Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. An earlier version appeared at Project Syndicate and the Korea Herald. 

October 25, 2024 — Why have some countries grown rich and others not?   The three winners of this year’s Nobel Prize — Daron Acemoglu, Simon Johnson and Jim Robinson — offered a one-word answer: Institutions.  Specifically, “inclusive institutions,” which refers to an open society, accountable government, economic freedom, and the rule of law.

To illustrate concretely, the World Bank offers country-by-country indicators of six aspects of institutional quality: control of corruption, voice and accountability, government effectiveness, absence of violence, regulatory quality, and rule of law.  At the top of the rankings are Denmark and Finland.  At the bottom are Equatorial Guinea and South Sudan.  Across a broad set of countries, these indicators are indeed highly correlated statistically with national income per capita.

1. Sugar and gold, versus industrialization

Acemoglu, Johnson and Robinson (AJR) argue that institutions are long-lasting. Four centuries ago, Europeans considered the colonies that exported commodities such as gold to be the most valuable.  But a government that can stay in power by force — for example, by retaining physical control of gold or silver mines, sugar plantations or oil wells — does not have as much incentive to develop conditions conducive to an economically prosperous citizenry, in part because the government doesn’t depend on the tax revenue.  Dependence on rule by an autocratic elite and on slavery (or later, a class system) left the extractive colonies ill-equipped to take advantage of the industrial revolution when it arrived.

The colonizers valued small sugar-producing plots of land in the Caribbean more highly than they valued future-industrializing but sugar-free holdings in North America.  My favorite illustrations: In the Treaty of Breda (1667), the Dutch ceded their claim to New Netherland (New York and neighboring lands) to the English in exchange for Suriname in South America. A century later, the French were willing to give up Canada, so long as they could keep their sugar plantations on Guadeloupe.  Three centuries later, the resource-rich colonies had become independent countries, but as victims of the Natural Resource Curse they had not industrialized, while North America had.  AJR call this reversal of fortunes.

2. Settler Mortality

AJR are not the only ones to have emphasized the importance of institutions to economic development.  Their original unique contribution to the field was an idea of how to address the causality question, which had previously seemed an insoluble stumbling block for the econometrics of development.  How do we know that high institutional quality is a cause of economic growth, and not merely a result?  Think of reforms, for example, that improve countries’ tax and regulatory systems as the economy develops.  South Korea climbed in the institutional quality rankings during its period of democratization, which came subsequent to its economic takeoff, and thus was more likely a result of growth than a cause. Usually, the two kinds of development – institutional and economic — occur simultaneously, making it difficult to distinguish which is causing which.

AJR, in their 2001 paper, “Colonial Origins of Comparative Development,” addressed the causality problem by examining an exogenous determinant, or “instrument”, for institutions.  (In econometrics, an instrumental variable can isolate an exogenous component in fluctuations of an endogenous variable.)  Their proposed instrument was the rate of settler mortality at the time of colonization, or more specifically the mortality rate in historical records of soldiers and clergy, because that is where they found data.  Settler mortality may sound like a strange variable on which to focus.  But the AJR theory was that where European settlers were not wiped out by local disease, they put down roots, and so put good institutions in place, which eventually led to economic development.  In contrast, those colonies where the climate was inhospitable to Europeans were given extractive institutions.  It turned out that AJR’s theory worked:  first, colonies with higher settler mortality rates tended to develop better institutions and, second, even where this accident of climate was the reason for the institutions, these are the countries that were able to achieve more rapid industrialization later on.

3. Misinterpretations

Some misinterpreted the AJR finding as fatalistic: they inferred the message that countries are the prisoners of their climate and history.  But AJR did not say all or even most of the variation in institutions was due to settler mortality.  The argument was rather that some of the variation in institutions was due to settler mortality, and that similar effects would result from other sources of variation in institutions — most importantly, from policy decisions made in real time by non-fatalistic leaders.

A second possible misinterpretation is that the AJR argument is suspect because it sounds like a claim that Western institutions are superior to institutions in the rest of the world.  There is no doubt that Europeans, even where they did settle treated the locals abysmally — Native Americans in North America, Native Africans in South Africa or Kenya, or aboriginal peoples in Australia and New Zealand.  Emphasizing the word “inclusive” in describing the desirable institutions that accompanied settler colonization might seem to belie that these colonies practiced slavery, land seizures, and rule by an elite as much as did the extractive colonies.

But slavery and rule by a closed elite had been attributes of most civilizations for millennia before European colonization, albeit not previously backed up by the power of western weapon and technology. One could argue that Europeans stand out in the 19^th century as essentially the first to ban slavery.  Britain did so in 1834.  (Mauritania did not officially abolish slavery until 1981.)  The anti-slavery movement grew out of philosophical principles such as the idea of equality, the rudiments of which were present in European institutions in preceding centuries. Attributes such as economic freedom, property rights, rule of law, absence of a stratified caste system, democracy, independent checks on the power of the executive, and low corruption — in addition to their moral value — yield better economic performance on average. Their value could be viewed as universal, even if they tended to develop more rapidly in Europe and European-settled lands, as a generalization.  By analogy, the law of gravity is universal, even though its discovery via physics came in Europe.

Of course, other societies worldwide have had their own unique histories and cultures, their own frameworks for governance and social organization, and their own innovations and accomplishments.

Institutions remain central to economic development. It is too bad that the colonizers left behind poor institutions in so many places.  But neither a disease-prone climate nor an unfortunate colonial history need prevent a country from undertaking social, political and economic reforms to improve its long-term economic performance. Leaders have free will and can work to re-vamp their countries’ institutions. That may be the most important conclusion to take away from this year’s Nobel Prize winners.

This post written by Jeffrey Frankel.