The World Through Institutional Lenses

What explains the differences in prosperity among nations? How does a nation create sustainable broad base economic growth? Is growth the result of differences in human capital and technology? According to Daron Acemoglu, the Elizabeth and James Killian Professor of Economics at Massachusetts Institute of Technology, and James Robinson, the David Florence Professor of Government at Harvard University, the differences among nations cannot simply be explained by economic factors. The answer lies in the ability of nations to create inclusive (versus extractive) political, economic, and social institutions. Below is a conversation with Daron Acemoglu done by Edge.org that gives insight in how to view the economic system through institutional lenses.  

BOSTON - When I got into economics one of the things that attracted me was thinking about why some nations are rich and some are poor, why some are democratic and others aren't, and why they're socially, politically, and economically so different. I grew up in Turkey and I came of age in the middle of a military regime and the economy wasn't doing well so those questions were in the air. That's the sort of thing that attracted me to economics.

When I came into economics I realized those weren't the issues that most economists worked on. I was still interested in economic development and economic growth, but I tried to think about it using the same approach as economists did. Then about 17 or 18 years ago, I started talking to James Robinson who became my long time collaborator, and James and I both had the same issues with the economics approach. A lot of the interesting issues related to politics, institutions, and the roots of the politics of policies and institutions were left out. We started working, thinking, and discussing to try to write papers on these things. At the time it wasn't a big area within economics.

The collaboration with James and my work and thinking on this has been the most defining aspect of my career. The main issues that I have worked on have all come out of that collaboration and that process. At the center of it is the huge difference in prosperity that we see around us. We live in a very integrated globalized world, but if you compare the United States to Haiti, that's not that far, or the United States to some countries in sub-Saharan Africa there are huge differences in prosperity. Depending on how you measure it there are 40, 50, 60-fold differences in income per capita.

At the time that Adam Smith wrote the defining text of economics in the 18^th Century, the same gaps would have been four or five fold at most. So even though we're in a much more unified world, these gaps, these disparities are huge and I think that's one of the major questions facing social science. What I've been trying to do is trying to understand that. The standard economic approach is all about understanding why countries grow thinking about human capital—education, skills, and so on—thinking about physical capital—machinery or technology—but really at the root of these things there must be some other differences.

We can't really have a satisfactory explanation for why the United States is so much richer than Haiti by saying the United States has much better machinery, has much better education, and so on. The question is why? Why did the United States end up with this better machinery? Why did the people make the choices to go to schooling or why did they organize their production and factories differently?

The perspective that has shaped my thinking on this is all about institutions. 'Institutions' is a catch-all word. Many things in a society are part of its institutions. Douglass North who was one of the leading proponents of the institutions view defined it as the set of humanly designed constraints that shape human behavior. That's a very broad definition. What James and I tried to do is bring greater clarity and discipline to thinking about institutions both empirically and theoretically. We distinguish between economic and political institutions.

Economic institutions are those that really shape the economic incentives. They create opportunities or incentives for investment and innovation. They are crucially related to how level the playing field is. You now have many societies in which only a small fraction of the population are given the opportunity to get into the action. They are the only ones who can work in the modern sector. They're the only ones that can open businesses or open factories or get into trade or get into whatever occupations that they want. So that's really important to have this level playing field, in addition to economic institutions such as property rights and contracting institutions that give incentives to people to take advantage of whatever calling they have in life. (read more)

The Importance of Politics in the Economic System

What role has politics played in the Great Recession? Did politics play a causal role in creating and prolonging the recession? Or was the recession created by underlying economic forces? Economists have traditionally insisted on the primacy of economic factors. In studying growing inequality, for instance, they have focused on economic forces like trade and technological change. However, according to Jacob Hacker (Yale University) and Paul Pierson (UC Berkeley) the most compelling counter argument to the traditional economic story comes, ironically, from two Nobel price-winning economists. Hacker and Pierson state that "in recent years (in part through the urgings of iconoclasts like Krugman and Stiglitz) has there been a turn to politics to explain America’s distinctive economic challenges—a reorientation that brings economics back toward its original conception as the science of political economy. No one can doubt that the American political economy has changed dramatically over the last generation. Perhaps most fundamental is a transformation that Stiglitz and Krugman seem to assume and barely mention: the huge shift in the relative influence of business and labor."

NEW YORK - Five years after the onset of the financial crisis that badly damaged the US economy, the nation remains mired in chronic joblessness. The unemployment rate, stubbornly above 8 percent, actually makes the situation look better than it is. Many millions have given up looking for work and no longer figure in the statistics. Long-term unemployment remains at levels unseen since the Great Depression. Young Americans are entering the worst job market in at least a half-century. For both the long-term unemployed and new job seekers, this sustained absence from the workforce will have permanent effects on both their earnings and their well-being. And not just theirs. We have all lost, and continue to lose, from the prolonged mass idleness of potentially productive workers.

Yet Washington is stuck in neutral. Worse than neutral; it is in reverse. As the last elements of the 2009 stimulus phase out, the initial flood of federal aid has slowed to a trickle. If no agreement is reached before early next year, the trickle will become a huge backward flow, as President Obama’s payroll tax cut and all the Bush tax cuts expire while automatic spending cuts agreed to in previous legislative sessions kick in. Already, Republican leaders are threatening to replay last year’s standoff over the debt ceiling. Meanwhile, state and local governments—prohibited from running sustained deficits, increasingly dominated by anti-spending forces—continue to cut aid to those out of work and slash programs that invest in the nation’s future while laying off teachers and other public workers. Without those layoffs, the current unemployment rate would probably be around 7 percent.

Against this backdrop, no book could be more timely than Paul Krugman’s End This Depression Now! Since the crisis began, Krugman has argued with consistency and increasing frustration that the United States has become caught not in a normal recession, but in a “liquidity trap.” Since interest rates are already at rock bottom, normal measures, such as easy credit, won’t work, and expanded government expenditures must play a central part in boosting anemic demand. Otherwise, the efforts of private citizens to pay down debts laid bare by the financial crisis will continue to hold the economy back.

To Krugman, this is all the more regrettable because it is almost wholly preventable. We know what to do, he argues: increase public spending and make it clear that monetary expansion will continue until the economy fully recovers. Krugman advocates greater federal aid to state and local governments, as well as an aggressive effort to relieve private mortgage debts. He also argues that the Fed has been too timid in setting higher inflation targets to restore expectations of growth. “Unfortunately,” Krugman writes,

we’re not using the knowledge we have, because too many people who matter—politicians, public officials, and the broader class of writers and talkers who define the conventional wisdom—have, for a variety of reasons, chosen to forget the lessons of history and the conclusions of several generations’ worth of economic analysis, replacing that hard-won knowledge with ideologically and politically convenient prejudices.

Krugman is at once ruthless and humorous in taking on these prejudices. (read more)