#001: Why Nations Fail

On understanding why countries are rich or poor and why Bill Gates didn't like this book

TLDR

  • Summary: Why Nations Fail explains why some nations are rich and others poor. The main theme of the book is: politics define economic growth as they are the system of defining Inclusive Institutions or Extractive institutions. The book reads as an ode to capitalism.

  • Why read it: If you're curious to understand where prosperity and growth comes from, the book will walk you through a millennia of examples in a study conducted over 15 years. It's a comprehensive thesis of economic

  • What you get from it: A deeply connected and backed-up model of how political decisions affect future economic prosperity. A mental model to quickly understand and predict future growth of countries in the next decades.

  • Rating:

    • Timeless? ⚠️

    • Comprehensive? ✅

    • Mental model? ✅

    • Return on investment of reading? ✅

    • One-sided VS full-scoped: ⛔️

    • All in all: ⭐️⭐️⭐️⭐️(4/5)

  • Should you read it? If you're interested learning about a theory that tries to explain the differences of wealth in countries, this is a good book.


Before we start:

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The book

Why Nations Fail: The Origins of Power, Prosperity, and Poverty

by Daron AcemogluJames A. Robinson

Why Nations Fail: The Origins of Power, Prosperity, and Poverty ...

Summary

The book starts by going through the traditional thesis that try explain Nation wealth differences. These are the theories that don’t work to explain social inequality between different countries:

  • Geography - myth: warmer climates make people work less. Counter example: Singapore is very close to the equator and has grown substantially

  • Culture - myth: people in a few countries are lazy and others are super productive. While culture helps to explain differences, it's not enough. Cultural differences are impacted by the political decisions each country has. Example: Nogales is a city in both Mexico and Arizona separated by a fence. Culturally people are the same however they have very different quality of life.

  • Ignorance - myth: leaders don’t know how what measures to implement to achieve prosperity. This is a myth, leaders know exactly what to do. It's just that, historically, that is synonym to improving their own status of those close to them.

This leads to the main thesis of the book: Politics define economic growth as they are the system of defining Inclusive Institutions or Extractive institutions within a country.

An inclusive institution is one that is pluralistic, that incentivizes participation in both politics and economy, that protects property rights with a strong central state. A democratic country where citizens can effectively choose their presidential or parliamentary representation is said to have some inclusive institutions.

On the other hand, an extractive institution is defined by non pluralistic representation or non centralized governments where only a few can participate in the economic benefit. It normally means that an Elite controls the political and, therefore, economic institutions and force them to favor them. An autocratic regime without any democratic participation is said to have extractive institutions.

A main difference also between these two is how they interact with Creative Destruction. Creative destruction is the process by which old status quo ways of doing things get challenged and consequently destroyed by invention and adoption of technology. Example: the Industrial Revolution created many opportunities for Creative Destruction where old manual way of producing textile was substituted with technology.

This notion of Creative Destruction is fundamental as Extractive institutions fear it, given that it threatens their status and position. In fact, the book states that the fear of Creative Destruction is why there was no sustained increase in living standards between 4500 BC (neolithic) and the industrial rev (17th c).

A few examples of fear of Creative Destruction to frame this thesis:

  • William Lee in 1589 invented the stocking frame after Elizabeth I ruled to make knitted caps mandatory (which created a huge surge in demand). He asked the Queen for a patent (so he could benefit from his invention) which she denied saying it would make people poorer and destabilize the country. In truth, the Queen was afraid of how the innovation would affect her control and status.

  • Absolutist leaders (like Francis I in Germany/Austria or Peter the Great in Russia) in the 18th century Europe had strong resistance to industrialization as it would mean more people moving to cities that could unite and revolt against them.

  • China had enormous progress in the 16th century under the Song dynasty but closed itself during the Qing and Ming dynasties - Including stopping all foreign trade. This was because the emperors did not want an instructed population that could revolt against them. The lack of oversees trade hindered China’s growth in 19th and 20th century. In 1949 when Mao came to power, China was one of the poorest countries in the world.

  • In the US, in the 20th century, certain businessmen were ruthless in creating and maintaining monopolies. They were called “Robber Barons”. Markets left to their own devices can become controlled by Monopolies. Monopolies are a natural sign of Extractive institutions as they reduce the ability for people to participate in economic activity. An example of a Robber Baron was Rockefeller who created an oil monopoly with Standard Oil which made him the world’s first Billionaire in 1910. During this period, wealth inequality rapidly increased.

  • In 1445, Gutenberg created the printing press with the first mechanical moving type. This enabled mass production of printed books. As a consequence, literacy increased. In the Ottoman empire, sultans controlled the means of printing with commissions on what should be allowed to be published. As a consequence, only a few books were printed. The fear of a literate population was too great.

All in all, Creative Destruction enables a Nation to evolve its technology, which further enables for wealth to be created for people outside the circles of the Elites. As a dictator or the Elite, the incentive to maintain the status quo is too great. Creative destruction, although rationally was excellent for the prosperity of all, did the opposite of appealing to the interest of autocratic rulers.

Because of this lack of Creative Destruction, Extractive societies with Extractive institutions cannot create sustainable economic growth and prosperity.

Extractive institutions have, however, short term growth potential that can be created. Nations like the Soviet Union saw a spur of growth after Lenin and Stalin took over. However, due to Extractive institution nature of the regime, it was impossible to sustain as people had little incentive to produce, innovate, create. In fact, when bonuses were explored, they were on the basis of throughput of production and did not incentivize people in anyway. Given that there were no property rights or any patents to be granted, there was little incentive to do better.

Historically, Nations have been Extractive and have have only moved to become Inclusive through Critical Juncture events. Example: At the turn of the 14th century, England had a Feudal order. The black plague was a driver in England to move from Extractive institutions to Inclusive Institutions. Because of the huge scarcity of labor, peasants demanded higher wages. Peasants started to free themselves from compulsory labor services and many obligations to their lords. Wages started to rise. It was then pushed back, as it happens in most Extractive Nations, in 1351 with the Statute of Laborers, which fixed wages and ordered peasants to work for their lord.

Critical junctures pushed nations between Inclusive Institution and Extractive institution. Both types, inclusive and extractive, are also self-reinforcing.

In the case of Inclusive institutions, nations this self-reinforcement is called a virtuous circle. When Nations create Inclusive Institutions, this leads to them entering a cycle where it’s harder for them to go back. This is because powerful groups see the value in having the Inclusive Institutions that made possible for them to prosper. Several mechanisms are enabled throughout this virtuous circle, one of them being the media. Journalism is a critical part of checks and balances. In the US, between 1910 and 1920, during and after the Great Depression, there were a number of efforts to implement FDR’s New Deal which was an extensive overhaul to overcome 25% of unemployed labor. The Supreme Court blocked some laws and this made FDR question, challenge and try to remove the Supreme Court in order to get his laws passed. This failed with people not supporting the cause of removal of the judges. An example of the virtuous cycle working as Inclusive Institution protected against extractive behavior

Alternatively, when having Extractive institutions, nations enter into a vicious circle. This is again easily explained because incentives are too strong for humans to deprive themselves from their status and benefits as rulers. An example: in the 19 century, after the civil war in 1865 where the confederacy lost, southern elites created what is now called Jim Crow. Jim Crow was a collection of laws passed to segregate black people from the rest of society. The Black Code, for example, removed the mobility of black labor. Even today, shockingly, section 256 of the Alabama constitution defines segregation of white and black children from schools. The point is that the incentive for the south to continue using cheap labor by reducing the status of black people was too big.

All in all: the book posits that Authoritarian Growth is never desirable nor viable as the incentive for Extractive institution is too great and it’s never sustainable.

EDIT: As the discussion in Hacker News suggested, colonialism is indeed a huge theme of this book that should not go unmentioned.

The book suggests that one of the largest manifestations of extractive behavior and institutions was colonization, particularly of South America and sub saharan Africa. Unfortunately for the world, this extraction of value by the colonizers resulted in the construction of cultures that did not break the vicious circle.

A few examples of colonialism:

  • The Dutch East Company was the second European joint stock (following the English East India Company), which was a landmark in the development of the modern corporation. Unfortunately, they were quite brutal. To pursue international trade of spices, who were in high demand due to rise in incomes from Europe and USA, valuable in Europe, the Dutch, tried to make a deal with Indonesia for the rights of the trade. However, since there was no central authority to force to make a monopoly treaty, the Dutch resorted to a different tactic. They went in 1621 to Banda, killed approximately 15,000 people, only left a few alive with know how to plant the spices. They implemented a plantation society and even brought slaves in. A genocidal approach to ensure a monopoly.

  • Throughout the Spanish colonial world in the Americas in the 16th century, similar extractive institutions and social structures emerged. After an initial phase of looting, and gold and silver lust, the Spanish created a web of institutions designed to exploit the indigenous peoples. The full gamut of encomienda, mita, repartimiento, and trajin was designed to force indigenous people’s living standards down to a subsistence level and thus extract all income in excess of this for Spaniards.

Counter points

It's important with any thesis to contemplate counter arguments.

While the book explored centuries of historical facts and critical junctures to sustain its thesis of delta in comparing inter Nation wealth, I feel as though there is an important topic to cover: wealth inequality within a country. As an example: the wealth gap in the US is rising. Because high Inequality is associated with less economic mobility, this reduces people’s ability to participate economically and, therefore, reduce the Inclusive Institution power. This means that children born in poor families become less likely over time to improve their economic status. The poor stay poor over generations even in categorical inclusive institutions. Obvious in the book however is the idea that it's the central government's responsibility to find opportunities to balance this difference. This is a massively complex topic which I'm not knowledgable to discuss but interested in learning more.

A few interesting data points on this: The Great Gatsby Curve and Pew Research Center

Another critique comes from Bill Gates, who said that this book is a major disappointment. He found the authors' views simplistic and not complete. He offers an alternative view to explain growth:

This points to the most obvious theory about growth, which is that it is strongly correlated with embracing capitalistic economics—independent of the political system. When a country focuses on getting infrastructure built and education improved, and it uses market pricing to determine how resources should be allocated, then it moves towards growth. This test has a lot more clarity than the one proposed by the authors, and seems to me fits the facts of what has happened over time far better.

Interesting to note that Bill's review got itself a review.

Another critique of this book seems to indicate that it's a too westernized and capitalistic view of how the world should work to achieve prosperity (i.e. the book relies on Ethnocentrism to posit the USA as the greatest democracy in the world).

All in all, there's reason to believe that, while the thesis of the book is provocative and interesting, doesn't seem universally accepted.

Conclusion

I picked this book as I wanted to expand horizons on economic theories. For this purpose, I consider it a great addition to a set of theories one should have. I'd like to explore further other contrasting views to complement this book.