Why Nations Fail: The Origins of Power, Prosperity, and Poverty (19 page)

Extractive economic institutions in the urban areas of the Ottoman Empire were no less stifling. Commerce was under state control, and occupations were strictly regulated by guilds and monopolies. The consequence was that at the time of the Industrial Revolution the economic institutions of the Middle East were extractive. The region stagnated economically.

By the 1840s, the Ottomans were trying to reform institutions—for example, by reversing tax farming and getting locally autonomous groups under control. But absolutism persisted until the First World War, and reform efforts were thwarted by the usual fear of creative destruction and the anxiety among elite groups that they would lose economically or politically. While Ottoman reformers talked of introducing private property rights to land in order to increase agricultural productivity, the status quo persisted because of the desire for political control and taxation. Ottoman colonization was followed by European colonization after 1918. When European control ended, the same dynamics we have seen in sub-Saharan Africa took hold, with extractive colonial institutions taken over by independent elites. In some cases, such as the monarchy of Jordan, these elites were direct creations of the colonial powers, but this, too, happened frequently in Africa, as we will see. Middle Eastern countries without oil today have income levels similar to poor Latin American nations. They did not suffer from such immiserizing forces as the slave trade, and they benefited for a longer period from flows of technology from Europe. In the Middle Ages, the Middle East itself was also a relatively advanced part of the world economically. So today it is not as poor as Africa, but the majority of its people still live in poverty.

W
E HAVE SEEN
that neither geographic- nor cultural- nor ignorance-based theories are helpful for explaining the lay of the land around us. They do not provide a satisfactory account for the prominent patterns of world inequality: the fact that the process of economic divergence started with the Industrial Revolution in England during the eighteenth and nineteenth centuries and then spread to Western Europe and to European settler colonies; the persistent divergence between different parts of the Americas; the poverty of Africa or the Middle East; the divergence between Eastern and Western Europe; and the transitions from stagnation to growth and the sometimes abrupt end to growth spurts. Our institutional theory does.

In the remaining chapters, we will discuss in greater detail how this institutional theory works and illustrate the wide range of phenomena it can account for. These range from the origins of the Neolithic Revolution to the collapse of several civilizations, either because of the intrinsic limits to growth under extractive institutions or because of limited steps toward inclusiveness being reversed.

We will see how and why decisive steps toward inclusive political institutions were taken during the Glorious Revolution in England. We will look more specifically at the following:

Our discussion will also show that certain areas that managed to transform institutions in a more inclusive direction, such as France or Japan, or that prevented the establishment of extractive institutions, such as the United States or Australia, were more receptive to the spread of the Industrial Revolution and pulled ahead of the rest. As in England, this was not always a smooth process, and along the way, many challenges to inclusive institutions were overcome, sometimes because of the dynamics of the virtuous circle, sometimes thanks to the contingent path of history.

Finally, we will also discuss how the failure of nations today is heavily influenced by their institutional histories, how much policy advice is informed by incorrect hypotheses and is potentially misleading, and how nations are still able to seize critical junctures and break the mold to reform their institutions and embark upon a path to greater prosperity.

I
NSTITUTIONAL DIFFERENCES PLAY
the critical role in explaining economic growth throughout the ages. But if most societies in history are based on extractive political and economic institutions, does this imply that growth never takes place? Obviously not. Extractive institutions, by their very logic, must create wealth so that it can be extracted. A ruler monopolizing political power and in control of a centralized state can introduce some degree of law and order and a system of rules, and stimulate economic activity.

But growth under extractive institutions differs in nature from growth brought forth by inclusive institutions. Most important, it will be not sustained growth that requires technological change, but rather growth based on existing technologies. The economic trajectory of the Soviet Union provides a vivid illustration of how the authority and incentives provided by the state can spearhead rapid economic growth under extractive institutions and how this type of growth ultimately comes to an end and collapses.

T
HE
F
IRST
W
ORLD
W
AR
had ended and the victorious and the vanquished powers met in the great palace of Versailles, outside Paris, to decide on the parameters of the peace. Prominent among the attendees
was Woodrow Wilson, president of the United States. Noticeable by its absence was any representation from Russia. The old tsarist regime had been overthrown by the Bolsheviks in October 1917. A civil war then raged between the Reds (the Bolsheviks) and the Whites. The English, French, and Americans sent an expeditionary force to fight against the Bolsheviks. A mission led by a young diplomat, William Bullitt, and the veteran intellectual and journalist Lincoln Steffens was sent to Moscow to meet with Lenin to try to understand the intentions of the Bolsheviks and how to come to terms with them. Steffens had made his name as an iconoclast, a muckraker journalist who had persistently denounced the evils of capitalism in the United States. He had been in Russia at the time of the revolution. His presence was intended to make the mission look credible and not too hostile. The mission returned with the outlines of an offer from Lenin about what it would take for peace with the newly created Soviet Union. Steffens was bowled over by what he saw as the great potential of the Soviet regime.

“Soviet Russia,” he recalled in his 1931 autobiography, “was a revolutionary government with an evolutionary plan. Their plan was not to end evils such as poverty and riches, graft, privilege, tyranny, and war by direct action, but to seek out and remove their causes. They had set up a dictatorship, supported by a small, trained minority, to make and maintain for a few generations a scientific rearrangement of economic forces which would result in economic democracy first and political democracy last.”

When Steffens returned from his diplomatic mission he went to see his old friend the sculptor Jo Davidson and found him making a portrait bust of the wealthy financier Bernard Baruch. “So you’ve been over in Russia,” Baruch remarked. Steffens answered, “I have been over into the future, and it works.” He would perfect this adage into a form that went down in history: “I’ve seen the future, and it works.”

Right up until the early 1980s, many Westerners were still seeing the future in the Soviet Union, and they kept on believing that it was working. In a sense it was, or at least it did for a time. Lenin had died in 1924, and by 1927 Joseph Stalin had consolidated his grip on the
country. He purged his opponents and launched a drive to rapidly industrialize the country. He did it via energizing the State Planning Committee, Gosplan, which had been founded in 1921. Gosplan wrote the first Five-Year Plan, which ran between 1928 and 1933. Economic growth Stalin style was simple: develop industry by government command and obtain the necessary resources for this by taxing agriculture at very high rates. The communist state did not have an effective tax system, so instead Stalin “collectivized” agriculture. This process entailed the abolition of private property rights to land and the herding of all people in the countryside into giant collective farms run by the Communist Party. This made it much easier for Stalin to grab agricultural output and use it to feed all the people who were building and manning the new factories. The consequences of this for the rural folk were calamitous. The collective farms completely lacked incentives for people to work hard, so production fell sharply. So much of what was produced was extracted that there was not enough to eat. People began to starve to death. In the end, probably six million people died of famine, while hundreds of thousands of others were murdered or banished to Siberia during the forcible collectivization.

Neither the newly created industry nor the collectivized farms were economically efficient in the sense that they made the best use of what resources the Soviet Union possessed. It sounds like a recipe for economic disaster and stagnation, if not outright collapse. But the Soviet Union grew rapidly. The reason for this is not difficult to understand. Allowing people to make their own decisions via markets is the best way for a society to efficiently use its resources. When the state or a narrow elite controls all these resources instead, neither the right incentives will be created nor will there be an efficient allocation of the skills and talents of people. But in some instances the productivity of labor and capital may be so much higher in one sector or activity, such as heavy industry in the Soviet Union, that even a top-down process under extractive institutions that allocates resources toward that sector can generate growth. As we saw in
chapter 3
, extractive institutions in Caribbean islands such as Barbados, Cuba, Haiti, and Jamaica could generate relatively high levels of incomes
because they allocated resources to the production of sugar, a commodity coveted worldwide. The production of sugar based on gangs of slaves was certainly not “efficient,” and there was no technological change or creative destruction in these societies, but this did not prevent them from achieving some amount of growth under extractive institutions. The situation was similar in the Soviet Union, with industry playing the role of sugar in the Caribbean. Industrial growth in the Soviet Union was further facilitated because its technology was so backward relative to what was available in Europe and the United States, so large gains could be reaped by reallocating resources to the industrial sector, even if all this was done inefficiently and by force.

Before 1928 most Russians lived in the countryside. The technology used by peasants was primitive, and there were few incentives to be productive. Indeed, the last vestiges of Russian feudalism were eradicated only shortly before the First World War. There was thus huge unrealized economic potential from reallocating this labor from agriculture to industry. Stalinist industrialization was one brutal way of unlocking this potential. By fiat, Stalin moved these very poorly used resources into industry, where they could be employed more productively, even if industry itself was very inefficiently organized relative to what could have been achieved. In fact, between 1928 and 1960 national income grew at 6 percent a year, probably the most rapid spurt of economic growth in history up until then. This quick economic growth was not created by technological change, but by reallocating labor and by capital accumulation through the creation of new tools and factories.

Growth was so rapid that it took in generations of Westerners, not just Lincoln Steffens. It took in the Central Intelligence Agency of the United States. It even took in the Soviet Union’s own leaders, such as Nikita Khrushchev, who famously boasted in a speech to Western diplomats in 1956 that “we will bury you [the West].” As late as 1977, a leading academic textbook by an English economist argued that Soviet-style economies were superior to capitalist ones in terms of economic growth, providing full employment and price stability and even in producing people with altruistic motivation. Poor old Western capitalism did better only at providing political freedom. Indeed, the
most widely used university textbook in economics, written by Nobel Prize–winner Paul Samuelson, repeatedly predicted the coming economic dominance of the Soviet Union. In the 1961 edition, Samuelson predicted that Soviet national income would overtake that of the United States possibly by 1984, but probably by 1997. In the 1980 edition there was little change in the analysis, though the two dates were delayed to 2002 and 2012.