The Great Degeneration: How Institutions Decay and Economies Die

by Niall Ferguson

  In a similar vein, Francis Fukuyama’s Origins of Political Order defines ‘the three components of a modern political order’ as ‘a strong and capable state, the state’s subordination to a rule of law and government accountability to all citizens’.7 These three components came together for the first time in Western Europe, with England once again the trailblazer (though Fukuyama gives credit to the Netherlands, Denmark and Sweden for not being far behind). Why Europe and not Asia? Because, says Fukuyama, the idiosyncratic development of Western Christendom tended to undercut the importance of extended families or clans.

  In their book Why Nations Fail, Daron Acemoglu and Jim Robinson make a striking comparison between Egypt today and England in the late seventeenth century:

  The reason that Britain is richer than Egypt is because in 1688 . . . England . . . had a revolution that transformed the politics and thus the economics of the nation. People fought for and won more political rights and used them to expand their economic opportunities. The result was a fundamentally different political and economic trajectory, culminating in the Industrial Revolution.8

  In their terms, England was the first country to move to having ‘inclusive’ or ‘pluralistic’ rather than ‘extractive’ political institutions. Note that other West European societies – for instance, Spain – failed to do this. As a result, the outcomes of European colonization in North and South America were radically different. The English exported inclusive institutions; the Spaniards were content to superimpose their extractive ones on top of those they took over from the Aztecs and Incas.

  The imperial context also reveals the difference between the institutional argument and the older cultural interpretation – first formulated by Max Weber, later revived by David Landes – that there was some link between Protestantism and the ‘spirit of capitalism’. Unlike the Nazi in Hanns Johst’s play Schlageter, I do not reach for my revolver when I hear the word culture, but I do issue a polite health warning. It is very tempting to attribute historical agency to an amalgam of ideas and norms – Greek philosophy, the Hebrew Commandments, Roman law, Christ’s ethics, the doctrine of Luther and Calvin – called something like ‘Judaeo-Christian culture’. But there is a real risk of cherry-picking here. Somehow no really terrible Western ideas like, say, witch-burning or communism ever get mentioned, though they seem just as plausibly the products of Judaeo-Christian culture as the spirit of capitalism. In any case, while culture may instil norms, institutions create incentives. Britons versed in much the same culture behaved very differently depending on whether they emigrated to New England or worked for the East India Company in Bengal. In the former case we find inclusive institutions, in the latter extractive ones.

  Glorious Institutions

  The debate about the causes of the great divergence is of more than merely historical interest. Understanding Western success helps us to frame some rather more urgent questions about the recent past, the present and possible futures. One reason the institutional argument is so compelling is that it also seems to offer a good explanation for the failure of most non-Western countries, until the later twentieth century, to achieve sustained economic growth. Acemoglu and Robinson illustrate the power of institutions relative to geography and culture by describing the city of Nogales, which is bisected by the US–Mexican border. The difference in living standards between the two halves is shocking.9 The same point can be made with regard to the two great experiments run during the Cold War. Essentially, we took two peoples – the Koreans and the Germans – and divided them in two. South Koreans and West Germans got capitalist institutions; North Koreans and East Germans got communist ones. The divergence that occurred in the space of just a few decades was enormous. Their analysis makes Acemoglu and Robinson sceptical that China has yet made the decisive breakthrough to sustainable growth. In their view, Chinese market reforms remain subject to the decisions of an exclusive and extractive elite, which continues to determine the allocation of key resources.

  Development economists – notably Paul Collier – have been thinking in these terms for some time.10 The case of Botswana seems to illustrate the point that even a sub-Saharan African economy can achieve sustained growth if its people are not plagued by chronic corruption and/or civil war like, say, the Democratic Republic of Congo. Unlike most post-colonial African states, Botswana succeeded in establishing inclusive not extractive institutions when it gained its independence. The Peruvian economist Hernando de Soto is another who has been arguing for years that institutions are what matter.11 By slogging away in the shanty towns of Lima, Port-au-Prince, Cairo and Manila, he and his researchers established that, though their incomes are low, the poor of the world have a surprisingly large amount of property. The problem is that this property is not legally recognized as theirs. It is nearly all held ‘extra-legally’. This is not because the poor are tax-dodgers. As de Soto makes clear, the black economy has its own kind of taxation – protection rackets and the like – which make legality positively attractive. It is just that getting legal title to a house or a workshop is well-nigh impossible.

  As an experiment, de Soto and his team tried to establish a small garment workshop on the outskirts of Lima on a legal basis. It took them a staggering 289 days to do so. And when they tried to secure legal authorization to build a house on state-owned land, it took even longer: six years and eleven months, during which they had to deal with fifty-two different government offices. Dysfunctional institutions like these, de Soto argues, are what force the poor to live outside the law. We should not imagine that the extra-legal economy is marginal. One of the most memorable findings of de Soto’s book The Mystery of Capital is that the total value of the real estate held (but not legally owned) by the poor of developing countries amounts to $9.3 trillion. Yet, in the absence of legal titles and a working system of property law, this is all so much ‘dead capital’: ‘like water in a lake high up in the Andes – an untapped stock of potential energy’. It cannot be efficiently used to generate wealth. Only with a working system of property rights can a house become collateral, can its value be properly established by the market, can it easily be bought and sold.

  Since de Soto published The Mystery of Capital, revolutions in countries like Tunisia and Egypt have provided compelling evidence in support of his approach. He sees the ‘Arab Spring’ primarily as a revolt by frustrated would-be entrepreneurs against corrupt, rent-seeking regimes that preyed on their efforts to accumulate capital. The prime example is the story of the twenty-six-year-old Tarek Mohamed Bouazizi, who burned himself to death in front of the governor’s offices in the town of Sidi Bouzid in December 2010.12 Bouazizi killed himself precisely one hour after a policewoman, backed by two municipal officers, had seized from him two crates of pears, a crate of bananas, three crates of apples and a second-hand electronic weight scale worth $179. Those scales were his only capital. He did not have legal title to his family’s home, which might otherwise have served as collateral for his business. His economic existence depended on the ‘fees’ he paid to officials to allow him to operate his fruit-stand on two square yards of public land. Their arbitrary act of expropriation cost Mohamed Bouazizi his livelihood and his life. But his self-immolation sparked a revolution – though how glorious a revolution remains to be seen. It will depend on how far new constitutional arrangements in countries like Tunisia and Egypt achieve the shift from an extractive to an inclusive state, from the arbitrary power of rent-seeking elites to the rule of law for all.

  If de Soto’s approach is right, then it does make a great deal of sense to explain the success of the West after the 1500s in terms of institutions, and particularly the rule of law. For what was at the heart of England’s seventeenth-century battles over Parliamentary power was surely the protection of individuals from arbitrary expropriation by the Crown. To specialist historians, of course, all this smacks suspiciously of the old Whig interpretation of history that Herbert Butterfield once held up to ri
dicule. Yet none of the authors I have been quoting takes a naively determinist view of the historical process. Far from being a story of teleological inevitability, these are authentically evolutionary narratives, in which contingency plays a major role. England was not preordained by Providence to become (as in 1066 and All That) ‘top nation’. Only a series of near-run things averted an absolutist outcome in the seventeenth century. There were, after all, rebellions in 1692, 1694, 1696, 1704, 1708 and 1722, and a civil war in 1715 – not forgetting the Jacobite Rising of 1745.13

  The real question is how decisive an institutional break occurred in 1688. The majority of historians would say: not very. The Glorious Revolution, they argue, was backward looking, ‘conservationist’, with minimal consequences outside the narrow sphere of aristocratic power and patronage.14 I think this is too parochial a view. The 1689 Bill of Rights – the Act Declaring the Rights and Liberties of the Subject – states (among other things):

  that levying money for or to the use of the Crown by pretence of prerogative, without grant of Parliament, for longer time, or in other manner than the same is or shall be granted, is illegal;

  that election of members of Parliament ought to be free;

  that the freedom of speech and debates or proceedings in Parliament ought not to be impeached or questioned in any court or place out of Parliament; and

  that for redress of all grievances, and for the amending, strengthening and preserving of the laws, Parliaments ought to be held frequently.

  With all due respect to the specialists, I think this does deserve to be seen as an historical turning point, even if religious prejudice (anti-Catholicism) loomed as large as constitutional principle at the time.

  True, the ‘rights and liberties of the subject’ set out in the 1689 Bill of Rights were conceived at the time as ancient rather than novel. But the consequences of the Glorious Revolution really were new, not least in the way Parliaments after 1689 set about energetically legislating for economic development, protecting the infant textile industry, encouraging the enclosure of common land, promoting turnpike roads and canals. Even war became an increasingly profitable activity as the Whigs launched their bid for global commercial supremacy.15 The sequence is clear: first the Glorious Revolution, then agricultural improvement, then imperial expansion, then industrial revolution.

  The institutional argument is even more compelling when we take a comparative approach. None of the institutional changes I am talking about happened in Ming or Qing China, where the power of the Emperor and his officials remained unrestrained by semi-autonomous corporate bodies or representative assemblies. Asia had merchants; it did not have companies, much less parliaments.16 Institutions as they evolved in the Ottoman Empire were also significantly different in ways that hampered capital formation and economic development, as Timur Kuran has argued. This was because Islamic law took a fundamentally different approach to partnership, inheritance, questions of debt and corporate personalities from the legal systems that developed in Western Europe. Islam had waqfs, unincorporated trusts established by individuals, but not banks.17

  The Inglorious Revolution

  So if institutional evolution is the key to understanding Western ascendancy as well as enduring poverty in Africa and elsewhere, is this also how we should understand what is surely the most astonishing trend of our lifetimes: the end of the great divergence, and the advent of a great reconvergence between West and East? I think it is. What we need to do is to apply the insights of the institutional school of economic history to our own time – indeed, to our own Western societies.

  Writing in the 1770s, it seemed obvious to Adam Smith that the reasons for China’s puzzling ‘stationary state’ of economic stagnation lay in its ‘laws and institutions’. Could it be, by the same token, that the economic, social and political difficulties of the Western world today reflect a degeneration of our once world-beating institutions? There certainly seems little doubt that the West is experiencing a relative decline unlike anything we have seen in half a millennium. Having been more than twenty times richer than the average Chinese in 1978, the average American is now just five times richer. In a whole range of dimensions, the gap between the West and the Rest has narrowed dramatically. In terms of life expectancy and educational attainment, for example, some Asian countries are now ahead of most in the West. According to the 2009 OECD PISA study, the gap in mathematical attainment between the teenagers of the Shanghai district of China and those of the United States is now as big as the gap between American teenagers and Tunisians.18

  In some ways, it is easy to explain non-Western success. China has belatedly followed a number of other East Asian countries – the first was Japan – in downloading most (not all) of what I have called the ‘killer applications’ of Western civilization: economic competition, the scientific revolution, modern medicine, the consumer society and the work ethic.19 Copying the Western model of industrialization and urbanization tends to work if your entrepreneurs have the right incentives, your labour force is basically healthy, literate and numerate, and your bureaucracy is reasonably efficient. So in what follows I am going to say relatively little about what has gone right in the rest of the world. What interests me here is what has gone wrong in the West.

  Most commentators who address this question tend to concern themselves with phenomena like excessive debt, mismanaged banks and widening inequality. To my mind, however, these are nothing more than symptoms of an underlying institutional malaise: an Inglorious Revolution, if you like, which is undoing the achievements of half a millennium of Western institutional evolution.

  Debt and the English

  The title of this chapter –‘The Human Hive’ – is an allusion to Mandeville’s poem, The Fable of the Bees. Mandeville’s central point was that societies with the right institutions can flourish even when the individuals who live in them misbehave. It was not biblical virtue that made eighteenth-century England richer than almost anywhere in the world, but rather secular vices. It was just that these vices had what economists like to call ‘positive network externalities’ precisely because the institutions of British society at that time were favourable to saving, investment and innovation.

  After the Glorious Revolution of 1688, as we have seen, the monarch was subordinated to Parliament. Not only did the Whigs who dominated the new regime usher in an age of agricultural improvement, commercial growth and imperial expansion. Financial institutions also developed rapidly: William of Orange brought more than just Protestantism with him from Holland; he also brought templates for a central bank and a stock market. Meanwhile, numerous associations, societies and clubs encouraged scientific and technological innovation. As Robert Allen has shown, the specifically British combination of cheap coal and dear labour encouraged innovation in productivity-enhancing technologies, especially in textile production.20 But the institutions provided the indispensable framework for all this. Here is Mandeville’s version:

  A Spacious Hive well stock’d with Bees,

  That lived in Luxury and Ease;

  And yet as fam’d for Laws and Arms,

  As yielding large and early Swarms;

  Was counted the great Nursery

  Of Sciences and Industry.

  No Bees had better Government,

  More Fickleness, or less Content.

  They were not Slaves to Tyranny,

  Nor ruled by wild Democracy;

  But Kings, that could not wrong, because

  Their Power was circumscrib’d by Laws.

  There was one particular institution that decisively altered the trajectory of English history. In a seminal article published in 1989, North and Weingast argued that the real significance of the Glorious Revolution lay in the credibility that it gave the English state as a sovereign borrower. From 1689, Parliament controlled and improved taxation, audited royal expenditures, protected private property rights
and effectively prohibited debt default. This arrangement, they argued, was ‘self-enforcing’, not least because property owners were overwhelmingly the class represented in Parliament. As a result, the English state was able to borrow money on a scale that had previously been impossible because of the sovereign’s habit of defaulting or arbitrarily taxing or expropriating.21 The late seventeenth and early eighteenth century thus inaugurated a period of rapid accumulation of public debt without any rise in borrowing costs – rather the reverse.

  This was in fact a benign development. Not only did it enable England to become Great Britain and, indeed, the British Empire, by giving the English state unrivalled financial resources for making – and winning – war. By accustoming the wealthy to investment in paper securities, it also paved the way for a financial revolution that would channel English savings into everything from canals to railways, commerce to colonization, ironworks to textile mills. Though the national debt grew enormously in the course of England’s many wars with France, reaching a peak of more than 260 per cent of GDP in the decade after 1815, this leverage earned a handsome return, because on the other side of the balance sheet, acquired largely with a debt-financed navy, was a global empire. Moreover, in the century after Waterloo, the debt was successfully reduced with a combination of sustained growth and primary budget surpluses. There was no default. There was no inflation. And Britannia bestrode the globe.