Book claims recipe for countries to prosper

YOUR MONEY, By Murray Becotte
I just finished reading Why Nations Fail: The Origins of Power, Prosperity, and Poverty, and would recommend it to anyone who has wondered why one country is prosperous and another exists in abject poverty.
Why is Norway, the world’s richest country, 496 times richer than Burundi, the world’s poorest country? The average per capita income of Norway and Burundi is $84,290 and $170 respectively, according to the World Bank.
The authors are Daron Acemoglu, a professor of economics at MIT, and James Robinson a professor of political science at Harvard. At 544 pages it is not an easy read but certainly worth it.
Jared Diamond says on the cover: “It will make you a spellbinder at parties,” which makes me realize that Diamond travels in a different social circle than I do.
The thesis of the book is illustrated with the example of the twin towns of Nogales, one on the Mexican side of the border, the other on the American side.
The residents of Nogales, Ariz., enjoy higher incomes and life expectancy; crime is lower and the infrastructure is better than in Nogales, Sonora.
Yet the geographic environment is identical on both sides of the border, and the ethnic makeup of the population is similar.
“The reason that Nogales, Ariz., is much richer than Nogales, Sonora, is simple: it is because of the very different institutions on the two sides of the border, which create very different incentives for the inhabitants of Nogales, Ariz., versus Nogales, Sonora.”
Successful countries have political and economic institutions that are “inclusive” and unsuccessful countries have institutions that are “extractive.”
Inclusive institutions encourage participation by the great mass of people in economic activities that make best use of their talents and skills and that enable individuals to make the choices they wish.
For example, in South Korea, people can get a good education, own property, start a business, sell products and services, accumulate and invest capital, spend money in open markets, take out a mortgage to buy a house, and thereby expect that by working harder they may enjoy a good life.
Not so in North Korea. People are motivated to work hard if they have opportunities to invest their earnings profitably, but not if their profits are likely to be confiscated by the powerful.
Countries thrive when they build political and economic institutions that “unleash,” empower and protect the full potential of each citizen to innovate, invest and develop.
Extractive economic institutions are structured to extract resources for an elite few. The institutions of power enable the elite to serve its own interest, and prevail over, those of the mass of the population.
Extractors will limit economic progress if it results in social turmoil that threatens the elite position. Progress is good only if it increases the wealth to be extracted.
The authors argue that if China is to continue to be successful, its institutions will have to become more inclusive.
A country with centralized control but without inclusive institutions may enable an economy to escape poverty, but will not permit the full ascent to modern prosperity.
China’s institutions don’t foster the degree of “creative destruction” that is necessary for innovation and higher incomes.
Can you imagine a 20-year old whiz kid in China being allowed to start a company that challenges a whole sector of state-owned Chinese companies funded by state-owned banks?
They argue that there is no natural process whereby extractive institutions become inclusive since it is rarely in the interest of the elites to cede power.
The elites must be faced with a choice such as a revolution before they will give up their privilege.
One wonders if there becomes a point in Western society that the growth in economic inequality allows the privileged one per cent so much power that they become extractive. As columnist Thomas Freidman said, “When one person can write a check to finance your whole campaign, how inclusive will you be as an elected official to listen to competing voices?”

(Murray Becotte is a chartered accountant and CFP working as an investment adviser with TD Waterhouse in Thunder Bay. Opinions expressed in this column are his. Your Money appears every Monday.)