Why Nations Fail

The book is a good read on why some nations are rich, and some are poor today. While the book Breakout Nations provides useful information on the current status quo of many countries, this book offers a useful lesson in the economy and politics which shaped the countries around the world.

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 juncture
7. Defending Prosperity

Inclusive vs. extractive economic and political institutions

Rich nations have inclusive institutions which respect property rights of individuals, have an independent judiciary, and general enforcement of the rule of law.

Poor nations have extractive economic institutions where a narrow set of elite tries to extract wealth from the rest of the population. The elite controls political institutions as well to ensure their control over economic institutions. In poor nations, since there is a lot to gain from having control over the extractive institutions, coups are the norm. Since most of the benefits go to the elite, such extractive institutions discourage the general public from investing in productivity. For a short period though, authoritative political institutions can clear up inefficient in labor and can show rapid growth, for example, in the Soviet Union from 1950-1980. But they soon run out of steam since the individuals don’t have an incentive to work.

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, the leftover extractive institutions still exist despite these nation’s independence.

Spain took over the Caribbean and South America, replacing the Aztecs and the Incas, 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 taken control of. The English colonies had no mining-worthy areas, and the population density was too low to enslave the local population. Therefore, over time the men sent to these colonies had to work on their own, unlike there Spanish counterparts who took natives as slaves.

The myth of Geography Hypothesis

Hypothesis – “Tropical geographies are poor because people in these climates tend to be lazy and suffer from diseases like Malaria.” This hypothesis is incorrect since historically India was more prosperous than most of temperate Europe and tropical Americas was richer than temperate Americas with a more advanced civilization. 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 the economy. One needs a central authority to levy taxes and build common properties like roads and maintain law and order. Many African nations where power is split in the hands of individual tribes lack the incentive to invest in the 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 can harm the current elites, they merely try to get it outlawed. Railways were prohibited in many parts of Eastern Europe and Russia for this reason. In the 17th century, Caribbean islands, engaged in a sugar plantation, were one of the wealthiest places on Earth. Their political institutions were extractive, but growth happened since most (slave) workforce was directed to the sugar plantation. Once there was a need to shift to new economic activities, the growth stagnated, since such a change would have threatened the plantation elite. Same happened in USSR where people were moved from agriculture into industry, increases the economic output, but that eventually fizzled out. When the printing press came out, it was forbidden in many countries since elites don’t want to let go of the control of knowledge. Sustained economic growth is not possible without creative destruction.

Critical Junctures

Sometimes nations encounter critical junctures and what path they choose has long-term consequences. For example, Plague wiped out a big chunk of the population in the 13th century England, the labor was scarce, and a free-market for buying and selling labor emerged. The same plague had the opposite effect on the eastern Europe where the existing landowners bought even more of land and held a stronger control over the serfs. While 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 produce drastically different outcome when a critical juncture is encountered. China and Japan both faced critical junctures when the UK and the US, respectively, tried to colonize them. China responded negatively and entered a death spiral while Japan modernized itself and became a major power. Similarly, once the new riches in the 13th century decided to make the institutions closed to the outsider, Venice went from a prosperous trading city with strong economics to a modern-day museum.

Defending Prosperity

A nation cannot enforce property rights unless it can protect itself. South-east Asia’s wealthyprosperous trading communities failed to survive after the Dutch East India company enslaved them. From forced treaties to genocides, the Dutch East India company did everything it can to take full control over the spice trade. Many islands stopped growing such valuable crops to avoid Dutch armies. In Africa, this took the form of the slave trade,  the prisoners of war captured by rivaling tribes were sold to Europeans. When the slave trade was abolished then many of these African turned slaves to forced labors. In South Africa, from 1840-1890, native Africans adopted modern laws along with the white Afrikaans and became more prosperous and then to get cheap labor for mining and eliminate competition, European Afrikaans introduced Apartheid. The land was disproportionately allotted to whites, and blacks were prohibited from certain jobs. British East India Company did the same in India where they destroyed the existing institutions and replaced them to extract wealth for Britain.

What does not work

1. Authoritarian growth – China seems to be the model example of growth under authoritarianism, this is similar to growth in USSR in the 1950s and 1960s, once enough inefficiency has been eliminated, the growth stops.
2. Engineering prosperity – Even when IMF/World Bank sets specific targets, the gaming of those targets happen to benefit the elite class ruling the country. Therefore, the poor do not get sufficient benefit.
3. Foreign aid – Foreign aid mostly gets consumed by NGOs and the corrupt leaders.