They showed institutions trump all other factors

Economists emphasise institutions as key to prosperity, as shown by Nobel laureates Acemoglu, Johnson, and Robinson.

Reflecting on the future of humanity, economist Avinash Dixit once wrote: “Will we move to a fifteen-hour work week? Will we be another four or eight times as rich as we are now? Will we colonize the moon or mars? I don’t know, and don’t much care. I believe that the improvements in institutions and organizations that figure in my dream are much more important than any increases in leisure or any substantial increases in material wealth in today’s first world. With good institutions, a good level of economic well-being can be sustained; without them, even great wealth can be fragile.”

Academy of Sciences permanent secretary Hans Ellegren, Jakob Svensson and Jan Teorell, of the Nobel Assembly at the Swedish Riksbank announce the Swedish Riksbank's prize in economic science in memory of Alfred Nobel 2024, which goes to Daron Acemoglu, Simon Johnson and James A. Robinson, during a press meeting at the Royal Swedish Academy of Sciences in Stockholm, on Monday. (REUTERS)

Why do economists care so much about institutions? Part of the answer comes from the winners of this year’s Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (popularly known as the economics Nobel Prize). This year, the prize has been awarded to Daron Acemoglu, Simon Johnson and James A. Robinson “for studies of how institutions are formed and affect prosperity”.

Economists do not use the word ‘institution’ in the dictionary sense. Rather, Douglas North, who pioneered the study of institutions in mainstream economics, defined institutions as “humanly devised constraints that structure political, economic and social interactions”. Institutions are essentially the rules of the game that are enforced somehow and thus shape people’s behaviour. To give some concrete examples, a constitution, a law, an administrative regulation, a religious taboo enforced by social sanctions–all of them fall under the definition of an institution.

With this broad definition, it is hardly surprising that institutions matter. The point of this year’s laureates is deeper: In the long run, institutions rule! Institutions trump all other determinants of human prosperity such as geography!

The work of Acemogulu, Johnson and Robinson (AJR henceforth) is twofold: They have provided empirical support for the claim that institutions are the ‘deepest determinants’ of growth and prosperity. And they have created theoretical frameworks for understanding the evolution of institutions.

Let us discuss both aspects of their work.

How does one prove the importance of institutions rigorously? Pointing to the fact that most rich countries have decent institutions–courts that enforce contracts expeditiously for example– is not sufficient due to the reverse causality problem. Rather than robust institutions making nations richer, it may be that richer countries have more resources for improving institutions and thus appear to have better institutions.

In order to prove their point, AJR studied one of the defining episodes in modern history: European colonization. They exploited the fact that whether European colonizers wanted to settle in a particular country was determined by the disease environment in the country. If the settlers’ mortality was high in a country due to tropical diseases such as malaria or yellow fever, European colonizers considered the place less suitable for long term settlement. Their primary consideration was as much extraction of resources as possible. Thus, they tended to create extractive and non-participatory institutions in such countries. The remarkable finding was that the initial institutions showed remarkable persistence throughout and ended up shaping economic outcomes even centuries later! Conversely, if settlers’ mortality was low in a country, European settlers considered it suitable for long term settlement. They tended to install growth promoting economic institutions and relatively more egalitarian political institutions.

These twin facts allowed AJR to use an indirect method for estimating the impact of institutions on the current economic outcomes by first estimating the association between a measure of institutional quality and the settlers’ mortality; and secondly the settlers’ mortality and current economic outcomes. Remarkably they found that institutions tended to have a large impact on the current economic outcomes, even after controlling for a number of factors.

Apart from estimating the impact of institutions on economic outcomes, there are additional questions related to the evolution of institutions. Why do bad institutions persist even if some reforms can potentially make everyone better off? Moreover, sometimes institutions do change: for example the political rights of the vast majority was expanded by giving them voting rights.

When and how do such changes take place? Such questions are hard to answer empirically. Rather, they require theoretical models capable of generating counterfactual scenarios.

Using the tools of a particular branch of theoretical economics called game theory, AJR constructed models capable of answering such questions. There are multiple nuances and subtleties, but the main insight is that institutions persist beyond a particular rule because the elites who inherit power also often inherit exactly the same incentives to retain institutions from their predecessors. Thus, even if someone promises to change institutions for the better, they are likely to be disbelieved (this is called ‘commitment problem’ in the terminology of game theory).

One exception when elites may give up their power and make the institutions more inclusive is when distributional conflicts turn into the threat of mobilization of the people (aka threat of revolution). Such threats often act as the driver of institutional change, leading to outcomes like universal adult franchise for example.

One of my colleagues jokingly remarked a few days ago that Acemoglu may be the first Marxist economist to win a Nobel. At one level this is not true: Acemoglu is not a Marxist economist like Paul Sweezy or Michio Morishima. But his work is very much ‘Marxist’ in two different senses. First, he considers the distributional conflict as the driving force that often leads to institutional change. Second, AJR are focussed on understanding the ‘broad sweeps of history’ rather than focussing on narrow, technical questions. Thus, the prize awarded to Daron Acemoglu, Simon Johnson and James Robinson may be more accurately described as a ‘social science Nobel’ rather than just an ‘economics Nobel’.

(Avinash Tripathi teaches economics in Azim Premji University, Bhopal. Views are personal.)