Cracking the prosperity code

Nobel winners in Economics emphasise role of inclusive institutions in fostering sustainable growth

In a momentous announcement, the Royal Swedish Academy of Sciences bestowed the 2024 Nobel Prize in Economics upon Daron Acemoglu, Simon Johnson, and James A. Robinson.

These economists have revolutionised our understanding of the intricate interplay between institutions and economic development. Their groundbreaking research has illuminated the pathways to prosperity and the pitfalls of stagnation, providing policymakers with invaluable insights for fostering inclusive and sustainable growth. These economists have, in essence, cracked the code of prosperity.

The research by MIT professor Acemoglu and Robinson, on the importance of institutions in explaining economic growth and political development, culminated in the best-selling book ‎Why Nations Fail (2012). One of the recurring tropes from their work is how colonial heritage endures over generations.

These demarcate extractive institutions that are species of penetration, some or all the way down imposed by colonial powers, and which frustrate economic development and introduce massive inequalities. Regarding sustainable development, it is imperative to have inclusive institutions that provide economic possibilities and serve as a safeguard of civil rights.

The winners stress the importance of property rights based on a secure foundation as central to economic development, which makes sense because lack of proper title is what causes land tenure in much poorer nations.

Confidence in ownership gives individuals an incentive to invest, innovate, and risk their capital – these are the pillars of increasing economic prosperity. Unfortunately, powerful elites often block institutional reforms that they believe threaten their vested interests, no matter how beneficial these might be for society.

Acemoglu and Robinson's vast body of empirical evidence points to the institution-economics link as a cause-effect relationship. Their results have broad policy implications and their emphasis on good governance, the rule of law, and inclusive institutions has had a global impact influencing policymakers across a wide range of countries. Their insights have resulted in new attention to policy efforts intended to promote economic growth by reducing inequality.

The work of Acemoglu, Johnson, and Robinson has fundamentally changed the way we think about economic development. They argue that prosperity is driven primarily by institutions, which include the rules and norms governing economic and social interactions (not geography, culture, or natural resources). Strong property rights, effective governance, and equitable opportunities in an inclusive institution encourage investment, innovation, and entrepreneurship. These institutions create trust, reduce uncertainty and provide incentives to engage in productive behaviour, which underpins economic growth. On the reverse, extractive institutions inhibit development because it causes power and wealth to become centralised.

At the heart of it is a chicken-and-egg problem: do institutions drive economic development, or does growth generate better rules? It is a complex, dynamic relationship. In this case, economic growth may lead to the development of more inclusive institutions if an expanding middle class pushes for accountability in government. But entrenched extractive institutions can prevent economic development from happening, consolidating powerful vested interests that fight reform. Acemoglu and Robinson provide evidence supporting their theories about the impact of institutions on economic growth. They compare countries with similar geography and culture but different institutional histories. Their research suggests that countries with inclusive institutions, often former British colonies, tend to have higher economic growth than those with extractive institutions, often former Spanish or Portuguese colonies.

Road for reform

Acemoglu, Johnson, and Robinson’s insights are highly relevant to policymakers interested in promoting economic development and quality of life. Their research highlights the need to strengthen and build inclusive institutions as a base for sustainable development. Governments must have a singular focus on pro-gain reforms that are essential for fostering economic development – strengthening property rights, the rule of law, and political accountability. In addition, they can invest in education and healthcare to bring about a decent competition field for all citizens. And importantly, tamp down socio-political tensions to contain the extractive institutions that have lingered on through centuries.

One of the enduring contributions to our understanding over time will be that made by Acemoglu, Johnson, and Robinson, on what drives long-term economic prosperity. Their research has shown how institutions, by promoting economic growth, have taken nations out of poverty traps and others to stable systems. As a result, their work allowed policymakers to understand the dynamics of institution-economy interaction better and enabled them to opt for policies that are geared towards fostering inclusive economic development. The Nobel Prize in Economics is a well-earned recognition of their outstanding research. Their observations will inform economists and policymakers for generations as they work towards a fairer, wealthier world.

(The writer is a professor at the Berlin School of Business and Innovation)