Political and economic institutions, which are ultimately the choice of society, can be inclusive and encourage economic growth. Or they can be extractive and become impediments to economic growth. Nations fail when they have extractive economic institutions, supported by extractive political institutions that impede and even block economic growth. But this means that the choice of institutions—that is, the politics of institutions—is central to our quest for understanding the reasons for the success and failure of nations. We have to understand why the politics of some societies lead to inclusive institutions that foster economic growth, while the politics of the vast majority of societies throughout history has led, and still leads today, to extractive institutions that hamper economic growth.
It might seem obvious that everyone should have an interest in creating the type of economic institutions that will bring prosperity. Wouldn’t every citizen, every politician, and even a predatory dictator want to make his country as wealthy as possible?
Let’s look the Kingdom of Kongo. Though this kingdom collapsed in the seventeenth century, it provided the name for the modern country that became independent from Belgian colonial rule in 1960. As an independent polity, Congo experienced almost unbroken economic decline and mounting poverty under the rule of Joseph Mobutu between 1965 and 1997. This decline continued after Mobutu was overthrown by Laurent Kabila. Mobutu created a highly extractive set of economic institutions. The citizens were impoverished, but Mobutu and the elite surrounding him, known as Les Grosses Legumes (the Big Vegetables), became fabulously wealthy.
Mobutu built himself a palace at his birthplace, Gbadolite, in the north of the country, with an airport large enough to land a supersonic Concord jet, a plane he frequently rented from Air France for travel to Europe. In Europe he bought castles and owned large tracts of the Belgian capital of Brussels.Wouldn’t it have been better for Mobutu to set up economic institutions that increased the wealth of the Congolese rather than deepening their poverty? If Mobutu had managed to increase the prosperity of his nation, would he not have been able to appropriate even more money, buy a Concord instead of renting one, have more castles and mansions, possibly a bigger and more powerful army? Unfortunately for the citizens of many countries in the world, the answer is no .Economic institutions that create incentives for economic progress may simultaneously redistribute income and power in such a way that a predatory dictator and others with political power may become worse off.
The fundamental problem is that there will necessarily be disputes and conflict over economic institutions. Different institutions have different consequences for the prosperity of a nation, how that prosperity is distributed, and who has power. The economic growth which can be induced by institutions creates both winners and losers. This was clear during the Industrial Revolution in England, which laid the foundations of the prosperity we see in the rich countries of the world today. It centered on a series of path breaking technological changes in steam power, transportation, and textile production. Even though mechanization led to enormous increases in total incomes and ultimately became the foundation of modern industrial society, it was bitterly opposed by many. Not because of ignorance or shortsightedness; quite the opposite. Rather, such opposition to economic growth has its own, unfortunately coherent, logic. Economic growth and technological change are accompanied by what the great economist Joseph Schumpeter called creative destruction. They replace the old with the new. New sectors attract resources away from old ones. New firms take business away from established ones. New technologies make existing skills and machines obsolete. The process of economic growth and the inclusive institutions upon which it is based create losers as well as winners in the political arena and in the economic marketplace. Fear of creative destruction is often at the root of the opposition to inclusive economic and political institutions.
European history provides a vivid example of the consequences of creative destruction. On the eve of the Industrial Revolution in the eighteenth century, the governments of most European countries were controlled by aristocracies and traditional elites, whose major source of income was from landholdings or from trading privileges they enjoyed thanks to monopolies granted and entry barriers imposed by monarchs. Consistent with the idea of creative destruction, the spread of industries, factories, and towns took resources away from the land, reduced land rents, and increased the wages that landowners had to pay their workers. These elites also saw the emergence of new businessmen and merchants eroding their trading privileges. All in all, they were the clear economic losers from industrialization. Urbanization and the emergence of a socially conscious middle and working class also challenged the political monopoly of landed aristocracies.
So with the spread of the Industrial Revolution the aristocracies weren’t just the economic losers; they also risked becoming political losers, losing their hold on political power. With their economic and political power under threat, these elites often formed a formidable opposition against industrialization.
The aristocracy was not the only loser from industrialization. Artisans whose manual skills were being replaced by mechanization likewise opposed the spread of industry. Many organized against it, rioting and destroying the machines they saw as responsible for the decline of their livelihood. They were the Luddites, a word that has today become synonymous with resistance to technological change. John Kay, English inventor of the “flying shuttle” in 1733, one of the first significant improvements in the mechanization of weaving, had his house burned down by Luddites in 1753. James Hargreaves, inventor of the “spinning jenny,” a complementary revolutionary improvement in spinning, got similar treatment.
In reality, the artisans were much less effective than the landowners and elites in opposing industrialization. The Luddites did not possess the political power—the ability to affect political outcomes against the wishes of other groups of the landed aristocracy.
In England, industrialization marched on, despite the Luddites’ opposition, because aristocratic opposition, though real, was muted. In the Austro-Hungarian and the Russian empires, where the absolutist monarchs and aristocrats had far more to lose, industrialization was blocked. In consequence, the economies of Austria-Hungary and Russia stalled. They fell behind other European nations, where economic growth took off during the nineteenth century.
The success and failure of specific groups notwithstanding, one lesson is clear: powerful groups often stand against economic progress and against the engines of prosperity. Economic growth is not just a process of more and better machines, and more and better educated people, but also a transformative and destabilizing process associated with widespread creative destruction. Growth thus moves forward only if not blocked by the economic losers who anticipate that their economic privileges will be lost and by the political losers who fear that their political power will be eroded.
Conflict over scarce resources, income and power, translates into conflict over the rules of the game, the economic institutions, which will determine the economic activities and who will benefit from them. When there is a conflict, the wishes of all parties cannot be simultaneously met. Some will be defeated and frustrated, while others will succeed in securing outcomes they like. Who the winners of this conflict are has fundamental implications for a nation’s economic trajectory. If the groups standing against growth are the winners, they can successfully block economic growth, and the economy will stagnate.
The logic of why the powerful would not necessarily want to set up the economic institutions that promote economic success extends easily to the choice of political institutions.
In an absolutist regime, some elites can wield power to set up economic institutions they prefer. Would they be interested in changing political institutions to make them more pluralistic? In general not, since this would only dilute their political power, making it more difficult, maybe impossible, for them to structure economic institutions to further their own interests. Here again we see a ready source of conflict. The people who suffer from the extractive economic institutions cannot hope for absolutist rulers to voluntarily change political institutions and redistribute power in society. The only way to change these political institutions is to force the elite to create more pluralistic institutions.
In the same way that there is no reason why political institutions should automatically become pluralistic, there is no natural tendency toward political centralization. There would certainly be incentives to create more centralized state institutions in any society, particularly in those with no such centralization whatsoever. For example, in Somalia, if one clan created a centralized state capable of imposing order on the country, this could lead to economic benefits and make this clan richer. What stops this? The main barrier to political centralization is again a form of fear from change: any clan, group, or politician attempting to centralize power in the state will also be centralizing power in their own hands, and this is likely to meet the ire of other clans, groups, and individuals, who would be the political losers of this process. Lack of political centralization means not only lack of law and order in much of a territory but also there being many actors with sufficient powers to block or disrupt things, and the fear of their opposition and violent reaction will often deter many would-be centralizers. Political centralization is likely only when one group of people is sufficiently more powerful than others to build a state. In Somalia, power is evenly balanced, and no one
clan can impose its will on any other. Therefore, the lack of political centralization persists.
Source; WHY NATIONS FAIL, By Daron Acemeglu and James A. Robinson. 2011 Economics Nobel Prize Research Book . pp 97-101.