[Jeffrey Frankel] What causes prosperity?

Why have some countries grown rich and others not? The three winners of this year’s Nobel Prize in Economic Sciences -- Daron Acemoglu, Simon Johnson and James A. Robinson -- offer a simple answer: institutions. Countries with “inclusive” institutions -- which underpin an open society, accountable government, economic freedom and the rule of law -- do better than those with “extractive” institutions that reward those in power.

The World Bank’s institutional quality rankings seem to support this assessment. Based on six governance indicators -- control of corruption, voice and accountability, government effectiveness, political stability and absence of violence, regulatory quality and the rule of law -- these rankings are highly correlated with national income per capita, from top (Denmark and Finland) to bottom (Equatorial Guinea and South Sudan).

But correlation does not mean causation. Showing that inclusive institutions led to prosperity -- not the other way around -- is no easy feat. After all, many countries pursue, for example, reforms to their tax and regulatory systems as the economy becomes more developed, not before. South Korea climbed in the World Bank’s institutional-quality rankings during its period of democratization, which came after its economic takeoff, suggesting that high-quality institutions were more likely a result than a cause of growth.

Usually, the two kinds of development -- institutional and economic -- occur simultaneously, making it difficult to distinguish cause and effect. That is why the causality question long seemed to be an insoluble problem. Acemoglu, Johnson and Robinson tackled it by examining the trajectories of European colonies over the last five centuries.

When Europeans arrived in areas with valuable commodities such as gold and sugar, their primary objective was to extract wealth, for which they used slavery and rule by an autocratic elite. A government that does not rely on tax revenue and can retain power by force -- for example, by retaining physical control of gold or silver mines, sugar plantations or oil wells -- has little incentive to develop political and economic systems that deliver inclusive prosperity.

In places with less natural wealth -- such as North America -- extraction held less appeal for European colonizers. In the Treaty of Breda of 1667, the Dutch ceded their claim to New Netherland -- which included New York and adjacent 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 tiny Guadeloupe.

And yet, what were once less appealing colonies are the economies that industrialized first. To explain this “reversal of fortunes” -- and, more fundamentally, the causal relationship between institutions and prosperity -- the Nobel laureates examined an exogenous determinant of institutions: the rate of settler mortality at the time of colonization, which varied widely with local climate conditions.

It might seem like a strange approach. But the idea was that, in places where settlers were not wiped out by local diseases, they had an incentive to create effective institutions that would support their new societies’ well-being. So, when the Industrial Revolution arrived, the economies where Europeans had settled were far better equipped to take advantage of it than the ones from which Europeans had focused on extracting natural wealth. Ultimately, this theory was borne out: the higher the mortality rate among colonizers, the worse the subsequent institutions and the lower today’s gross domestic product per capita.

Some might view this finding as fatalistic, interpreting it to mean that countries are prisoners of their climates and histories. But Acemoglu, Johnson and Robinson do not argue that all or even most of the variation in institutions reflects settler mortality. They say only that some of it does, and reason that other sources of institutional differences -- especially policy decisions made by non-fatalistic leaders -- can have similar effects.

Some might also misinterpret Acemoglu, Johnson and Robinson as claiming that Western institutions are superior to others even though the institutions European settlers established can hardly be considered “inclusive.” No one doubts that the European settlers treated locals abysmally in the settler colonies no less than the extractive ones. But their appalling practices -- slavery, land seizure and rule by a foreign elite -- had been commonplace worldwide for millennia at the time of colonization. It was Europeans who ended up leading the way in banning slavery -- Britain did so in 1834, compared to 1981 in Mauritania -- arguably because their institutions contained the rudiments of principles like equality, out of which the antislavery movement grew.

Beyond their moral importance, democracy, the rule of law, low corruption, economic freedom and absence of a stratified caste system tend to yield better economic outcomes than their alternatives. Their value could thus be viewed as universal, even if, historically, they generally developed more rapidly in Europe and European-settled lands. Isaac Newton discovered the law of gravity in England, but it does not apply only there or in former British colonies.

Neither a disease-prone climate nor an exploitative colonial history need prevent a country from undertaking social, political and economic reforms. And herein might lie the most important message of this year’s Nobel Prize-winning research: leaders everywhere have the power to build the kinds of inclusive institutions that can underpin long-term prosperity.

Jeffrey Frankel

Jeffrey Frankel is a professor of capital formation and growth at Harvard University. The views expressed here are the writer’s own. -- Ed.

(Project Syndicate)