western Europe are thirty or forty times as rich as some countries in the Caribbean or sub-Saharan Africa, but the influence is relative. "In the end the incentives to innovate, to invest and to educate are crucial. Institutions provide a framework for these incentives. They create a level playing field on which people can build," Acemoğlu says. "When that happens, economic growth takes place."
Unfortunately, these so-called "inclusive institutions" are the exception rather than the norm. Many historical and contemporary societies are ruled by so-called "extractive institutions," Acemoğlu says: "They provide neither incentives nor opportunities to people and are purely designed to extract resources from the many by the few." Those institutional differences are key to Acemoğlu's explanation for why some countries are much poorer than others.

North Korea, South Korea and China
Perhaps one of the best examples to illustrate Acemoğlu's theory is the case of North Korea versus South Korea. At the end of World War II, they both started at the same income per capita. Today, South Korea has about twelve times the income per capita of North Korea. "You see these two halves of this very ethnically, culturally and linguistically unified country diverge sharply over time," says Acemoğlu. "While in South Korea the incentives are improving over time, encouraging investment, innovation and export, the repressive dictatorship of North Korea provided no incentives for economic growth at all and no room for individuals to pursue their own economic activities and dreams." This development makes South Korea the perfect example of inclusive economic institutions. North Korea, meanwhile, is an extreme example of extractive economic institutions.
While Acemoğlu's theory generally received a positive response, many critics wonder how China fits into his framework. "China changed from one of the most extractive, inefficient institutions to a market economy with a heavy role for the Communist Party," says Acemoğlu. "This transformation to inclusive economic institutions is at the root of the country's rapid economic growth." This happened while extractive political institutions such as the Communist Party dominated the political system. This is the surprising part, since Acemoğlu states that all institutions must be inclusive to foster economic growth. "The question is whether China can reach the next stage of economic growth, based on innovation, without changing its political institutions."

The challenges of elites and inequality
What role do elites play in these institutions? As the examples illustrate, the actions of business, political and economic elites in many ways set the tone by creating incentives - or not. But the main thesis of "Why Nations Fail" is that you cannot trust elites to do the right thing purely from the goodness of their hearts. "Of course, I don't mean the good participants of the symposium, but the bad elites," jokes Acemoğlu. "These elites need to be controlled and need to be restrained by institutions."
He agrees that this is easier said than done, since people have an almost natural drive to gain power, but he doesn't think we can change this human cha-racteristic. "It is up to institutions as well as civil society to channel that greed and keep the elite accountable."
When asked if he sees Occupy Wall Street's protest against the greedy 1% as a successful intervention of civil society to keep the elite accountable, Acemoğlu shakes his head. "The Occupy movement was mainly good at articulating the discontent about the unfairness of the gap between rich and poor, but it is not the unfairness we should worry about."
According to Acemoğlu, the real problems are the implications of economic inequality for society - the inequality of opportunity, and especially political inequality. "Inequality of opportunity can underpin lack of economic dynamism, growth and innovation. If economic inequality leads to some people having much more voice and control of the political system than others, it starts a downwards spiral."

Focus on local politics
How can we prevent extractive institutions, greedy elites or political inequality from influencing the prosperity of nations? Certainly not by throwing the nation state out of the window. "Indeed, we inherited the nation state as an institution from the past, but we can't get rid of it right now without having an alternative," says Acemoğlu.
Although he is full of praise for the creation of the European Union as a supranational institution, he argues that its "political and economic top-down structure" makes it impossible to hold the people in power accountable. His solution is to focus on local democracy and bottom-up initiatives. Says Acemoğlu: "People's participation is essential to keep institutions working, and to make economic growth happen."

Growth - The good, the bad, and the ugly will be debated in the light of the 46th&nbspSt.&nbspGallen Symposium&nbsp(11-13&nbspMay&nbsp2016).