Why Some Countries Are Poorer Than Others
These are my notes on why some countries are poorer than others.
Proximate causes of prosperity link prosperity and poverty of nations to the levels of inputs, whereas fundamental causes look for the reasons these are such differences in the levels of inputs.
The geography, culture, and institutions hypotheses advance different fundamental causes of poverty.
Inclusive and extractive economic institutions affect economic development.
Creative destruction is integral to economic growth through technological change.
Reversal of fortune evidence provides support for the institution's hypothesis.
Proximate causes of prosperity are high levels of factors such as human capital, physical capital, and technology that result in a high level of real GDP per capita.
Fundamental causes of prosperity are factors that are at the root of the differences in the proximate causes of prosperity.
The geography hypothesis claims that differences in geography, climate, and ecology are ultimately responsible for the major differences in prosperity observed across the world.
The culture hypothesis claims that different values and culture beliefs fundamentally cause the differences in prosperity around the world.
Institutions are the formal and informal rules governing the organization of a society, including its laws and regulations.
The institutions hypothesis claims that differences in institutions-that is, in the way societies have organized themselves and shaped the incentives of individuals and businesses-are at the root of the differences in prosperity across the world.
Private property rights mean that individuals can own businesses and assets and their ownership is secure.
Economic institutions are those aspects of the society’s rules that concern economic transactions.
Inclusive economic institutions protect private property, uphold law and order, allow and enforce private contracts, and allow free entry into new lines of business and occupations.
Extractive economic institutions do not protect property rights, do not uphold contracts, and interfere with the workings of the markets. They also erect significant entry barriers into businesses and occupations.
Political institutions are the aspects of the society’s rules that concern the allocation of political power and the constraints on the exercise of political power.
Creative destruction refers to the process by which new technologies replace older ones, new businesses replace established companies, and new skills make old ones redundant.
Political creative destruction refers to the process by which economic growth destabilizes economic regimes and reduces the political power of rulers.
Physical capital, human capital, and technology are proximate causes of prosperity in the sense that, though they determine whether a nation is prosperous, they are themselves determined by other, deeper factors. Put differently, if we want to understand why some nations are poor, we have to ask why they do not sufficiently invest in physical capital or human capital and why they do not adopt the best technologies and organize their production efficiently.
The fundamental causes of prosperity include factors that potentially influence the physical and human capital investment and technologies of nations and, via this channel, shape their prosperity.
Three leading hypotheses about the fundamental causes of prosperity are geography, culture, and institutions. According to the geography hypothesis, geographic aspects determine whether a nation can be prosperous. According to the culture hypothesis, it is the cultural values of the country’s people that powerfully determine its potential for prosperity. According to the institution's hypothesis, it is the institutions that are central to prosperity.
Inclusive economic institutions are those that provide secure property rights, establish a judiciary system that allows and facilitates private contracting and financial transactions, and maintain relatively free entry into different businesses and occupations. In contrast, extractive economic institutions create insecure property rights, a partial judicial system, and entry barriers that protect the businesses and incomes of a small segment of society at the expense of the rest. According to the institution's hypothesis, inclusive economic institutions tend to generate prosperity, while extractive economic institutions do not.
Though the inequalities in GDP per capita around the world have multiple causes, the evidence from the economic experiences of former European colonies suggests that institutional factors, and not geography, are central to explaining these disparities. In fact, the major patterns cannot be explained by geographic factors.
Foreign aid can be useful to temporarily alleviate extreme poverty or manage crises but is unlikely to be a solution to poor economic development in many parts of the world. This is because aid largely fails to address the institutional roots of poverty.