Tuesday, October 27, 2015

Review: Why Nations Fail

Why Nations Fail tries to ask and answer several questions:

  • Why are certain nations rich or poor? Is it a matter of history?
  • Why do some nations stay poor, no matter what the World Bank, or the number of Live Aid events occur?
  • What are the ways nations that are previously poor can become rich?
Why Nations Fail espouses a theory as to how countries become wealthy and innovative. The idea is that such countries have inclusive/pluralistic political and economic institutions. Such institutions:
  • enforce property rights
  • make everyone equal under the law
  • prevent seizing of properties by government or its agents
  • prevent an elite minority from seizing institutions and operating the country or an economic resource for its own benefit and profit
  • forces groups of special interests to compromise and jealously guard against the possibility of usurpation of the institutions
Countries that are poor have extractive instituions. These institutions effectively allow an elite to effectively seize all the gains from the economic output of everyone else in the country. Furthermore, the extractive institutions are self-perpetuating, meaning that if a coup or revolution replaced the elite with another set of people, the new elites would be tempted to maintain the extractive institutions rather than replacing those institutions of more inclusive ones.

Most of the book illustrates this by recounting various histories, which include detailed histories and explanations of:
  • Why South American countries ended up with extractive instituions.
  • Why North America and Australia, despite being English colonies, ended up with relatively pluralistic institutions (the native population of both areas were too sparse to enslave, and indentured servitude was not possible when you can just run away and join the natives)
  • Why the southern (former-slave-owning) states in the USA caught up economically after the civil rights movement
  • How Botswana became an exception in Africa: having inclusive political and economic institutions and therefore having a great standard of living compared to its neighbors
Do I find these illustrations convincing? Sort of. Certainly the story is compelling. What I dislike about the social sciences, however, is that even with an over-arching theory like this one, the authors don't really generate any predictions that determine whether or not their theory is right. For instance, one theme that the authors kept repeating is that China's current growth is under an extractive regime, and they draw (appropriately) the parallels between China's growth and Russia's growth in the 1950s and 60s. (Remember, back then, even Western economists thought that the Communist states could have higher growth than the capitalistic states)

Rather than predict when that growth would slow, and that it would slow because extractive instituitions foil innovation (when anything you build can be taken away from you at any time, why work so hard), they do not provide a time frame. They write in wishy-washy terms, saying that they might be right, but the Chinese could (for whatever reason) build more pluralistic institutions. This is very unsatisfying.

Furthermore, the authors don't provide any prescriptions worth speaking of. None of this: "If you do this, this and this, you can break out of the extractive institution cycle and put your country onto a path towards prosperity and inclusiveness." They do do a good job of pointing out why development aid doesn't work, and neither does the Washington consensus prescriptions: If you don't root out the structural problems in a country, no amount of tinkering with economic policy will work. Finally, I don't think they did a good job of covering any of the Southeast Asian Tigers: Taiwan, Singapore, etc. The book covers Japan and Brazil, but Singapore and Taiwan to my mind started with authoritarian/absolutist regimes but managed to transition into first world class economies. While it could be argued that Taiwan is now a full fledged democracy with pluralist institutions, Singapore probably would not qualify.

Nevertheless, despite the flaws, the book is very much worth reading. If you think about it, they're taking a deep approach to historical and economic analysis that nobody else is doing. Previous analysis of poor countries have always left me thinking: "These people in charge of poor countries aren't stupid: they know that markets work, and that if you eliminate corruption people will be better off. So why are they still poor?" It turns out the answer is: "The people in charge aren't stupid: they know that by keeping their population poor and ignorant they can extract the fruits of their populations' labor and live like a king, even if it's bad in the long run for the country." That sort of incentive-based thinking is much more effective and explains, for instance, why companies that get big also become inefficient (and also incidentally become less innovative in the long run). After all, the typical person in a large organization is always going to what's best for him, rather than what's best for the organization.

Recommended.

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