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One of the most enduring puzzles in economics is the vast disparity in wealth and prosperity between regions of the world. Following the beginnings of the Industrial Revolution in Britain, economic growth spread rapidly to some regions, while others saw significant improvements in living standards only in the 20th century – and many have yet to industrialise.
The wealth gap between the richest and poorest nations has remained stubbornly persistent. Today, per capita GDP in the United States is roughly 50 times higher than that of the world’s poorest countries, with the wealthiest half of the global population generating over 90% of global income. These striking disparities have been remarkably persistent across time.
According to neoclassical growth theory, poorer countries should eventually catch up with richer ones as they adopt new technologies and as capital flows to where it can yield the highest returns. In these models, history doesn’t matter, as economies converge to a single long-run steady state. In practice, income disparities are enormously persistent, with poorer countries failing to narrow the gap with richer countries over many decades.
This year’s Nobel Prize in Economic Sciences honours three scholars – Daron Acemoglu, Institute Professor at MIT, Simon Johnson, Ronald A Kurtz Professor of Entrepreneurship at the MIT Sloan School of Management, and James Robinson, Reverend Dr Richard L Pearson Professor of Global Conflict Studies at the University of Chicago – whose groundbreaking research shines a light on the pivotal role of the institutions of a society in shaping long-run economic prosperity.
Acemoglu, Johnson and Robinson have shown that institutions – the formal and informal rules governing how societies function – play a critical role in shaping economic growth. Inclusive institutions, which encourage broad participation in economic and political activities, protect property rights, promote equal opportunities and uphold the rule of law, are essential for long-term prosperity. While some growth can happen without inclusivity, they argue that sustained industrial growth is far more likely when institutions are inclusive.
Institutions can be highly self-reinforcing, leading historical institutions to have a fundamental impact on economic prosperity today. The work of Acemoglu, Johnson and Robinson has brought institutions to the forefront, yielding novel insights and spurring large literatures on how institutional, historical and political factors influence economic development.
Context
Acemoglu, Johnson and Robinson introduced their influential view on long-run economic development in the early 2000s, at a time when there was growing frustration with the limited success of 20th-century development policies.
In the 1960s and 1970s, economic development strategies often emphasised state-led initiatives. While these policies plausibly succeeded in some cases, such as the development of South Korean heavy industries, they fell out of favour by the 1980s due to significant disappointments. For example, import substitution policies in Latin America largely failed to create globally competitive industries and contributed to the debt crises of the 1980s. More broadly, issues like rent-seeking and bureaucratic inefficiencies led to disillusionment with the state-led model.
In response to these shortcomings, the Washington consensus emerged, advocating market liberalisation and structural reforms. But by the late 1990s and early 2000s, its limitations were becoming increasingly evident, as highlighted by economists like the 2001 economics Nobel laureate Joseph Stiglitz (2002). At the same time, economics was undergoing a transformation, with personal computing driving a shift toward data-driven, empirical methods. This changing landscape provided fertile ground for Acemoglu, Johnson and Robinson’s institutional theory to reshape thinking about economic development.
Scholars proposed various explanations for the shortcomings of 20th-century development policies. Some argued that the problem was the overwhelming number of initiatives launched without a scientific approach to determine what worked and what didn’t. This led to a major push for evidence-based policymaking, exemplified by the 2019 Nobel Prize in Economic Sciences, which was awarded to Abhijit Banerjee, Esther Duflo and Michael Kremer (Bandiera 2019). Others, like Jeffrey Sachs, believed wealthy nations had simply not provided enough foreign aid, leaving poorer countries – disadvantaged by geography – struggling through no fault of their own.
Acemoglu, Johnson and Robinson offered an alternative perspective by focusing on political failures as a key driver of economic stagnation. While political failures had long been studied, their work shifted the focus by presenting novel evidence that historical experiences shape political institutions, which in turn drive the vast economic disparities between rich and poor nations. Their research emphasised how self-reinforcing historical factors play a critical role in shaping a country’s economic path, making it more challenging to change that trajectory through development policies. The work has sparked vast new literatures in political economy, economic development and economic history.
The origins of institutions
Do strong institutions drive prosperity, or do wealthy nations simply have the resources to build better institutions? To answer this, we need to understand how different institutions emerge, endure and evolve over time. To test the importance of institutions, Acemoglu, Johnson and Robinson (2001) developed a novel theory about the colonial origins of institutions and connected it to historical data to estimate the impact of institutions across countries.
They argued that the way in which colonisers reshaped societies had lasting effects. In places where Europeans could settle, like North America, they built institutions – such as secure property rights – that promoted long-term economic growth. But in regions where Europeans couldn’t settle due to the disease environment, they set up extractive institutions designed to maximise short-term wealth. These exploitative systems persisted, hindering long-term growth.
A related study (Acemoglu, Johnson and Robinson 2002) introduced the idea of a “reversal of fortune”. It showed that wealthier regions 500 years ago are relatively poorer today, and vice versa. To explain this intriguing correlation, they argue that colonisers enforced extractive institutions in the more prosperous, densely populated societies, and these extractive institutions in turn reduced industrial development.
I first encountered these studies as an undergraduate, when I was assigned to critique the “colonial origins” paper for a class. Intrigued, I went to James Robinson’s office hours to discuss the paper. Many people would not be keen to discuss critiques of their work, but he was quite enthusiastic, viewing it as an opportunity to think about what the work illuminated as the most promising future directions for research.
We discussed the advantages and limitations of using cross-country data, and how it makes it hard to explore historical mechanisms in depth since gathering detailed data covering hundreds of years for many countries is infeasible. He suggested that testing the significance of historical institutions using microeconomic data was the next frontier and would be an excellent topic for a thesis or term paper. I eagerly took him up on his offer to serve as an advisor, and later completed my PhD under the supervision of Daron Acemoglu at MIT.
This body of work has had a profound impact. The “colonial origins” and “reversal of fortune” papers have collectively garnered over 25,000 citations, fuelling widespread research into how institutions shape development. Equally significant is the mentorship they have provided to numerous students, colleagues and collaborators, leaving an enduring and highly influential legacy in the discipline.
Additional contexts
Acemoglu, Johnson and Robinson have applied their long-term institutional theory to a wide range of settings. In a 2005 paper, they investigate why modern economic growth began in Britain rather than elsewhere in Europe. They found that economic growth between 1500 and 1850 was concentrated in regions with access to Atlantic trade and colonialism. But this access alone wasn’t enough. The most significant economic benefits occurred in areas where the monarchy’s power was limited, allowing merchants to prosper and push for institutional changes that advanced merchant interests.
In Why Nations Fail, Acemoglu and Robinson take an even broader approach. While the focus is on modern economic prosperity, they extend their analysis back to the Neolithic Revolution when human societies made the transition from hunting and gathering to farming. They hypothesise that institutions like property rights were key in explaining why agriculture emerged in certain societies, supported by archaeological evidence showing large sedentary settlements before the adoption of farming.
Together with co-authors, the new laureates have empirically estimated the importance of institutions for development across a variety of contexts, including the impact of institutional reforms during the French Revolution in areas that today comprise Germany (Acemoglu, Cantoni, Johnson and Robinson 2011), the long-lasting impacts of exposure to the Holocaust in Russia (Acemoglu, Hassan and Robinson 2011) and the impact of increased competition among local chiefs in colonial-era Sierra Leone on long-term improvements in health and literacy (Acemoglu, Reed and Robinson 2014) .
The persistence and evolution of institutions
To understand the role of institutions in long-term prosperity, it’s essential to examine why they persist and evolve. Acemoglu and Robinson have focused on the durability of autocracies and democracies, as well as the transitions between them. Their innovative approach merges political science theories on democratic reform with game theory, creating a dynamic model that explains how institutions change and endure. This framework has become a foundational tool for analysing political and institutional reform.
In many societies, the expansion of voting rights was historically followed by the introduction of redistributive welfare programmes (Acemoglu and Robinson 2000). But why would ruling elites voluntarily give up their monopoly on political power?
Acemoglu and Robinson argue that this was a strategic move to avoid the higher costs of a potential revolution in the face of social unrest. Making economic transfers alone is not credible to diffuse unrest because non-elites, facing collective action challenges, know their ability to pressure the elites is temporary, and hence economic concessions could be reversed in the future. Institutional change, in contrast, shifts the distribution of political power, serving as a more durable commitment to continuing redistribution and resolving the credibility problem.
Acemoglu and Robinson (2001) subsequently expanded this framework, exploring why some societies oscillate between autocracy and democracy rather than making a permanent shift. In The Economic Origins of Dictatorship and Democracy (2006), they further developed their formal analysis of how democracies are created and consolidated. In 2008, they investigated “captured democracies”, where democratic regimes adopt the economic institutions favoured by elites, even though the elites are a political minority.
Why do elites not always welcome economically beneficial technologies and simply tax the returns? In a 2006 study, Acemoglu and Robinson formalise how elites may view economic growth as a double-edged sword that could increase the probability of democratisation or revolution by empowering new segments of society. Finally, in a 2019 article, Acemoglu, Naidu, Restrepo and Robinson empirically examine whether democracy promotes economic growth, providing valuable insights into the connection between governance and prosperity.
The big picture
Acemoglu, Johnson and Robinson presented groundbreaking theories about institutions, supported by empirical evidence. A key principle of modern economics is to use theory to guide empirical research. Theories simplify the complex world by abstracting away many details to focus on specific mechanisms. As Jorge Luis Borges wrote: “thinking is to forget differences, to abstract, to generalize.” The true test of a theory is whether it can still provide valuable insights, even with the many necessary simplifications.
This approach, central to economics, contrasts with that of historians, who typically focus on specific regions and time periods, aiming to explain as much variation as possible. While this has led to some critiques of the colonial institutions hypothesis, these approaches can be quite complementary. Exploring where broad economic theories align with detailed historical accounts helps us to deduce whether big picture ideas hold explanatory power. Equally important is identifying where they diverge – what complexities has the theory abstracted from that are crucial to reintegrate into the analysis?
This interplay between economic theory and history helps to guide and expand more detailed literatures, deepening our understanding. The theories developed by Acemoglu, Johnson and Robinson on institutional persistence and change have both enriched their own empirical research and laid the groundwork for extensive literatures, reshaping how economists think about global economic disparities.
Source: cepr.org
