The Rise and Fail of Countries and their Economic Elite

US Economic Performance: Forty Years of economic stagnation for all but the Very Rich.

There’s nothing new about trickle-down economics policies and their failure to deliver growth and jobs.  The 1980s saw a lot of empirical testing of Reagan-Bush Policies and new growth models. Basically, the parts of these policies that led to growth were those that put money and spending power into the demand side  and not the supply side.  The failure of the Bush 2 policies to provide sustained growth of jobs and the real economy–as well as real per capita income–reinforced earlier findings.  However, this hasn’t stopped the spread of political memes that falsely assert that providing vast wealth for “job creators” is best for an economy. It’s a popular fairy tale spun by Republican Politicians and it’s unsupported by evidence as well as theory.

Development economists have been studying why some countries are rich and some are poor for some time. There have been a number of factors identified that seem to drive growth.  Education of women, good legal and justice systems that protect property rights, and basic economic freedom are some of the factors that have been identified over the years.   Daron Acemoglu–a Turkish M.I.T. professor–has written an important book based on his research and the research of his colleague James Robinson called “Why Nations Fail”. Their work explains how nations can basically destroy their economic futures when they let their richest citizens loot their poorest.  Evidence comes from both historical and present day economies.

Surely even the most kleptocratic dictator would be in favor of economic development. Economic development means greater income, greater taxes and more stuff to grab, so what’s not to like about it? But actually, it often doesn’t work that way.

In the early 1980s in Takasera, a village in Rukum District in western Nepal, a group of locals decided to begin a development project and bought a Swiss-made water mill which would power machinery such as a press to make oil and a saw mill. The community sent a group of men to Kathmandu who learned how to dismantle the machinery and then put it back together again. The machinery was brought back and successfully put into operation. In 1984, a government official wrote saying that in autonomously undertaking this project the community had “usurped the role of the king” and the mill would have to be shut down. When the locals refused, the police was sent to destroy the mill. The mill was only saved because the villagers were able to ambush and disarm the police.

So why was the Nepalese government opposed to the mill? The answer is that the monarchy and the elite surrounding it, who controlled the government, were afraid of becoming political losers. Economic progress brings social and political change, eroding the political power of elites and rulers, who in response often prefer to sacrifice economic development for political stability.

This is a prime example of politicians blocking technology that would improve the country’s economy to maintain political control.  This suboptimal outcome is one of many examples the two economists have found and documented in their study.

But through a series of legendary — and somewhat controversial — academic papers published over the past decade, Acemoglu has persuasively challenged many of the previous theories. (If poverty were primarily the result of geography, say, or an unfortunate history, how can we account for the successes of Botswana, Costa Rica or Thailand?) Now, in their new book, “Why Nations Fail,” Acemoglu and his collaborator, James Robinson, argue that the wealth of a country is most closely correlated with the degree to which the average person shares in the overall growth of its economy. It’s an idea that was first raised by [Adam] Smith but was then largely ignored for centuries as economics became focused on theoretical models of ideal economies rather than the not-at-all-ideal problems of real nations.

Consider Acemoglu’s idea from the perspective of a poor farmer. In parts of modern sub-Saharan Africa, as was true in medieval Europe or the antebellum South, the people who work the fields lack any incentive to improve their yield because any surplus is taken by the wealthy elite. This mind-set changes only when farmers are given strong property rights and discover that they can profit from extra production. In 1978, China began allowing farmers to benefit from any surplus they produced. The decision, most economists agree, helped spark the country’s astounding growth.

According to Acemoglu’s thesis, when a nation’s institutions prevent the poor from profiting from their work, no amount of disease eradication, good economic advice or foreign aid seems to help. I observed this firsthand when I visited a group of Haitian mango farmers a few years ago. Each farmer had no more than one or two mango trees, even though their land lay along a river that could irrigate their fields and support hundreds of trees. So why didn’t they install irrigation pipes? Were they ignorant, indifferent? In fact, they were quite savvy and lived in a region teeming with well-intended foreign-aid programs. But these farmers also knew that nobody in their village had clear title to the land they farmed. If they suddenly grew a few hundred mango trees, it was likely that a well-connected member of the elite would show up and claim their land and its spoils. What was the point?

This is basically the idea that disincentives cut both ways which is an idea lost on Republican Politicians.  Why work if the fruit of your labor goes to absentee owners and investors?

Acemoglu, Robinson and their collaborators did not come up with the idea that incentives matter, of course, nor the notion that politics play a role in economic development. Their great contribution has been a series of clever historical studies that persuasively argue that the cheesiest of slogans is actually correct: the true value of a nation is its people. If national institutions give even their poorest and least educated citizens some shot at improving their own lives — through property rights, a reliable judicial system or access to markets — those citizens will do what it takes to make themselves and their country richer. This suggests, among other things, that instead of supporting one-off programs promoting health or agricultural productivity, the international community should focus its aid efforts on deep political and economic change.

Perhaps just as interesting, “Why Nations Fail” also shows the effects of different economic and political systems over the centuries. The sections on ancient Rome and medieval Venice are particularly compelling, because they show how fairly open and prosperous societies can revert to closed and impoverished autocracies. It’s hard to read these sections without thinking about the present-day United States, where economic inequality has grown substantially over the past few decades. Is the 1 percent emerging as a wealth-stripping, poverty-inducing elite?

Well, maybe. Acemoglu and Robinson’s frequent collaborator Simon Johnson, the former chief economist at the International Monetary Fund, told me that financial firms have so thoroughly co-opted the political proc­ess that the American economy has become fundamentally unsound. “It’s bad and getting worse,” he told me. Barring some major shift in our political system, he suggested, the United States could be on its way to serious economic failure.

I downloaded their most current working paper which has a lot of political ramifications.  (Robinson is a political science professor at Harvard.)It’s on why voters dismantle checks and balances on political and economic elites.  You probably want to avoid the model and just look at the bottom line.  Essentially, when we remove the checks and balances in our government, we make it easier and cheaper for the richest in the country to bribe the political class.  This creates a disconnect between the politics and spending and tax policies.  It’s an interesting analysis and way to model the current disconnect between polling of the electorate and policy coming out of legislatures.  The most interesting outcome of the model is that this behavior eventually makes every one worse off.  The ability of the rich to bribe politicians is central to the outcomes.

One of the most interesting theses in the new books is elucidated in this Guardian Review.  It’s about China and its potential.

Far from seeing China as the clue to spreading prosperity, Acemoglu and Robinson see it as yet another instance of a society rushing into a cul-de-sac. China is not, on their analysis, on course for our own level of prosperity.

Their argument is that the modern level of prosperity rests upon political foundations. Proximately, prosperity is generated by investment and innovation, but these are acts of faith: investors and innovators must have credible reasons to think that, if successful, they will not be plundered by the powerful.

For the polity to provide such reassurance, two conditions have to hold: power has to be centralised and the institutions of power have to be inclusive. Without centralised power, there is disorder, which is anathema to investment.

China most certainly ticks this box – it has centralised power and order in spades. Some African societies don’t; localised power usurps the authority of the state. But China resoundingly fails to tick the box of inclusive institutions. Acemoglu and Robinson quote a summary of the structure of Chinese political power: “The party controls the armed forces; the party controls cadres; and the party controls the news.”

That states need order to prosper is important but no longer controversial. That they need inclusive institutions is, in view of China’s success, wildly controversial. Their argument is that order without inclusive institutions may enable an economy to escape poverty, but will not permit the full ascent to modern prosperity. Their explanation is that if the institutions of power enable the elite to serve its own interest – a structure they term “extractive institutions” – the interests of the elite come to collide with, and prevail over, those of the mass of the population.

So, in order for nations to grow, institutions should focus on inclusion instead of exclusion.  This seems like an intuitive suggestion and an unnecessary one for a democracy.  However, their work suggests that the rich and political elite will work against this if the right incentives and institutions exist.  It’s an interesting way to look at the current situation in the U.S. where politicians–using money from huge donors–work to remove regulations and dismantle organizations that increase inclusion.  Notice how public education, community activists, unions, and other institutions aimed at including workers and regular folks into policy making have been demonized recently.    I’m definitely up for reading more on this.


8 Comments on “The Rise and Fail of Countries and their Economic Elite”

  1. bostonboomer says:

    This is just fascinating. Maybe we should send a copy of the book to President Obama. I really think he still buys into Reaganomics much of the time.

    Thanks for all your hard work pulling this together, Dak. I wasn’t even that hard to understand.

  2. peggysue22 says:

    Interesting material, Dak. I’ve seen this book mentioned on several of the financial blogs. There certainly seems to be a disconnect between politics and the spending and tax policies being proposed. I read another piece by a former GOP [Reagan, I think] aide [this is in addition to Stockman and Bartlett] basically say that if you dig into the Republican candidates’ programs, their proposed spending and tax cut plans, the debt load is far worse than Obama’s plan, which they screech about. Yet no one is willing to call any of them on it. The silence is deafening.

    The problem is if the elites kill the host, don’t they end up sh*t’s creek, too? Or am I being too optimistic :0).

    Good one.

  3. janicen says:

    Fascinating. Thanks for this post, dak. The power elite would weaken the economy and the society rather than to let those people see any benefit.