Monday, April 7, 2014

Why Nations Fail?

Why Nations Fail?

The president of the New Zealand Government Economic Network (GEN) Girol Karacaoglu reviewed Acemoglu and Robinson's book “Why Nations Fail: the Origin of Power, Prosperity and Poverty” on the GEN website. This is a very interesting topic and a promising field of research. The central thesis of this book, Girol says, is that “economic prosperity is associated with “inclusive” economic and political institutions, while “extractive” institutions typically lead to stagnation and poverty.” And he explained that “inclusive” (or good) economic institutions tend to be free (as distinct from unregulated) – market-supporting institutions that enable, allow, encourage and incentivise participation by the great mass of people in economic activities that male best use of their talents and skills, invest and innovate, make the choices they wish, and freely contract and exchange; that secure private property rights, and provide a level playing field, as well as an unbiased system of law; and that encourage a process of ongoing “creative destruction.” 

Here, I examine the Acemoglu-Robinson hypothesis. I provide two graphs. Acemoglu and Robinson used the case of Korea as a test of their hypothesis. The Korean peninsula was split into two different countries in 1948. North Korea, formally known as the Democratic People's Republic of Korea (DPRK) is a communist dictatorship with a centrally-planned economic system, while over time, South Korea slowly evolved into a democratic country with a market economy. The two countries share the culture, the geography, the history, and the DNA. Figure 1 plots the real GDP per capita (PPP-adjusted Maddison data). The idea of this graph is to show that differences in economic outcomes are related to differences in the political and economic systems. Note also that North Korea is almost a closed economy. They trade with China, and a few other countries.

In figure 2 I provide another, more general, test for the Acemoglu-Robinson theory. I present a scatter plot of a measure of the political institutions and the economic outcomes for 115 countries. The data are taken from Global Democracy. The political institution index is based on (1) political rights, (2) freedom of press, (3) civil liberties, which are taken from Freedom House; and (4) global gender gap report , (5) the corruption index from Transparency International; and  (6) peaceful changes of head of governments (last 13 years), and (7) peaceful changes of political party of the head of governments (last 13 years). High index value denotes "inclusive" countries - i.e., democracies. The economic outcomes index is based on (1) PPP-adjusted real GDP per capita, (2) central government debt as a percent of GDP, (3) inflation rate, (4) unemployment rate, and (5) youth unemployment rate. The data cover the period 2008-2009 (I do not plot the year 2011-2012 because they do not show any change in the data that might alter the conclusion). 

If political institutions are the only predictor of the economic outcomes we would expect a high correlation and the scatter points to be on the 45-degree line, or very close around it. However, the correlation is only 0.62, which is not very high and the scatter points are not on the 45-degree line. 

In figure 2, the European countries, particularly the Scandinavians, the U.S., Australia and New Zealand are in the top right-hand side corner. Countries above the 45-degree line are the oil-rich plutocratic political economies of Libya, Kuwait, Bahrain, and also Russia. The African countries are close to the horizontal axis. The rest of the world which includes Eastern European countries, South and Latin America, Asian countries, China, and India are in the middle of the graph and far from the 45-degree line.   

One could argue that these is a measurement problem(s); that these indices do not measure the political institutions and the economic outcomes well. Economic outcomes such as unemployment and debt for examples are highly related to policy. Even the most democratic systems and free market economies in the world suffer from boom-bust cycles related to policy errors. The conclusion is that political institutions influence the economic outcomes, but they do not map one-to-one. The case of China is a stark example. 

China is not a Western "inclusive" democracy despite the remarkable growth it experienced since the 1990s. China experienced high economic growth from the late 1990 because earlier the government embarked on a series of economic reforms and deregulation, which do not accord with communism. For example, China allowed for the market to play a major role in resource allocation. It introduced privatization and profit maximization, which are inconsistent with communism, but created a viable private sector. It also allowed for foreign investments, a degree of free capital mobility, a tax reform, and less restrictive property right laws among other local reforms. 

My conclusion, however, is that the data seem to lend some support the Acemoglu - Robinson story. 


Figure 1

Figure 2