Daron Acemoglu – Institutional Development

In a recent assignment, A2 students were asked to write a 500 word profile on each of two development economists of their choice and to capture their key ideas and connect to one or more current issues in development. I will be adding some of their responses to the economics blog. Here Ben Evans focuses on the work of Daron Acemoglu

Professor Acemoglu's key contribution to development economics has been his work on the primacy of political institutions to development – a theory publicized in the book “Why Nations Fail”. In this he argues that there are two main types of institution, extractive and inclusive.

Extractive institutions are engineered to provide wealth and power to a small group or single individual (e.g. the nobles of a feudal society, or the dictator of a military junta). However Inclusive institutions are controlled by the majority (or something approximating them) and therefore aim to enhance the general welfare of the population. Extractive institutions have a negative effect upon development for three reasons. Acemoglu argues that the driving force of economic development is “creative destruction” caused by Schumpeterian technological progress. The rise of new ideas, firms and innovations accrue great benefits to society at large, however they often (indeed almost always) undermine the established elites who have grown rich off of the economic situation prior to such “waves of creative destruction”.

In inclusive institutions the majority benefits from progress and as a result change and development can occur (although it may be impeded by particularly vociferous interest groups – witness the US or French farm lobby). However in extractive institutions the very people who are threatened by change control the government and legal system. As a result countries under extractive institutions often actively dissuade technological progress (e.g. through granting monopolies).

The second way in which extractive institutions harm growth is due to the burdens and dangers they foist upon entrepreneurs and businesses (which are vitally important to the growth of an economy). Under extractive institutions the law is usually arbitrary and heavily bent in the favour of the elite group; when successful businesses may be simply expropriated or shut down on a whim, the incentive to establish them is reduced. On top of this high taxes and corruption are often present in extractive institutions, and both negatively affect economic development.

Extractive institutions are also inferior to Inclusive institutions in their provision of public goods. In a country governed by inclusive institutions there will be strong pressure for the government to provide the public goods (e.g. police and transport etc.) vital to development or to correct the market failures (e.g. in education and healthcare) which impinge upon it. However the governing elites of (say) the Congo, have no need to supply such services to the general population (they can buy them for themselves at a much cheaper cost) and as a result are unlikely to provide them to a similar degree as in inclusive institutions.

A key current application of Acemoglu theories is the rapid development of China, something which could (and has been) seen as falsifying the concept that inclusive institutions are necessary for growth. However Acemoglu argues that growth under extractive institutions is possible and that one scenario where it can occur is the forcible relocation of resources from an inefficient sector to a more efficient one (in the Chinese scenario this would be the movement of peasants from the unproductive countryside to the productive industrial areas). However this means of growth has almost been exhausted in China (as it was in the USSR during the 60’s). Meanwhile numerous problems are facing the country (a demographic shift, an ongoing environmental crisis, a vast glut of unproductive investment, a dysfunctional financial system, a corrupt state sector) all of which are the direct result of its political structure.