Nations Fail When Institutions Are Not Inclusive

This is a brief overview in MIT News, of book published by two MIT professors. The book Why Nations Fail, takes an historical approach to answer a perennial question. It argues that social institutions determine the incentives in a society. Nations fail when they provide the wrong incentives. North and South Korea provide one of their examples. South Korea is ten times more prosperous than North Korea primarily because it extends property rights to a broad class of citizens and its government is more inclusive. That is, it has not been captured by elites. The extension of property rights encourages innovation that is the basis for economic growth and innovation is amplified when those rights are inclusive. The book also argues that the pattern for failure is not based upon the ignorance of government leaders. The decisions that they make are designed to solidify their power and the power of elites with whom they are allied. Together they block innovations that promote economic growth.

Economics has tended to focus on the behavior of individual agents, rather than on the role of institutions that provide the incentives that shape behavior. Since individuals, acting to maximize their utility, are pretty similar across the globe, we would not expect the differences in wealth that we observe between nations. A state of perfect freedom would be the best way to generate wealth. It makes more sense to me to take the institutional approach that was taken in this book. Good institutions are essential and they are not universal. Moreover, they are subject to change over time. They can become better or worse. We should become concerned when governments and elites provide the wrong incentives.