How Institutions Shape a Nation's Prosperity: Insights from Nobel Laureates

The three Nobel laureates have demonstrated the importance of societal institutions for a country’s prosperity.

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The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2024 was awarded on Monday, 14 October, to Daron Acemoglu, Simon Johnson, and James Robinson for their research on the role of institutions in shaping a country's economic prosperity.

James Robinson is a British American economist at the University of Chicago, Simon Johnson is a British economist at the Massachusetts Institute of Technology, and Daron Acemoglu is a Turkish American economist at the Massachusetts Institute of Technology.  

According to the citation, the prize is given "for studies of how institutions are formed and affect prosperity," which means that sociological and political study is just as much a part of it as economic research.

What Their Research Demonstrates

Their research demonstrates how societal institutions significantly impact a country's economic prospects. They look at historical occurrences like colonisation to illustrate how the institutions put in place during these times have a lasting impact on whether a nation develops economically or stays trapped in poverty.

In this context, their research talks about the history of European colonialism and the contrast in the fortunes of countries such as the US or Australia versus countries in Sub-Saharan Africa or South Asia.

The laureates' research showed how European colonisation had dramatic yet divergent impacts worldwide, depending on whether the coloniser’s focus was on extracting resources (extractive) or setting up long-term institutions to benefit European migrants (inclusive).

This means that the nature of colonial institutions was extractive in already rich countries or where European settlers did not survive well because of illnesses or the climate. 

In contrast, in countries that were poorer initially or had better climates, Europeans built more inclusive institutions like their own countries.

Findings

The established institutions occasionally underwent significant changes due to European colonisation across the globe, but not always. The exploitation of the native population and the extraction of natural resources for the advantage of the colonisers were the goals in initially prosperous colonies. In other cases, the colonisers established inclusive economic and political structures.

This, they found, resulted in a "reversal of fortune" where former colonies that were once rich became poor.

In contrast, some poorer countries where institutions were often set up were, in the end, able to garner generalised prosperity through them. One of their research works used the example of Nogales, located on the border between the USA and Mexico, to explain this role of institutions.

This is also the theme in Acemoglu and Robinson’s 2012 book – Why Nations Fail: The Origins of Power, Prosperity, and Poverty.

In its statement, the committee mentions that the wealthiest 20 percent of nations are currently almost 30 times more affluent than the poorest 20 percent.

Furthermore, the income disparity still exists; despite economic growth, the poorest countries are not catching up to the richest – a classic explanation for why global inequality persists. A few of their findings, which can be explained in the Indian context, follow.

How Does Their Research Explain India’s Story?

When societal institutions become extractive, they provide short-term gains for the people in power. The ruling class faces a problem when revolution is a real possibility, and the common masses do not trust their promises of future economic reforms. 

However, they would rather stay in power and attempt to appease the public by promising economic reforms. Still, if things calm down, the populace is unlikely to believe that they will not revert to the previous system.

Ultimately, establishing democracy and transferring power might be the only viable solution. This is what happened in India’s case before independence. Their results also have other implications in the Indian context.

Compared to Australia or New Zealand, the diseases in India were far more common and hazardous to the British colonists. Historical mortality records from colonial times show a substantial correlation between disease prevalence and present-day economic prosperity.

Where the diseases were most dangerous to Europeans, we now find poverty, dysfunctional economic systems, highest levels of corruption, and the weakest rule of law. The extractive institutions the European colonists either created or decided to maintain, if it benefited them, are a major contributing factor.

This is what made India's colonial rule extractive compared to that of, say, Australia's. A direct fallout of this is industrial productivity in modern-day India, greater than that of the US, as late as the middle of the eighteenth century, which underwent a significant transformation since the beginning of the nineteenth century.

Like India, their model also has been used to explain the democratisation process in Western Europe at the end of the nineteenth century and in the early twentieth century. Their theoretical research shows that an ideal situation is when democratic nations governed by the rule of law end up having wealthier citizens.

Summing Up

Sixteen former winners of the Nobel Prize in Economic Sciences recently issued a widely reported statement sharing their deep concern about the US' economic policies, especially inflation-related policies and fiscally irresponsible budgets, if Donald Trump wins the Presidency in November.

Acemoglu has called Trump "a threat to democracy" and discussed the potential risks if he gets voted back to power.

This seems very interesting, as the Nobel Committee has recognised research involving democracy and the role of institutions at a time when democracy appears to be losing out.

In the years to come, the quadrangular nexus between the role of institutions vis-à-vis democracy, inequality, poverty, and economic growth will become all the more critical.

(Sovik Mukherjee is an Assistant Professor in Economics, Faculty of Commerce and Management, St Xavier’s University, Kolkata. This is an opinion piece, and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)