Why Nations Fail

The question why some nations are rich while others are poor is not new. It has been the focus of economists for centuries. The great Scottish economist and moral philosopher Adam Smith dealt with that in his famous book, An Inquiry into the Nature and Causes of the Wealth of Nations, published in 1776 (that miraculous year[1].) That question can be particularized for India as “Why is India poor when it could have been rich?” It can be restated as “Why has India failed?” if by failing one means not being able to emerge out of poverty. Unfortunately, that question is avoided studiously by not just the general educated population but also by most economists who study India. Why is that?

The easiest and the most efficient way to become unpopular is to tell someone a few unpleasant truths. Don’t do it if you care about your reputation. In fact, tell people what they want to hear, and you can be assured of a wide audience. Write a paper, or better yet a newspaper or magazine article, arguing why India will be a superpower (or that India is a superpower), and you will be quoted, feted, invited to a lecture circuit, tweeted, facebooked and generally regarded as a public intellectual worth heeding. Follow that up with another piece asserting that any day now China’s economy is going to hit a brick wall while India will be reaping dividends demographic (say it with a French accent dee-vee-daan day-mo-gra-feek), and your reputation is sealed as the wisest of all wise sages.

You could take the road less traveled. Point out to a bunch of well-educated, comfortably off Indians at a dinner party that India is desperately poor, and you can forget about getting invited back to any future parties. Argue that India is a failed state, and you will be socially ostracized and people will cross the street to avoid running into you.

The demand for unpleasant truths is very low and therefore there is not much in terms of supply. The market for any truth consequently is very thin. That’s one of the reasons that the “Why is India poor?” question does not get much play. The other reason is that the people in power don’t want it highlighted because the answers may lead to their undoing. If people actually figured out the real reason for India’s poverty, it would create a very unhealthy atmosphere for those at the top who are running the whole show. They depend on popular ignorance for their continued survival. Writers and speakers generally don’t want to get on the wrong side of those in power. You cannot blame them for it can be very bad for one’s health, not just one’s reputation.

Since I don’t have a reputation to protect and since there’s no need to be concerned about any future reputation (I will never have one), I have been asking that question for many years. Fortunately for me, I had a lot of time to think about it. It was not really a hard question to answer for me. A lot of very smart people had worked very hard and came up with a variety of answers for the general question of why nations are poor. The best ones survived in a competitive marketplace of ideas. Even without reading very widely (I can’t read more than a couple of pages a day), I got to know of those ideas. Then I thought about them and looked at India — and figured out why India is poor and why it is most likely to fail. (I actually think that has indeed a failed state but I will not go into it right now.)

I remember clearly the aha moment. It was a spring day in 1998 in Berkeley. I was having coffee with Brad DeLong at Nefali Cafe. DeLong is an economic historian. So he says something like this: “The governor of colonial Bengal had to figure out a way to extract the wealth that the local population was already producing. Bengal therefore got systems that were exploitative. The governor of Massachusetts during that same period had a different problem. There wasn’t much economic activity in Mass: a few natives minding their own business and a whole bunch of lobsters on the beaches. You cannot collect taxes from lobsters. The governor of Massachusetts had attract people to come, settle down, work hard and create wealth.. Therefore, Massachusetts got systems that created economic wealth.”

Since I had previously thought about the problem and how institutions held the answer, when Brad made that observation, it immediately made sense to me. India was poor because its system of governance was exploitative and extractive. The British created the exploitative system and it was as good a system as can be for their purposes. The British were evidently good — how else would they have ruled so many people for as long as they did. Rule Britannia and all that sort of thing, ol’ chap.

India was not particularly rich when the British came to India. But it was not abjectly poor either. For the time — the 17th century C.E. — India was about average. Its per capita income was nothing to write home about but — important bit coming up — the aggregate was substantial since the population was large even then (compared to the population of Britain.) One can come up empty handed trying to rob a poor person but can make a fortune robbing millions of people, poor or rich. Anyhow, the British came, built the necessary institutions, and started extracting and exploiting Indians.

Note the word “institutions.” The British created institutions. They created institutions to extract and exploit.

Institutions explain the wealth and poverty of nations. Good institutions are necessary (but not sufficient) for nations to prosper. Bad institutions are sufficient for nations to fail. The institutions that the British created were good for them but bad for Indians. By the time the British left (which some claim was because of a freedom struggle but I beg to differ and think that it was just time for them to go), India had been reasonably impoverished.

I don’t blame the British for what they did. They did it because they had the opportunity and the desire. I too would do the same thing under the exact same conditions. I don’t do it not because I am morally superior but because I don’t have the opportunity. If I did have the opportunity and yet I did not do it, then I could claim moral superiority. Be that as it may, the British did what they did and left.

Here’s the last bit. They left but the institutions they had created continued after them. Those same exploitative and extractive institutions which helped impoverish India under the British, precisely those institutions stood in the way of India’s economic growth. After 1947, it was “The British are Dead; Long Live the British”. It was — and still is — British Raj 2.0.

I have been writing about the extractive and exploitative system for a while now on this blog. At the end of this piece, I append quotes from a few of those. Here I will quote from some others. See this — “The Citizen at War.”

. . . the interests of the people in the government are antagonistic to the interests of the citizens. To make the case, we have to distinguish between two types of governments: one is a development-oriented government which is committed to economic freedom, individual freedom, and political freedom; and the other, a predatory government which denies citizens freedoms for extractive and exploitative (E&E) ends.

It is both an analytically and empirically well-established fact that economic and individual freedoms are necessary for development. It is also beyond doubt that a “license control permit quota” regime—a command economy in other words—is inconsistent with economic growth and development. The explanation for India’s dismal economic performance can be explained almost entirely if one posits that the Indian governments have been of the E&E kind. The evidence is overwhelming.

The reason for why India has an E&E government lies in India’s colonial history. Imperial powers get into the business of running colonies for economic gain. The economic interests of the ruled and the rulers are necessarily mutually antagonistic. The relationship between the colonial masters and their subjects is not voluntary, and as a consequence, power is asymmetric: the rulers have the power to extract economic rents from the economy, at the expense of the ruled. For this, the masters create the laws and regulations which are consistent with their goals. It is perfectly natural and understandable that the British framed laws that gave the colonial government supreme power. During the British Raj, the government was the master and the people its servants.

But of course that relationship between the government of India and Indians changed after India became politically independent. Or did it? The laws which the British had framed for their purposes continued to operate. The institutions continued as before, with minor cosmetic changes, such as renaming “Indian Civil Service” to be “Indian Administrative Service.” Different people occupied the chairs but the functions remained exactly the same. Admittedly the new rulers had more pigment in their skin but they were actors in the same old play on the same old stage with the same old script. Like their predecessors, the new rulers went around with the same red flashing lights on their cars as they did before 1947. They still do. It was, and still is, what in modern parlance can be labeled “British Raj 2.0.” It would be, in the immortal words of Yogi Berra, déjà vu all over again for us except for the fact that most of us were born after 1947.

Unlike the United States, India did not have a “Revolutionary War of Independence.” Actually, India never had any revolutions to speak of, unlike other countries; nor did it have a civil war to iron out what India really stood for. Indians are as a lot not very excitable, and prefer the laid back chalta hai attitude. The British left in their own sweet time when it suited them. They had extracted enough wealth out of India by then, India had become too impoverished, and in any case, colonialism was fast going out of fashion. Their imperial power and hegemony was waning. They left because the sun was setting over the British Empire and it was time to go home.

There are major differences in the cases of India and the US, though they were both British colonies at some time. The Americans won their freedom by defeating the British, and decided that they will not ever be subjects of a king. They gave themselves a new set of rules, and were not interested in reusing or recycling British rules. They wrote an absolutely brilliant constitution which gave the people power over their government. It is short enough for one to read over a lazy cup of coffee, and most Americans have read it in high school.

The American constitution spelled out what the government could and could not do. The constitution severely limits the power of the government, and prudently distributes it across three institutions—the legislative, the executive, and the judiciary. The people are the masters and the government that they elect does what the people allow them to do. In India’s case, the government is the master and the people exist to serve it. The Indian constitution is a set of prescriptions and prohibitions limiting the freedom of the people.

What India needs is a fundamental transformation, a change in the rules of the game, not a mere change in the set of players. The independence that Indians should have fought for should have been about real economic and personal freedoms. Granted that Indians have the political freedom to choose but it is more a matter of servants choosing which master they wish to serve, rather than free people choosing who is to serve them. My contention is that the independence of 1947 was at best a partial one. Because Indians of the previous generation avoided a real war of independence, it remains for us to fight and win the upcoming war.

I have been writing that stuff for a while. In Dec 2005, I wrote in a piece titled “Wars, Opium, Powerful Governments and Weak Nations“:

In the case of India, the majority of Indians do not subscribe to intolerant monotheistic creeds. Due to this, an all-powerful religious institution cannot grow up. In a sense, it is as if in the religious sphere, India has a competitive market and is not dominated by a monopolist. As long as the monotheists don’t take over India (and I am not sure one day India may not become majority monotheistic), India is safe from that threat. But India is more and more vulnerable from the other evil: powerful government.

An increasingly bigger and powerful government is the real and present danger that India faces. It was a large intrusive controlling government that has forged the chains that have held the Indian economy captive since independence. The British created that government for its own extractive and exploitative ends and once the British left, those who took over the reins were more than willing to enjoy the benefits of power over the economy. However, a government that becomes powerful does so only at the expense of the power of the people. And since the power of the people determine the prosperity of the nation, the more powerful the government relative to the people, the more impoverished the nation is.

If you want a prosperous nation, you must have a powerful people and a weak government. For India to develop, the power has to shift from the government to the people. That is the law.

This has been a constant theme. In May 2007, in a piece on education, “The Indian Education System – Part 3” I wrote:

In the broadest terms, the government of India is an extractive and exploitative system created specifically for that purpose during the nearly one hundred years of its existence as a British colony before India became politically independent. The British, as a colonial power, created a system designed to control every aspect of the economy to maximize extraction. The challenge of administering such a large population required a certain small percentage of the native population to be educated in a very specific way. Therefore the total and absolute control of the education system was a necessity.

Even after British left, the structures they had created for controlling the economy in general, and the educational system more specifically, remained intact. The new political leaders saw it was beneficial for them not to deviate from the old colonial goal of imposing an extractive and exploitative government on the people. By continuing to control the education system, they were able to impose a degree of control over the population that would be unthinkable in a free society.

As you can readily ascertain, India is not really a free country. The lack of freedom has been a unifying theme that explains why India is not rich and is more likely than not to fail. Last year in April, in “The Illusion of Freedom“, a piece I wrote for Pragati, I wrote:

Robert Solow, Nobel prize-winning economist, observed that poverty is not simply an economic problem and that “underdevelopment is a web of economic, political, institutional, ethnic, and class-related connections with persistent historical roots.” My conjecture is that India’s continued struggle with poverty and underdevelopment are the understandable consequences of its governments’ objective. I believe that roots of the Indian government’s “license permit control quota” regime lie in its history of British colonialism.

In 1947, Indians got political freedom but little economic freedom, and only limited personal freedom. Merely changing the people who ruled India without changing the rules is superficial change which does not change the objective of the government. The government’s objective continued to be extractive and exploitative. It was “British Raj 2.0”.

Under the British Raj, the rules were made for the convenience of the rulers. Power was vested in the government and the people were subservient to it. The British government employed a strategy of “divide and rule” effectively and pitted one community against another. The government controlled important sectors of the economy: the railways, telecommunications, power, education. There was no violent revolution that overthrew the British. When they left, every institution that the British had created was left intact. The people who replaced the British found the system suited them quite well.

Note “persistent historical roots.” Even if we don’t know much history, this much we know that what we have today has its roots in what happened in the past. As Toranaga-sama would put it, “It is all karma, neh?”

Well, anyway, so why do nations fail? Daron Acemoglu and James Robinson have a recent book titled Why Nations Fail:The Origins of Power, Prosperity, and Poverty. Jared Diamond, the author of such wonderful books as Guns, Germs and Steel, and Collapse, did a book review for the New York Review of Books a few days ago titled, “What Makes Countries Rich or Poor.” Excerpts:

There is no doubt that good institutions are important in determining a country’s wealth. But why have some countries ended up with good institutions, while others haven’t? . . .

. . . An additional factor behind the origin of the good institutions that I discussed above is termed “the reversal of fortune,” and is the subject of Chapter 9 of Why Nations Fail. Among non-European countries colonized by Europeans during the last five hundred years, those that were initially richer and more advanced tend paradoxically to be poorer today. That’s because, in formerly rich countries with dense native populations, such as Peru, Indonesia, and India, Europeans introduced corrupt “extractive” economic institutions, such as forced labor and confiscation of produce, to drain wealth and labor from the natives. (By extractive economic institutions, Acemoglu and Robinson mean practices and policies “designed to extract incomes and wealth from one subset of society [the masses] to benefit a different subset [the governing elite].”)

On May 24th, I heard Jared Diamond on NPR’s Talk of the Nation program, hosted by Neal Conan. Both the audio and the transcript are available on the NPR website. Here’s a quote:

DIAMOND: Right. Given the fact that temperate zones have an advantage, and so Europe starts off richer than tropical countries, that advantage is then multiplied when European countries colonized African countries and South American countries and then set up basically corrupt, exploitative institutions to make the local people work for the good of the colonial masters.

And those then corrupt institutions have persisted until this day and left a bad legacy of colonialism, making it a double-whammy in the tropics.

CONAN: And then you have other kinds of colonies, though, where there were not extractive policies. There wasn’t much to extract, at least not initially.

DIAMOND: Sure, the United States is a prime example. The Native American population in the United States, particularly after European diseases swept across, was lower in population density than, say, in Mexico or Peru so that Europeans who came to the United States had to work for themselves, and they set up institutions that rewarded them for working for themselves. Whereas in densely populated tropical countries, such as Mexico and Peru and Bolivia, Europeans set up institutions to extract work and money out of the local population, and those institutions have persisted and continue to impoverish the countries until this day.

India can avert going over the abyss even now. We have to figure out a way to change the institutions. It can be done but the people have to first understand what the basic problem is.

India’s problem is not corruption. Corruption is merely the visible and inevitable consequence of a powerful government ruling over a weak people. What India needs is powerful people and a government that is its servant, not their master.

QUOTES from previous posts:

Fundamental Change. Dec 2003.

The policy in [the telecom] sector is so wrong-headed that it is difficult to imagine a system that is more detrimental to the goal of economic development. Indeed, I would find it more believable if someone were to reveal that the policy was actually made by an enemy government to sabotage any chances of India becoming a developed nation.

Why does India have the misfortune of being saddled with malevolent policy? My conjecture is that the context in which the government framework was built was one where the goal was not economic and social development but rather the exploitation of the economy. The government objective should have changed once it was a government of the people. But it did not because the administrative structure found it too hard to give up its control. Power corrupts and absolute power corrupts absolutely, as Lord Acton observed. The British government was the dispenser of India’s destiny — bharat bhagya vidhaataa — and it was not easy for those who replaced the British to not take on that mantle.

So what is the answer to India’s millions of woes? I believe that the government of India has to be re-invented. We need a “government of the people, for the people, and by the people.” We need a government whose objective is human development and economic growth. We need a government that is accountable to the people. We need a government that delivers on its promises. We need a government that values freedom and which does not chain the citizens of the country simply because it is easier to extract and exploit the system.

The Enemy Within. Dec 2003.

. . . India has been saddled with an extractive and exploitative government. Until we change the basic nature of our government, all this futzing around in the margins is not going to amount to a hill of beans. All the talk about India becoming an IT superpower or a BPO superpower is not going to materialize. We need to wake up to that fact and figure out how we can change the nature of the government.

India’s Much Vaunted Freedom. May 2011.

I think the reports of India’s independence from colonial rule are severely exaggerated. Indians have been under foreign rule for several centuries and have become accustomed to being treated like irresponsible slaves, demanding to be controlled. Sure they do “democratically” determine who will rule them, but in the end, they are still slaves entrusted with the task of electing their masters.

NOTES:

[1] Here’s a bit from a previous post, Darwin’s Big Idea. (Feb 2008).

Great ideas are the greatest achievements of humans. What is worth pondering is why these ideas arise among certain people and not among others. Are there any regularities that characterize the populations within which great ideas arise? In 1776, Adam Smith (1723 – 1790) published his An Inquiry into the Nature and Causes of the Wealth of Nations. In the same year, the founding document of the United States of America, the Declaration of Independence, was written (principally) by Thomas Jefferson (1743 – 1826). And again it was in 1776 that Thomas Paine (1737 – 1809), “The Father of the American Revolution,” published Common Sense.