Why Nations Fail

by Daron Acemoglu

  Even greater caution is necessary in drawing policy recommendations from this broad account of the origins of prosperity and poverty. In the same way that the impact of critical junctures depends on existing institutions, how a society will respond to the same policy intervention depends on the institutions that are in place. Of course, our theory is all about how nations can take steps toward prosperity—by transforming their institutions from extractive to inclusive. But it also makes it very clear from the outset that there are no easy recipes for achieving such a transition. First, the vicious circle implies that changing institutions is much harder than it first appears. In particular, extractive institutions can re-create themselves under different guises, as we saw with the iron law of oligarchy in chapter 12. Thus the fact that the extractive regime of President Mubarak was overturned by popular protest in February 2011 does not guarantee that Egypt will move onto a path to more inclusive institutions. Instead extractive institutions may re-create themselves despite the vibrant and hopeful pro-democracy movement. Second, because the contingent path of history implies that it is difficult to know whether a particular interplay of critical junctures and existing institutional differences will lead toward more inclusive or extractive institutions, it would be heroic to formulate general policy recommendations to encourage change toward inclusive institutions. Nevertheless, our theory is still useful for policy analysis, as it enables us to recognize bad policy advice, based on either incorrect hypotheses or inadequate understanding of how institutions can change. In this, as in most things, avoiding the worst mistakes is as important as—and more realistic than—attempting to develop simple solutions. Perhaps this is most clearly visible when we consider current policy recommendations encouraging “authoritarian growth” based on the successful Chinese growth experience of the last several decades. We next explain why these policy recommendations are misleading and why Chinese growth, as it has unfolded so far, is just another form of growth under extractive political institutions, unlikely to translate into sustained economic development.

  THE IRRESISTIBLE CHARM OF AUTHORITARIAN GROWTH

  Dai Guofang recognized the coming urban boom in China early on. New highways, business centers, residences, and skyscrapers were sprawling everywhere around China in the 1990s, and Dai thought this growth would only pick up speed in the next decade. He reasoned that his company, Jingsu Tieben Iron and Steel, could capture a large market as a low-cost producer, especially compared with the inefficient state-owned steel factories. Dai planned to build a true steel giant, and with support from the local party bosses in Changzhou, he started building in 2003. By March 2004, however, the project had been stopped by order of the Chinese Communist Party in Beijing, and Dai was arrested for reasons never clearly articulated. The authorities may have presumed that they would find some incriminating evidence in Dai’s accounts. In the event, he spent the next five years in jail and home detention, and was found guilty on a minor charge in 2009. His real crime was to start a large project that would compete with state-sponsored companies and do so without the approval of the higher-ups in the Communist Party. This was certainly the lesson that others drew from the case.

  The Communist Party’s reaction to entrepreneurs such as Dai should not be a surprise. Chen Yun, one of Deng Xiaoping’s closest associates and arguably the major architect behind the early market reforms, summarized the views of most party cadres with a “bird in a cage” analogy for the economy: China’s economy was the bird; the party’s control, the cage, had to be enlarged to make the bird healthier and more dynamic, but it could not be unlocked or removed, lest the bird fly away. Jiang Zemin, shortly after becoming general secretary of the Communist Party in 1989, the most powerful position in China, went even further and summarized the party’s suspicion of entrepreneurs by characterizing them as “self-employed traders and peddlers [who] cheat, embezzle, bribe and evade taxation.” Throughout the 1990s, even as foreign investment was pouring into China and state-owned enterprises were encouraged to expand, private entrepreneurship was greeted with suspicion, and many entrepreneurs were expropriated or even jailed. Jiang Zemin’s view of entrepreneurs, though in relative decline, is still widespread in China. In the words of a Chinese economist, “Big state companies can get involved in huge projects. But when private companies do so, especially in competition with the state, then trouble comes from every corners [sic].”

  While scores of private companies are now profitably operating in China, many elements of the economy are still under the party’s command and protection. Journalist Richard McGregor reports that on the desk of the head of each of the biggest state companies in China stands a red phone. When it rings, it is the party calling with orders on what the company should do, where it should invest, and what its targets will be. These giant companies are still under the command of the party, a fact we are reminded of when the party decides to shuffle their chief executives, fire them, or promote them, with little explanation.

  These stories of course do not deny that China has made great strides toward inclusive economic institutions, strides that underpin its spectacular growth rates over the past thirty years. Most entrepreneurs have some security, not least because they cultivate the support of local cadres and Communist Party elites in Beijing. Most state-owned enterprises seek profits and compete in international markets. This is a radical change from the China of Mao. As we saw in the previous chapter, China was first able to grow because under Deng Xiaoping there were radical reforms away from the most extractive economic institutions and toward inclusive economic institutions. Growth has continued as Chinese economic institutions have been on a path toward greater inclusiveness, albeit at a slow pace. China is also greatly benefiting from its large supply of cheap labor and its access to foreign markets, capital, and technologies.

  Even if Chinese economic institutions are incomparably more inclusive today than three decades ago, the Chinese experience is an example of growth under extractive political institutions. Despite the recent emphasis in China on innovation and technology, Chinese growth is based on the adoption of existing technologies and rapid investment, not creative destruction. An important aspect of this is that property rights are not entirely secure in China. Every now and then, just like Dai, some entrepreneurs are expropriated. Labor mobility is tightly regulated, and the most basic of property rights, the right to sell one’s own labor in the way one wishes, is still highly imperfect. The extent to which economic institutions are still far from being truly inclusive is illustrated by the fact that only a few businessmen and -women would even venture into any activity without the support of the local party cadre or, even more important, of Beijing. The connection between business and the party is highly lucrative for both. Businesses supported by the party receive contracts on favorable terms, can evict ordinary people to expropriate their land, and violate laws and regulations with impunity. Those who stand in the path of this business plan will be trampled and can even be jailed or murdered.

  The all-too-present weight of the Communist Party and extractive institutions in China remind us of the many similarities between Soviet growth in the 1950s and ’60s and Chinese growth today, though there are also notable differences. The Soviet Union achieved growth under extractive economic institutions and extractive political institutions because it forcibly allocated resources toward industry under a centralized command structure, particularly armaments and heavy industry. Such growth was feasible partly because there was a lot of catching up to be done. Growth under extractive institutions is easier when creative destruction is not a necessity. Chinese economic institutions are certainly more inclusive than those in the Soviet Union, but China’s political institutions are still extractive. The Communist Party is all-powerful in China and controls the entire state bureaucracy, the armed forces, the media, and large parts of the economy. Chinese people have few political freedoms and very little participation in the political process.

  Many have long believed th
at growth in China would bring democracy and greater pluralism. There was a real sense in 1989 that the Tiananmen Square demonstrations would lead to greater opening and perhaps even the collapse of the communist regime. But tanks were unleashed on the demonstrators, and instead of a peaceful revolution, history books now call it the Tiananmen Square Massacre. In many ways, Chinese political institutions became more extractive in the aftermath of Tiananmen; reformers such as Zhao Ziyang, who as general secretary of the Communist Party lent his support to the students in Tiananmen Square, were purged, and the party clamped down on civil liberties and press freedom with greater zeal. Zhao Ziyang was put under house arrest for more than fifteen years, and his public record was gradually erased, so that he would not be even a symbol for those who supported political change.

  Today the party’s control over the media, including the Internet, is unprecedented. Much of this is achieved through self-censorship: media outlets know that they should not mention Zhao Ziyang or Liu Xiaobo, the government critic demanding greater democratization, who is still languishing in prison even after he was awarded the Nobel Peace Prize. Self-censorship is supported by an Orwellian apparatus that can monitor conversations and communications, close Web sites and newspapers, and even selectively block access to individual news stories on the Internet. All of this was on display when news about corruption charges against the son of the general secretary of the party since 2002, Hu Jintao, broke out in 2009. The party’s apparatus immediately sprang into action and was not only able to prevent Chinese media from covering the case but also managed to selectively block stories about the case on the New York Times and Financial Times Web sites.

  Because of the party’s control over economic institutions, the extent of creative destruction is heavily curtailed, and it will remain so until there is radical reform in political institutions. Just as in the Soviet Union, the Chinese experience of growth under extractive political institutions is greatly facilitated because there is a lot of catching up to do. Income per capita in China is still a fraction of that in the United States and Western Europe. Of course, Chinese growth is considerably more diversified than Soviet growth; it doesn’t rely on only armaments or heavy industry, and Chinese entrepreneurs are showing a lot of ingenuity. All the same, this growth will run out of steam unless extractive political institutions make way for inclusive institutions. As long as political institutions remain extractive, growth will be inherently limited, as it has been in all other similar cases.

  The Chinese experience does raise several interesting questions about the future of Chinese growth and, more important, the desirability and viability of authoritarian growth. Such growth has become a popular alternative to the “Washington consensus,” which emphasizes the importance of market and trade liberalization and certain forms of institutional reform for kick-starting economic growth in many less developed parts of the world. While part of the appeal of authoritarian growth comes as a reaction to the Washington consensus, perhaps its greater charm—certainly to the rulers presiding over extractive institutions—is that it gives them free rein in maintaining and even strengthening their hold on power and legitimizes their extraction.

  As our theory highlights, particularly in societies that have undergone some degree of state centralization, this type of growth under extractive institutions is possible and may even be the most likely scenario for many nations, ranging from Cambodia and Vietnam to Burundi, Ethiopia, and Rwanda. But it also implies that like all examples of growth under extractive political institutions, it will not be sustained.

  In the case of China, the growth process based on catch-up, import of foreign technology, and export of low-end manufacturing products is likely to continue for a while. Nevertheless, Chinese growth is also likely to come to an end, particularly once China reaches the standards of living level of a middle-income country. The most likely scenario may be for the Chinese Communist Party and the increasingly powerful Chinese economic elite to manage to maintain their very tight grip on power in the next several decades. In this case, history and our theory suggest that growth with creative destruction and true innovation will not arrive, and the spectacular growth rates in China will slowly evaporate. But this outcome is far from preordained; it can be avoided if China transitions to inclusive political institutions before its growth under extractive institutions reaches its limit. Nevertheless, as we will see next, there is little reason to expect that a transition in China toward more inclusive political institutions is likely or that it will take place automatically and painlessly.

  Even some voices within the Chinese Communist Party are recognizing the dangers on the road ahead and are throwing around the idea that political reform—that is, a transition to more inclusive political institutions, to use our terminology—is necessary. The powerful premier Wen Jiabao has recently warned of the danger that economic growth will be hampered unless political reform gets under way. We think Wen’s analysis is prescient, even if some people doubt his sincerity. But many in the West do not agree with Wen’s pronouncements. To them, China reveals an alternative path to sustained economic growth, one under authoritarianism rather than inclusive economic and political institutions. But they are wrong. We have already seen the important salient roots of Chinese success: a radical change in economic institutions away from rigidly communist ones and toward institutions that provide incentives to increase productivity and to trade. Looked at from this perspective, there is nothing fundamentally different about China’s experience relative to that of countries that have managed to take steps away from extractive and toward inclusive economic institutions, even when this takes place under extractive political institutions, as in the Chinese case. China has thus achieved economic growth not thanks to its extractive political institutions, but despite them: its successful growth experience over the last three decades is due to a radical shift away from extractive economic institutions and toward significantly more inclusive economic institutions, which was made more difficult, not easier, by the presence of highly authoritarian, extractive political institutions.

  A DIFFERENT TYPE of endorsement of authoritarian growth recognizes its unattractive nature but claims that authoritarianism is just a passing stage. This idea goes back to one of the classical theories of political sociology, the theory of modernization, formulated by Seymour Martin Lipset. Modernization theory maintains that all societies, as they grow, are headed toward a more modern, developed, and civilized existence, and in particular toward democracy. Many followers of modernization theory also claim that, like democracy, inclusive institutions will emerge as a by-product of the growth process. Moreover, even though democracy is not the same as inclusive political institutions, regular elections and relatively unencumbered political competition are likely to bring forth the development of inclusive political institutions. Different versions of modernization theory also claim that an educated workforce will naturally lead to democracy and better institutions. In a somewhat postmodern version of modernization theory, New York Times columnist Thomas Friedman went so far as to suggest that once a country got enough McDonald’s restaurants, democracy and institutions were bound to follow. All this paints an optimistic picture. Over the past sixty years, most countries, even many of those with extractive institutions, have experienced some growth, and most have witnessed notable increases in the educational attainment of their workforces. So, as their incomes and educational levels continue to rise, one way or another, all other good things, such as democracy, human rights, civil liberties, and secure property rights, should follow.

  Modernization theory has a wide following both within and outside academia. Recent U.S. attitudes toward China, for example, have been shaped by this theory. George H. W. Bush summarized U.S. policy toward Chinese democracy as “Trade freely with China and time is on our side.” The idea was that as China traded freely with the West, it would grow, and that growth would bring democracy and better institutions in China, as modernization theory predi
cted. Yet the rapid increase in U.S.-China trade since the mid-1980s has done little for Chinese democracy, and the even closer integration that is likely to follow during the next decade will do equally little.

  The attitudes of many about the future of Iraqi society and democracy in the aftermath of the U.S.-led invasion were similarly optimistic because of modernization theory. Despite its disastrous economic performance under Saddam Hussein’s regime, Iraq was not as poor in 2002 as many sub-Saharan African nations, and it had a comparatively well-educated population, so it was believed to be ripe ground for the development of democracy and civil liberties, and perhaps even what we would describe as pluralism. These hopes were quickly dashed as chaos and civil war descended upon Iraqi society.

  Modernization theory is both incorrect and unhelpful for thinking about how to confront the major problems of extractive institutions in failing nations. The strongest piece of evidence in favor of modernization theory is that rich nations are the ones that have democratic regimes, respect civil and human rights, and enjoy functioning markets and generally inclusive economic institutions. Yet interpreting this association as supporting modernization theory ignores the major effect of inclusive economic and political institutions on economic growth. As we have argued throughout this book, it is the societies with inclusive institutions that have grown over the past three hundred years and have become relatively rich today. That this accounts for what we see around us is shown clearly if we look at the facts slightly differently: while nations that have built inclusive economic and political institutions over the last several centuries have achieved sustained economic growth, authoritarian regimes that have grown more rapidly over the past sixty or one hundred years, contrary to what Lipset’s modernization theory would claim, have not become more democratic. And this is in fact not surprising. Growth under extractive institutions is possible precisely because it doesn’t necessarily or automatically imply the demise of these very institutions. In fact, it is often generated because those in control of the extractive institutions view economic growth as not a threat but a support to their regime, as the Chinese Communist Party has done since the 1980s. It is also not surprising that growth generated by increases in the value of the natural resources of a nation, such as in Gabon, Russia, Saudi Arabia, and Venezuela, is unlikely to lead to a fundamental transformation of these authoritarian regimes toward inclusive institutions.