Spotlighting the work of the Economics Nobel winners : Valley Vision

‘AJR’s research came into prominence at a time when the economics profession was moving away from a presumptive policy framework to something more diagnostic’
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The Great Divergence is a term used to describe the gap in economic and political development between the west and the east. It emerges from this idea that in the 17th and the 18th centuries, the advantages that western Europe enjoyed due to industrialisation allowed them to project political power elsewhere. This in turn helped them to reap economic rewards. One of the most relevant findings that emerged from this scholarship is the idea that institutions established during colonialism can have persistent effects many years after countries transitioned to sovereign rule.

Institutions and development

The winners of this year’s Economics Nobel, or the Sveriges Riksbank Prize awarded for economic sciences, Daron Acemoglu, Simon Johnson and James Robinson (AJR), pioneers in new institutional economics, emphasised the role of institutions in the direction of development. Institutions are constraints on human behaviour, the rules of the game in the form of law and order that prevent the state or any other party from the coercive use of force on those who cannot defend themselves. This can take the shape of the constitutional limits on the powers of an executive. Institutions exert their effect through incentives, such as the traffic fines on a busy street that nudges a driver from breaking the speed limit.

AJR’s work has highlighted the role of extractive institutions in shaping a country’s growth trajectory. Extractive institutions are common in history because they still offer the possibility of generating prosperity but distribute the fruits of growth to a small group of elites. Inclusive institutions, on the other hand, have rules and incentives that motivate people. Colonialism established extractive institutions in Sub-Saharan Africa, Latin America, the Caribbean, and South Asia while there are relatively fewer extractive institutions in the United States, Canada, Australia and New Zealand. AJR’s seminal work was in establishing how these institutions have a causal impact on economic growth. They assembled archival evidence to show differences in settler mortality rates in tropical and temperate countries. For instance, settler colonists of Australia and the U.S. settled there in large numbers due to a relatively disease-free environment while colonists who settled in more tropical countries were wiped due to disease.

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The key to this type of research was the natural experiment. Social scientists usually cannot manipulate the variables they study like natural scientists running a clinical trial. What they can do is create research design innovations that approximate true experiments. They find observational settings in which causes are randomly assigned among units that they can compare such as individuals, villages, cities or countries. A simple comparison across these units exposed to the presence or absence of a cause can provide evidence for the effects that that particular cause has.

Investigations in India

The biggest contribution by AJR is in inspiring several studies that looked at the long-term effects of historical events on economic development where they identified new variables from detailed historical data. Two of the most well-known studies in this genre come from the Indian subcontinent.

Abhijit Banerjee and Lakshmi Iyer (2005) found that landlord-based colonial land tenure systems resulted in lower agricultural investments and productivity in those areas years later. Lakshmi Iyer (2010) showed that areas under direct colonial rule had fewer schools, health centres and roads than those under indirect colonial rule — an effect that seems to be fading away only recently.

Economic institutions are collective choices determined by political power. Political power can be de jure or de facto. The political power for Joe Biden does not come from the person but the office that he holds, the President of the United States of America. On the other hand, you cannot say the same for Teodoro Obiang Nguema, the President of Equatorial Guinea, one of the world’s longest serving leaders. This would be de factor power.

The question of reform of an extractive institution is about the ability to solve a collective action problem through the economic resources available to them. What AJR’s research has shown is that it is difficult for groups with conflicting interests to agree on what good institutions look like. Groups with political power will always have an incentive to use that power to change the distribution of resources in their favour.

A perspective

AJR’s research came into prominence at a time when the economics profession was moving away from a presumptive policy framework to something more diagnostic. There was a deliberate move away from universal remedies such as the erstwhile shock therapy in Latin America or the Washington Consensus. Their approach is not without criticism. Acemoglu and Robinson have been sceptical about China’s spectacular growth that is expected to slow down due to the eventual spread of extractive institutions.

However, scholars such as Yuen Yuen Ang have argued that AJR’s approach tends to privilege western liberal institutions. When the U.S. was a developing country, they were as corrupt or engaged in risky practices quite similar to those undertaken in China today. The narrative of the import of inclusive institutions from western Europe is at odds with America’s chequered history with slavery, exclusion of women from property rights, and genocide of Native Americans. Other scholars such as Onur Ulas Ince (2022) have also pointed out the reluctance of AJR to critically engage with the complexity of actually existing colonialism and capitalism.

Rohith Jyothish is an Assistant Professor at the Jindal School of International Affairs, O.P. Jindal Global University