Why Nations Fail

The Economic Nature of the Resource Curse: Mechanisms

Daron Acemoglu and James Robinson — Thu, 23 May 2013 12:17:00 +0000

We saw in our last post that cross-national evidence suggests countries with poor institutions, such as lack of checks and balances or high levels of corruption, experience economic contractions when they discover natural resources? The question is why.

There is no consensus amongst academics on this. A very nice overview of many arguments is provided in a recent 2011 survey by Rick van der Ploeg, an expert on resource economics, “Natural resources: curse or blessing?”.

One set of hypotheses is developed in our work “Economic Backwardness in Political Perspective” and in Daron’s survey article “Modeling Inefficient Institutions”. The idea is simple: if a dictator or a group of elites is willing to do inefficient things in order to cling to power — in the way that the Russian and Austria-Hungarian elites in early 19th century were willing to block railways and industrialization as we discussed in Why Nations Fail — then greater natural resource rents will make matters worse. In particular, natural resources will raise the “political stakes” and increase the desire of such elites to cling to power and expand the range of inefficient policies, institutions and repressive strategies they would be willing to utilize in order to achieve this objective.

Another related idea that greater political stakes will not only make the elites more likely to pursue inefficient policies or repression to cling to power, but also encourage would-be elites to contest power in order to take control of natural resources rents — a possibility only made more plausible by the all too frequent civil wars in resource-rich countries. (Theoretically, this result follows from standard contest models applied to politics, for example, as in the work of Stergios Skaperdas, and also has a bit of the flavor of the “war of attrition” games, though these may not be as natural in this context).

A related theory, perhaps better suited to some of the dynamics of Cameroon, is the one developed by James in collaboration with Ragnar Torvik and Thierry Verdier (“The Political Economy of the Resource Curse”). In this model an incumbent politician is trying to stay in power when faced with an election, or more generally a contest, by engaging in patronage. In the model patronage takes the form of granting employment in the public sector to some selected groups. This is socially inefficient because people are more productive in the private sector but the role of public sector employment is to tie people’s future incomes to the incumbent staying in power, thus giving them an incentive to support him in the election/contest. If there is a boom in natural resources, it becomes much more desirable for the incumbent to stay in power and so he engages much more aggressively in patronage, expanding the size of the public sector. This reduces national income. Of course the increase in natural resource wealth mechanically increases national income.

The paper shows however that the indirect negative effect can actually be so large as to dominate the direct positive effect so that a resource windfall can lead to a fall in national income. This happens when patronage is a very effective way of staying in power that the paper interprets in terms of institutions. When there are few checks and balances for example or when the state is weak so it is easy to over-ride meritocratic criteria for employment in the public sector as was the case in Cameroon at the end of the 1970s, then a boom in natural resource wealth can reduce income per-capita.

The Economic Nature of the Resource Curse: Evidence

Daron Acemoglu and James Robinson — Tue, 21 May 2013 12:02:00 +0000

So oil has been a curse for Cameroon.

Is it true more generally that natural resource wealth, or perhaps more specifically oil wealth, has a negative effect on economic growth? If it does, via what mechanisms?

Before we start thinking about mechanisms let’s focus on the cross-national evidence. In fact, the more careful evidence does not suggest that there is such an unconditional effect.

Early work by Jeffrey Sachs and his collaborators suggested that this was the case. And it is true that the discovery and exploitation of oil in the Cameroon coincided with a massive economic decline and deterioration in human development.

But as we discuss in Chapter 14 of Why Nations Fail, this was not the case in Botswana where the diamond wealth has been a key part of the economic and human development success of the country. Other obvious examples of resource wealth helping economic development include Australia, Chile, Norway and the United States.

So the claim that the average effect of natural resource wealth on economic growth is negative must either be wrong or uninteresting – meaning that the heterogeneous effect of resource wealth in different contexts are what is really interesting to study. What context? As we point out in Why Nations Fail, Botswana’s distinctive characteristic was its institutional development prior to the discovery of diamonds.

It is also obvious that while Cameroon had poor institutions in 1977, Australia, Chile, Norway and the US all had relatively good institutions when they benefitted from resource discoveries.

The idea that the economic impact of natural resources is conditional on the quality of institutions was brought home vividly in a paper by Karl Moene, Halvor Mehlum and Ragnar Torvik, “Institutions and the Resource Curse,”. (See also this related paper). The three Norwegians showed that there is only a “conditional resource curse” in the sense that there is a negative correlation between resource abundance (as measured by the ratio of primary exports to GDP in 1970) and economic growth for countries with low institutional quality. But the same correlation is positive for countries, such as Norway, with stronger institutions (or what we would call “inclusive institutions”).

There are of course many ways to measure institutional quality, and several of these measures are correlated. The three Norwegians created an institutional quality index as an un-weighted average of five indexes based on data from Political Risk Services: a rule of law index, a bureaucratic quality index, a corruption in government index, a risk of expropriation index, and a government repudiation of contracts index. Since many of the measures of institutions used in this literature are the outcomes of political processes, they are also closely related to policy outcomes. Thus this conditional resource curse bundles quite a large number of factors into what conditions the impact of resources which stretch all the way to fundamental aspects of the political institutions of a country (such as the nature of the constitution) to basic economic institutions (security of property rights), the nature of the state (bureaucratic quality) all the way to government policy (repudiation of contracts).

All the same, the paper produces a very important bottom line: to the extent that Cameroon did experience a resource curse after 1977 this was because some key facets of its institutions were initially poor.

What about the mechanisms? We will turn to this in our next post.

Is There a Curse of Resources? The Case of the Cameroon

Daron Acemoglu and James Robinson — Thu, 16 May 2013 20:45:20 +0000

Are natural resources really a curse? Before discussing cross-country regressions analysis let’s begin with a case study that appears to illustrate exactly what people have in mind when they talk about the resource curse. In their recent edited volume “Plundered Nations? Successes and Failures in Natural Resource Extraction” Paul Collier and Anthony Venables have a very interesting chapter by Bernard Gauthier and Albert Zeufack called “Governance and Oil Revenues in Cameroon”. There is no better place to start to study the resource curse.

Oil was discovered in Cameroon in 1977. At the time the economy had been growing well based on coffee and cocoa exports. The arrival of oil triggered a boom with the economy growing at an average rate of 9.4% between 1977 and 1986, but then the slide began. Positive turned negative, and by 1993 income per capita was half of the 1986 level. Though growth then resumed, Cameroon is still about 1/3 poorer than it was in 1986. This poor growth experience went along with deteriorating human development. Life expectancy fell from 56 to 50 years between 1995 and 2006 and infant mortality increased by almost 30% over the same period. Primary and secondary school enrollments declined by 10%. A lot of these declines are due to a collapse of public investment.

On the face of it this is odd given that over the period since 1977 Gauthier and Zeufack estimate around US$20 billion has accrued as oil rents to the Cameroonian government. This represents around 67% of the total oil rents, so the lions share of the rent went to the government, not to big bad oil companies.

What did the government do with this windfall?

Gauthier and Zeufack don’t know the answer to this because for a start only 54% could be properly accounted for in the sense that they appeared somewhere in the government budget. They rest simply vanished and “may have been looted”.

Just getting to this first number takes a lot of work and the use of many sources because “The oil sector in Cameroon has been surrounded by official secrecy for most of the last 30 years … very little is known about the level of resources accruing to the country and the use of these resources.’’

Interestingly in 1977 President Ahmadou Ahidjo of the Cameroon decided to create an extra-budgetary account abroad to “manage” the oil revenues. The size of this account was never published, and the president released no information about it. This was not a sovereign wealth fund of the type run by Norway or Chile. Sadly, some erroneous ex post justifications were provided for this lack of transparency even by the international community which should have known better.

Gauthier and Zeufack quote a 1988 World Bank report as noting:

While this secrecy has potentially dubious effects on the responsibility and accountability for public revenues, it does presumably have the benefit of reducing various pressures to increase government spending, which emerge once it becomes clear that the government is flush with funds

Meanwhile, between 1978 and 1986 government expenditures went from 17% of GDP to 26% of a much larger number. Public sector wages increased as did subsidies. There was also a boom in government capital formation that tripled. The government, based on a temporary increase in oil revenues, embarked on an unsustainable boom in consumption and investment, much of which was in “white elephant” projects with little social value. The crash came in 1986 and in 1988 Cameroon entered into a structural adjustment program with the IMF.

Cameroon has limped along since then. The President Paul Biya, who replaced Ahidjo in 1982, is still in power having survived the democratization of the country in 1992. In October 2011 he won his sixth term in office with 77.9% of the votes. In the meantime he had to amend the 1996 Constitution to remove the two-term presidential term limit.

Oil seems to have brought few development benefits to Cameroon, indeed quite the opposite. This looks like the resource curse doesn’t it? So is resource wealth always a curse?

Economic Growth in the Democratic Republic of the Congo?

Daron Acemoglu and James Robinson — Tue, 14 May 2013 13:17:00 +0000

This year on June 6-7 the World Bank is sponsoring the first Annual Kinshasa Conference on Economic Growth and Governance. The blurb for the conference starts:

In recent years the Democratic Republic of Congo (DRC) has put in place important foundations to move to a new stage of development. The consolidation of peace and stability, and the strengthening of the macroeconomic framework are major accomplishments, including lowering of the annual inflation rate from 500 percent (2001) to 10 percent (2012). Thanks to these advances, economic growth accelerated to an estimated 7.2 percent in 2012. Progress, though from a very low base, has been registered in the social sphere as well. The infant mortality rate has dropped significantly, several endemic diseases have been eradicated and school enrollment has risen sharply. In terms of infrastructure, rehabilitation of road infrastructure has been launched across the country, telecommunications have made considerable progress, and the energy sector is increasingly becoming a focus of investments.

You’ve got to admire their optimism. Many might have looked at the recent or more distant history of the Congo, a country trapped in desperate poverty despite its fabulous wealth in natural resources, and reached a gloomier conclusion.

The readers of Why Nations Fail will recall that we trace the long 500 year history of extractive institutions in the Congo. Should we be gloomy?

All that history notwithstanding, things do appear to have started changing, and the World Bank has been enrolled in this change, trying to find ideas for how to move forward recognizing the many institutional problems that exist in the country.

One thing they did was to engage in a massive data collection and analysis of many different aspects of the Congolese economy. The results of this came out in French in three thick volumes, but the findings were summarized in the 2012 book Resilience of an African Giant edited by Johannes Herderschee, Kai Kaiser and Daniel Mukoko.

Reflecting the huge potential of the country, the theme for the first conference is “Harnessing Natural Resources for Development”. The optimistic focus is on trying to propose better ways for the Congo to use it’s natural resource wealth in socially desirable ways.

The conference includes such luminaries as Paul Collier. Why Nations Fail’s own James Robinson will also be there addressing the issue of “Governing Natural Resources for Shared Prosperity: Getting beyond the Resource Curse.” Gulp!

But perhaps we should first ask: is there really a “curse of natural resources”? And if so, what is it and what can the Congo do about it?

We’ll try to think this through over the next few blogs in anticipation of the conference.

The Looting of Bogotá

Daron Acemoglu and James Robinson — Fri, 10 May 2013 15:22:00 +0000

Colombia is not a country known for good governance or institutions. Long the drug and murder capital of the world, it has been struggling back towards some sort of stability since the government of President Álvaro Uribe between 2002 and 2010 brought large improvements in security.

Yet even in the worst of days in the 1990s, the capital city Bogotá provided some small grounds for optimism. Starting with the election of Jaime Castro as mayor in 1992 and accelerating with the election of Antanas Mockus in 1995, Enrique Peñalosa in 1998 and the second Mockus administration between 2001 and 2003 big changes happened in Bogotá.

There were huge improvements in security and a large expansion in the supply of public goods. Bogotanos began to think about their city differently. They began to walk about on their streets again. In 1985 only 25% of Bogotá citizens believed the city to be a good place to live but 15 years later, 67% thought the same way. Mockus, a philosophy Professor at the National University of Colombia used many unorthodox but apparently highly effective tactics to change people’s behavior. For instance, to get people to inform the government about the anti-social behavior of others he went around with a toy frog pinned to his jacket – in Colombia someone who tells tales is called “un sapo,” a frog. He also hired mime artists to shame people into obeying the rules.

Here is one waving the banner “incorrecto” incorrect!

That Castro, Mockus and Peñalosa won was quite a surprise. To do so they had to defeat the machine politics of the traditional Liberal and Conservative parties. Research by Rafael Santos at the University of the Andes showed how this was caused by reforms to the structure of the voting procedure. In particular the 1991 Constitution introduced the tarjeton, a new more secret method of voting where voters were given a single unified ballot, instead of having separate party ballots. Santos showed that the introduction of the tarjeton coincided with a breakdown in the spatial relationship within Bogotá between votes for traditional political parties and where public sector workers lived. The tarjeton broke down the traditional mechanisms of patronage allowing people to vote on new issues, those raised by Mockus et al.

Yet in 2004 the sequence of reformist mayors came to a grinding halt. The new mayor was Luis Eduardo Garzón from the leftist Alternative Democratic Pole political party. To many it seemed that while the reformist independent mayors had been successful at defeating traditional clientelism, they were vulnerable to left wing clientelism.

Moreno came from an interesting family. His grandfather, Gustavo Rojas Pinilla was Colombia’s only real military dictator of the 20^th century between 1953 and 1958. Yet this was a mild dictatorship and Rojas Pinilla had wide support when he overthrew the Conservative government of Laureano Gómez in 1953 in the midst of an inter-party civil war known simply in Colombia as The Violence (La Violencia). Rojas Pinilla had actually developed an infrastructure, such as building the national airport, El Dorado, and the broad avenue that leads out to it known as “the twenty six” (la veinte seis). He gave women the vote. In 1970 he’d made a political comeback with Samuel’s mother, María Eugenia as his running mate and only lost the presidential election because the incumbent Liberal party committed fraud. In 1974 María Eugenia ran for president.

Thus Moreno was the heir to an interesting alternative political tradition in Colombia. Many had high hopes that his control of the capital city would be the launching pad for a new type of politics.

Things turned out quite different. Moreno, it turns out, had spent all these years climbing the ladders of power to get the chance to loot. He did this along with his brother and former national senator, Ivan Moreno. Moreno was stripped of his position in May 2011 before his term was up and by September was in prison. The whole story is only just coming out (see this article in Spanish in the Colombian Newsweek Semana.

Here is Semana’s map of the Carousel.

After taking power Moreno set up a “shadow government” for the city, headed by his brother Ivan. This ran the “contract carousel” which basically handed out all the valuable contracts for the city in exchange for kickbacks and bribes. In particular the Morenos took a percentage for themselves from each contract.

The brothers hired Emilio Tapia to run the shadow government that had a “board” and was based in a luxurious suite of offices in the north of Bogotá. It also had a private plane and used to meet regularly in Miami. The brothers developed a cute slang, if they had an interest in a contract they called it “un mordida” a bite. The jewel in the crown of bites was the contract to run the integrated public transport system in Bogotá. This carries about 7 million people per day. The Morenos cut was 8 pesos per passenger, implying 56 million pesos per day. This works out at around US$30,000 per day, for 16 years. Part of the irony here was the contracts for the extension of the “Transmilenio” bus system along the “26” out to the airport, the road to the airport built by his grandfather.

The brothers did not stop there. They looted everything. Existing hospitals were very lucrative, but building new ones created even better opportunities for stealing. They took between 25 and 30% for themselves. They handed out the ambulance contract, but of this only half went to the firm that ran the ambulances, the rest was for the brothers and their cronies. Companies which refused to offer “the bite” lost out being told they were “too cheap”. Roads and bridges were also lucrative and some were 100% lucrative. 45 million pesos (US $25,000) were allocated to start on a bridge linking Carrera 9 to Calle 94 to alleviate traffic jams. It was never started. The story goes on and on.

Where is all the money? The Colombian government is trying to find out. Much was invested in real estate in the US, stashed away in the Virgin Islands, Switzerland, and all the usual suspects. Nobody really knows how much was stolen in three years; one estimate is US$500 million!

What is so depressing about this story is that Mockus and Peñalosa failed to institutionalize the gains that they had made for a decade.

All of the rules and procedures that they had established were quickly subverted and Moreno apparently faced no checks and balances or mechanisms that stopped the orgy of looting. That this also happened in Bogotá, supposedly the most functional part of Colombia, is a salutary lesson. Other Colombian reformers will need to carefully study what lessons can be learned.

In Medellín, for example, a city with much worse initial conditions than Bogotá, a series of reformist mayors initiated by Sergio Fajardo in 2003 made even more progress than the mayors of Bogotá did. Fajardo, now governor of the Department of Antioquia, and in the midst of a radical plan to transform the education system of the department, must be asking himself what will happen when he is term limited. How does he institutionalize all of the improvements he managed to implement?

Perhaps Bogotanos should have known what was coming. Before the election in a line TV debate Moreno was asked by Antanas Mockus if he would buy 50 votes if that prevented someone who had already bought 50,000 votes from winning, thus “saving Bogotá”.

His response was “Yes, without doubt!”.

It was a premonition of what was to come. You can even watch it on YouTube.

The Persistence of Institutions in Mexico?

Daron Acemoglu and James Robinson — Wed, 08 May 2013 12:59:00 +0000

Last week we pointed out that one hypothesis about why Why Nations Fail was unavailable in Mexican bookshops is that Carlos Slim owns the biggest book retailer in the country.

Now our point about Carlos Slim is not that he is a “bad guy”. Quite the contrary, he’s just behaving like a normal rational person would, responding to incentives and trying to further his interests.

Slim is in fact just the most recent incarnation of a long history of monopolization in Mexico that stretches far back into the colonial period. His monopolization of media is nothing new. Only the monopolizers and the strategies change.

To see this, ask yourself whether our book would have sold better under the long one-party rule of the PRI? Probably not. It certainly would have gone against the interests of the PRI elites — if they had noticed it. Probably it would have gotten even less media coverage.

To see why, let us turn to the most compelling account of the origins of the PRI and the way it worked is the 2008 book Mexico Since 1980 by Stephen Haber, Herbert Klein, Noel Maurer and Kevin Middlebrook. Though this looks like it is a commentary on contemporary Mexico, in fact it is a penetrating model of the political economy of the PRI and how it collapsed to usher in democracy.

The context for the creation of the party is the Mexican Revolution between 1910 and 1919. After the full-blown revolution stopped, intense violence continued. In 1920 the President Venustiano Carranza was overthrown and assassinated. His successors Álvaro Obregón and Plutarco Calles faced major revolts by the military and their own cabinet ministers in 1923, 1927 and 1929, and a civil war between 1926 and 1929, the Cristero War. In 1928 Obregón was assassinated after being re-elected president.

In response to the potential chaos, Calles crafted in 1929 the Revolutionary National Party (the PNR) that would eventually become the PRI in 1946. The PRI was an institution for incorporating and sharing power between the factious and violent elites who were endlessly scheming to overthrow the system. It also used agrarian reform as a way of consolidating peace in the countryside and creating a vast rural patronage machine to make sure it would win elections.

This new party program was implemented by President Lázaro Cárdenas between 1934 and 1940. In 1938 Cárdenas moved to exert control over the media with a simple strategy. He nationalized the production of newsprint which could not be imported. If you wrote something too critical of the PRI, you wouldn’t get any newsprint to publish on, and that was that.

Hence our guess that Why Nations Fail wouldn’t have sold well under the one-party state of the PRI either.

Why Regions Fail in Mexico

Daron Acemoglu and James Robinson — Thu, 02 May 2013 14:11:39 +0000

James was asked by Mexican Senator Zoé Robledo of the political party the PRD how to apply the ideas from our book to explain within country variation. Senator Robledo is from Chiapas, the poorest and most unequal state in Mexico.

Why, Senator Robledo wanted to know? Reasonable question.

We do talk quite a bit about regional inequality in the book, for example about how the US South was poorer than the North because the South had more extractive institutions. We also examine regional inequality in Argentina pointing out that the northwest, where in contract to Buenos Aires and the Pampas there we dense populations of indigenous peoples at the time of the conquest of the Americas.

In consequence such states as Salta and Tucumán had many of the extractive institutions of colonial Spanish America like the encomienda. Today these parts of Argentina are much poorer than Buenos Aires and the places which were neglected during the colonial period (until the Bourbon reforms of the 18^th century the Spanish actually made it illegal to export anything from Buenos Aires, instead, if anyone was crazy enough to want to do this, they had to ship it over the Andes and export it from Perú!).

But in Why Nations Fail we don’t talk about this issue in Mexico. So how might we explain why Chiapas other Southern states like Oaxaca and Guerrero are much poorer and more unequal than the Mexican average?

Here is a link to the speech that James Robinson gave at the Mexican Senate last Tuesday in Mexico City trying to tackle this question.

Though we don’t want to spoil the suspense, it turns out that it is because these states have more extractive institutions than the rest of Mexico (a bit like the US South really).

Reading Why Nations Fail in Mexico

Daron Acemoglu and James Robinson — Tue, 30 Apr 2013 11:29:00 +0000

With all this discussion of Slim, monopolies and well, let’s face it, extractive institutions in the air in Mexico, you might have conjectured that Why Nations Fail was selling like hot cakes. Not quite hotcakes but the Spanish Translation has actually done quite well in a number of places. It was even the 5^th best selling book in Colombia last year after the autobiography of President Álvaro Uribe and the Fifty Shades of Grey trilogy (…well you couldn’t really have expected us to outsell them!).

Not in Mexico. In fact the leading bookseller in Mexico, Sanborns, does not stock it (James checked recently at the branch in the Centro Histórico next to Porfirio Díaz’s wonderful Palacio de Bellas Artes – they didn’t have it and hadn’t heard of it).

Frustrating.

But then someone suggested a simple explanation: Sanborns is owned by Carlos Slim.

Why Nations Fail in Mexico

Daron Acemoglu and James Robinson — Thu, 25 Apr 2013 12:26:00 +0000

If there is one country in Latin America where you might have thought the analysis of Why Nations Fail was relevant, it would be Mexico. In the first chapter of our book we traced the economic and political history of Mexico and showed how and why it diverged from that of the United States. We ended the chapter with a discussion of how the difference between how Carlos Slim made his money (monopolies) and Bill Gates made his money (innovation) is telling about the economic problems of Mexico.

This doesn’t come as news to most Mexicans, though it does come as a surprise to Bill Gates apparently since he has recently claimed that Carlos Slim was good for the Mexican economy.

Last year Mexicans elected a new President Enrique Peña Nieto who took office in December. There were quite a few skeptics about whether Mr. Peña Nieto was up to the job (he made several highly publicized gaffes during the campaign). But since getting into power he has turned out to be something quite different from his detractors.

First, he immediately signed a multiparty pact with the opposition parties the PRD and the PAN (the party of outgoing President Felipe Calderon). This “Pact for Mexico” outlined a large number of policy priorities, but one of the ones prioritized by Peña Nieto was educational reform.

Such reform faced a big obstacle in the teachers union headed by Elba Esther Gordillo known as “La Maestra” (the schoolteacher). La Maestra has used the union like a personal fiefdom for two decades, enriching herself and blatantly intervening in elections (the teachers count the votes in Mexico, which turns out to be particularly useful in close elections such as the one in 2006 when La Maestra backed President Calderon and he won a hotly contested election by a narrow margin – 233,000 votes).

Perhaps the most unfortunate aspect of all of this seems to be that the teacher’s union controls the hiring and training of teachers. One result is that Mexico has a terrible education system. Peña Nieto’s response to this obstacle was have La Maestra arrested for charges of embezzlement. Another priority was to completely re-vamp telecommunications regulation with serious attempts to increase competition and challenge Slim’s monopoly. The statements of the Finance Minister Luis Videgaray show clearly that the government understands the connection: less extractive economic institutions, faster economic growth and less inequality in Mexico.

How come there is now seemingly a move towards dismantling extractive economic institutions in Mexico?

Our framework in Why Nations Fail suggests one answer. Since 2000, Mexico has moved towards more inclusive political institutions, and one implications is mounting pressure to make economic institutions less extractive.

But history suggests this is the optimistic interpretation. Carlos Slim acquired his telecom monopoly during the Presidency of Carlos Salinas de Gortari. Salinas was seen at the time as a reformer, just like Peña Nieto, and was of course from the same party, the PRI. He brought a wave of “market reforms” to Mexico, like the telecom privatization. But this didn’t really change Mexican institutions. Rather, these reforms can be interpreted as an attempt by Salinas to develop a new political base by creating a group of wealthy oligarchs, politically beholden to him. In reflecting on this, it is good to ask who actually appointed La Maestra in the first place? (Answer: Salinas.)

So the big question for Mr. Peña Nieto is: a move towards inclusive institutions or the Iron Law of Oligarchy in action? Did he arrest La Maestra because he really wants to reform Mexico’s education system or is it because he’s mad at her for abandoning the PRI and backing Calderon’s PAN in 2006?

Efficient Organization among Pirates?

Daron Acemoglu and James Robinson — Mon, 22 Apr 2013 12:48:00 +0000

In our last post, we discussed pirate democracy, based on Peter Leeson’s The Invisible Hook, a great and thought provoking read.

Our main argument was that democratic elections and checks on leaders that emerged in pirate ships illustrate a more general point: if we want to understand democracy, we should think not about the idea of democracy extending back to the Ancient Greeks, but about the incentives that democracy creates and the distribution of political power among different groups in society that underpins democracy.

We also questioned Peter Leeson’s interpretation, which explains the emergence of pirate democracy solely on the basis that this was the efficient arrangement for pirates — a specific instance of what we have dubbed elsewhere “the efficient institutions view”.

Peter Leeson has now followed up with a post, providing additional arguments supporting the idea that pirate democracy emerged because it was the efficient organization, and more generally defending the efficient institutions view.

Of course Leeson wrote the book on the subject, so we cannot disagree with the facts he presents.

Nevertheless, our interpretation differs.

First of all, we find the general presumptions upon which the efficient institutions view rests fairly unconvincing. What are exactly the forces that will ensure that institutions are efficient? And efficient for whom?

After all, Why Nations Fail is all about the ubiquity of extractive economic and political institutions that are blatantly inefficient. How can we understand, if not as highly inefficient for economic prosperity and for the majority of the population, regimes such as North Korea? We cannot appeal to their ephemeral nature easily either, since many of these are not exactly short lived. (Wonky note: here by “inefficiency”, we are not referring to Pareto inefficiency. Such regimes, under some circumstances, could lead to Pareto efficient equilibria given the existing set of economic and fiscal instruments. But they are “inefficient” from the viewpoint of maximizing the economic surplus in society or the size of the “economic pie” so to speak).

Second, there is a bit of an internal inconsistency to the efficient institutions view. Let us illustrate this with the example of pirates. Suppose that in fact democracy was adopted by pirates because it was the “efficient organization” for them. That would presumably mean that it furthered the ability of pirates to raid and ransack as many ships as possible. But is this really efficient from the viewpoint of society? Most people would presume that the damage that pirates cause is much greater than the benefits to themselves, especially because the prospect of piracy is likely to discourage commerce and investment. So in a world of complex economic, social and political relationships — i.e., the world we live in — even if efficiency at the level of some subunit can be ensured, this will typically be at the expense of inefficiency at some more aggregate level. But then how can we talk of efficient institutions prevailing in the society at large?

Third, Peter Leeson’s superior knowledge on this topic notwithstanding, we did not find his interpretation that compelling. Leeson notes that a democratic organization, with a more equal distribution of political power and better checks on leaders, was efficient for pirates. Probably right. But the same reasoning suggests that it would have also been efficient for many other businesses and social and political organizations. But we see nondemocratic organizations persist in many of those spheres. So where are the efficient institutions?

Our hypothesis— truly nothing more than a hypothesis, since we are not experts on the history of pirates — is that what distinguished pirates from much of the rest of society at the time was the distribution of de facto political power (in fact, the distribution of de facto political power was at the center of our theory of democracy in our previous book, Economic Origins of Dictatorship and Democracy, and we are still keen on this idea).

The lower strata of society until the 19th century did not have much de facto power pretty much anywhere else in the world around that time, so they could not make effective demands for a level playing field or for direct economic transfers or for political change meant to support these economic outcomes. As a result, there was no need for those currently holding de facto and de jure power to make concessions to them — particularly political concessions to further increase their political power and participation.

This was possibly different among pirates for the reasons that Leeson masterfully recounts: all pirates had cutlasses.

Now Leeson is right that there are other factors that may have made a democratic organization less costly among pirates than for other businesses. For example, a democratic organization on the factory floor, by shifting the ex post say on pay and profits to workers, may make it harder for the ex ante investments of the entrepreneur to be rewarded.

But in contrast to this reading of the purely efficiency-based view, workplaces have also become more democratic over the more recent past. Most notably, trade unions in many countries had a lot of say on many decisions of the factory throughout the latter half of the 19th century and much of the 20th century. But perhaps even more telling are economic cooperatives. These, following the Rochdale Principles named after the Rochdale Society of Equitable Pioneers founded in 1844, typically specify “democratic member control” as a defining characteristic. We would also hypothesize — once again without having studied the history of such cooperatives in detail— that the more democratic nature of today’s workplace and the much more democratic organization of cooperatives isn’t just because ex ante investments of entrepreneurs have become less important, but also at least in part because the de facto distribution of power on the factory floor has shifted towards trade unions and workers.