We are all aware of the fact that there is a rather large gap between rich and poor countries. The income gap between these two sets is persistent, and while the poorest countries have become richer, they are not catching up with the richest. Some part of this inequality is historical, but there is strong reason to believe that institutional differences in countries can explain this difference. The developed world has a common thread in the form of political and economic structures, and probably mindsets too. This is the theory espoused by three economists, Daron Acemoglu, Simon Johnson and James Robinson, who have been accorded this year’s Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.
What exactly do they mean by institutions? It is a gamut of political and economic edifices which drive the growth agenda of a country. Simply put, the regime can be inclusive, which is best exemplified by the West which is also largely democratic. This would mean a strong legal system where rules are defined, with an adjudication system in place. There are transparent laws relating to doing business, covering taxes, trade and commerce etc. This provides the contours for doing business.
Alternatively, it can be exploitative as can be seen in autocratic regimes, such as in some parts of Africa. Quite clearly, societies with poor rule of law and institutions that exploit the population do not generate growth or change for the better. When multilateral institutions keep harping on economic reforms, this is what they are talking about.
The 2024 Nobel Laureates do trace their theory to colonialism where they link the quality of institutions to the number of settlers in colonies post-independence. In some places, the aim of the colonists was to exploit the indigenous population and extract resources for their own benefit. In others, the colonists formed inclusive political and economic systems for the long-term benefit of European migrants. This varied across Europe and Asia and Africa. Where colonists remained and settled due to lower mortality, there was evidence of creation of institutions which worked well. They do not justify colonialism, which was exploitative, but do find this positive correlation in places where the colonists became settlers and contributed to this development.
The two main takeaways from their body of work is the importance of a democratic set up and the creation of the right institutions that foster investment. Democracies definitely work better, as there are free elections and while different parties may have varied motivations, one needs to perform in order to get back to power. Hence institutions would necessarily have to be built. Protection of private property is such an institution which comes automatically if there is a strong judicial system. Similarly, various policies that support the growth process would be part of the system.
A question which would come to mind is how China has managed to create one of the largest economies with the latest state-of-the-art infrastructure and production processes. The political system is autocratic for all practical purposes, but has delivered well. Here, the counter argument can be that while the economy is large and competes well with other developed nations, there is immense inequality within the country. Therefore, such guided growth, where the government owns and controls a large part of the means of production, does not bring about an optimal solution in terms of equality.
Singapore can be another contrarian example which is not democratic but has strong institutions. It can be considered an outlier for sure. There are also some of India’s neighbouring countries which are ostensibly democratic but tend to get oligarchic, which has impeded development.
Let us look internally now. The government has focused a lot on the ease of doing business which has been achieved by creating the appropriate institutional structure through a series of reforms in every sector. Providing access to infrastructure, land laws, dispute resolution, strong financial systems etc. are all part of the institutional set up that is required to keep growth ticking. This has been vindicated in our context in the last 10 years or so where India has become the fastest-growing economy though, admittedly, there is a long way to go in becoming a developed economy.
Therefore, while the Laureates do not provide specific solutions, a takeaway can be that unless there are democratic regimes which foster the building of strong institutions, growth across countries will remain lopsided.
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