the-anatomy-of-global-inequalities

Why are some nations rich while others remain poor? This is a question that has dogged leading thinkers for centuries.

 

The answer lies not in geography, climate or culture but in the way the countries create and nurture economic and political institutions that allow virtuous circles of innovation, expansion and prosperity.

 

This year’s Nobel Prize winners in Economics— Daron Acemoglu, Simon Johnson and James Robinson—are the strong advocates of this theory.

 

Their extensive body of work deals with the issue of economic disparities among the nations and the reasons behind it. Interestingly, all three economists are first-generation immigrants— Acemoglu is from Turkey while Johnson and Robinson are from the United Kingdom—now associated with American Universities.

 

Their research highlights how differences in institutions like the rule of law and property rights can explain the disparity between rich countries and poor countries.

 

We may not have all the answers to solve widening global inequalities. However, asking questions is the right first step.

 

The Nobel prize-winning economists have demonstrated the importance of societal institutions for a country’s prosperity.

 

There is strong reason to believe that institutional differences in countries can explain the difference in prosperity levels. The developed world has a common thread in the form of political and economic structures. The two main takeaways from their body of work are the importance of a democratic set-up and the creation of the right institutions that foster investment.

 

Democracies work better, as there are free elections and while different parties may have varied motivations, one needs to perform in order to get back to power. Hence institutions would necessarily have to be built.

 

Democracies make you rich

 

At a time when wealth disparities between nations are widening,

 

primarily due to the failure of institutions, it is important to draw lessons from the extensive research done by this year’s Nobel Laureates. The trio have analysed  500 years of statistical evidence to show that the quality of institutions determines success. Democracies have a better chance of getting rich.

 

The works such as these underscore the role of institutions in fostering global prosperity. Their work is crucial for future macroeconomic policies amidst geopolitical uncertainties that grip the world now.

 

Generally, inclusive institutions create incentives and opportunities for growth. On the other hand, extractive institutions — like slavery— concentrate power and resources in the hands of a small few, to the detriment of the broader population.

 

The Nobel laureates’ research helps us understand why societies with a poor rule of law and institutions that exploit the population do not generate growth or change for the better. While they do not provide specific solutions, an important takeaway can be that unless there are democratic regimes that foster the building of strong institutions, growth across countries will remain lopsided.

 

Power of pluralism

 

The countries escape poverty only when they have appropriate economic and political institutions and a strong legal system where there are transparent laws relating to doing business, covering taxes, trade and commerce. Such institutions will take shape only when there is an open pluralistic political system with competition for political office, a widespread electorate, and openness to new political leaders. 

 

This intimate connection between political and economic institutions is at the heart of the major contributions from the three renowned economists. Their studies show that authoritarian institutions like the ones that drive growth in China today are bound to run out of steam.

 

 Without inclusive institutions, sustainable growth is impossible, because only a truly free society can foster genuine innovation. 

 

Inclusive economic institutions allow and encourage participation by the great mass of people in economic activities that make best use of their talents and skills and enable individuals to make the choices they wish.

 

The benefits of the Industrial Revolution and technologies didn't spread to poor countries as the elites in those countries were disinterested in achieving prosperity for ordinary people. 

 

By mere revolution, a poor country doesn't become rich. 

 

To become rich, there should be political transformation with a commitment and action plan to bring prosperity to its ordinary people through accountability, responsiveness, promoting industries, using technologies, technical know-how and inclusive growth by creating economic opportunities for a great mass of people.

 

Countries such as the United States and UK became rich because they created a society where political rights are more broadly distributed, the government is accountable and responsive to citizens, and a great mass of people take advantage of economic opportunities.

 

Drawing on an extraordinary range of contemporary and historical examples, from ancient Rome through the Tudors to modern-day China, the Nobel laureates’ research work shows that to invest and prosper, people need to know that if they work hard, they can make money and actually keep it - and this means sound institutions that allow virtuous circles of innovation, expansion and peace.

 

Chinese puzzle

 

In their book “Why Nations Fail?”, they focus on the determinants of how some countries have attained high levels of prosperity, while others have consistently failed. Countries that belong to the former category have done it through “scientific and technological progress”, and through “pluralistic political institutions” that allow wide sections of society to participate in governing the country.

 

However, this theory fails to explain why an authoritarian regime in China has been able to achieve rapid economic growth.

 

The research by the three economists highlighted that authoritarian governments, though effective at exploiting existing resources, such as raw materials or workers in the short run, “fail to innovate”, which is a strength of democracies. This sort of authoritarian growth is unstable and doesn’t lead to innovation.

 

A clear message is that democracies are better at delivering prosperity over the long term.