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Chris Martenson: Welcome to this Peak Prosperity podcast. It is August 2, 2016, and I’ve got a very special podcast for you today. Each year, there is one book that stands out for me that I will recommend widely and often, and I think this year’s winner has already emerged even though five months still remain. We’re going to talk to the author of that book today, but first I want to tell you my criteria for book of the year. First, I have to learn something…something beyond interesting into the realm of what I’ll call important; and second, this book has to explain something about which I’ve been curious but lacked a good way of understanding it. And third, the book has to change the way I think about the world as in never quite the same afterwards and maybe even entirely differently.

Now, that might sound like a pretty tall order, but we live in a big, amazing, expanding world, and the challenge for the truly curious is in figuring out how to pare the list down and select from among the many excellent options out there. The book we’re going to discuss is Why Nations Fail, and it addresses a question that has long stumped pretty much everybody, which is why some nations are prosperous and some are poor. Now, there have been a lot of attempts at answering that question, and factors such as culture, geography, weather, resources, have each been promoted as the deciding one. Why Nations Fail takes a completely fresh look at the question and comes up with a rather surprising answer.

To speak with us is one of the authors, Daron Acemoglu, who co-authored the book with James Robinson, himself a Harvard economist, and Daron is the Killian Professor of Economics at MIT. And in 2005, he received the John Bates Clark Medal, awarded to economists under 40, judged to have made the most significant contribution to economic thought and knowledge. Welcome, Daron.

Daron Acemoglu: Thank you Chris. Great to be here. Can I hire you as my publicist for the next book?

Chris Martenson: Absolutely. But wait, let’s see how the interview goes first. You may change your mind.

[laughter]

Chris Martenson: Let’s start, Daron, if we could, right at the top with really broad outlines for people listening. Some nations are rich, some are poor. Your book has a rather concise summary of why that is. What is it?

Daron Acemoglu: So, you know, as you indicated in your introduction, people have come up with all sorts of reasons, but ours is actually extremely simple. We say it depends on incentives and opportunities. If people have opportunities to become rich, to open businesses, be innovative, do things that are going to further their interests and at the same time the nation’s GDP (Gross Domestic Product) and they have incentives to do so, that’s going to lay the foundations of economic prosperity. It sounds extremely simple, but the thing is that most nations don’t provide those sorts of opportunities and incentives to their citizens, and therein lies sort of the big divide. How do we summarize those opportunities and incentives? Well, we sort of use the word institutions, the rules, formal and informal regulations, organization of society that determines what sort of opportunities are available to different people, to people from different walks of life, and what sorts of incentives they function under.

Chris Martenson: So let’s talk about that for a bit, because here’s what really struck me…the piece that really crystallized for me in your book is this idea that we really have to understand the institutions as you just mentioned, the political and the economic institutions. Let’s get specific about this. Latin America versus say Canada and the United States…seemingly both with good geographic positioning, both with natural resources, but very different trajectories. What was it about the institutions, say in Latin America that you would say…begin to help us understand why there have been such different outcomes for these two areas.

Daron Acemoglu: I think that’s one of my favorite examples, also. Because it is in some ways easier to understand; because institutions both in the south and the north of the continent are shaped by their colonization experiences. When the Europeans arrived at the end of the 15^th century, there are some notable differences within the continent, but nowhere of the order of magnitude we observe today. There are some civilizations in the south. In particular, the Aztecs and the Incas that are much more complex, much more developed and nothing of the sort in the north, but the living standards are not hugely different.

But then you have, for reasons we can get into in a second. But let me give you the brief answer. We have that very different sets of institutions are imposed on the areas that make up Latin American today…what we call extractive institutions. Extractive institutions are the name we give to those that are designed in such a way that they extract resources from the mass of society for the benefit of the politically powerful; the elite. In particular, you have extractive economic institutions. Things like the encomienda system, for example.The forced labor system, the land grant system, other forced labor systems that essentially put the indigenous people to work for the benefit of the European colonialists/Spanish colonialists in particular that colonized most of Latin America. And these are in turn supported by what we call extractive political institutions…a political system that concentrates power in the hands of the same people who are benefitting from the same economic institutions and does not introduce any sorts of checks and balances or constraints coming from society on the exercise of that power.

For reasons that have very little to do with good hearted or enlightened nature of the English who colonized the north, very different sorts of institutions developed in the north. It has very little to do with their enlightened nature, because the English wanted to emulate the Spanish, wanted to do exactly the same thing, but they failed. And instead you have what we call inclusive economic institutions supported by inclusive political institutions emerging in the north. So, inclusive economic institutions; for instance, their basis is private property and land, which sort of gets introduced at the beginning of the 17^th century…no such thing existed in the English colonies or colonial attempts before and in the Spanish realm, because everything was the crown’s property and that private property and land introduced sort of incentives and opportunities for small land holders to sort of improve their productivity, work for their own benefit and, crucially, that whole system got to be supported by what we call inclusive political institutions. And sort of the same name for the economic and political legs of this is no coincidence, because we want to emphasize that extractive economic and political institutions generally tend to go together. Inclusive economic and political institutions also generally go together, and the inclusive political institutions who are much more self-governing institutions, such as assemblies at the local level culminating in national institutions. Of course, after the Articles of Confederation and US Constitution and so on. They opened the path to very different development experiences.

If you look at the development of Latin America – for example, Mexico or Peru such as it is…such as it is because there wasn’t much economic growth or economic development for long periods of time, it’s very much based on monopoly, it’s very much grants given by whoever was politically powerful. Either agents of the Spanish crown or generals who were ruling the colonies at the time, and then people who get these opportunities are very much the privileged and they exploited as monopolists generally do, and there is very little ability for the common folk to take part in economic activities and rise up. You contrast that to the United States, especially in the northeast United States, you see very vibrant economic scene where people, regardless of which walk of life they come in, are able to jump in. They become entrepreneurs. They become innovators. They become owners of factories, exporters, commercial men; and that sort of fuels technology based, productivity based economic growth, which is, of course, defining for the 19^th century and later 20^th century US economic growth.

Chris Martenson: Now, if I have the story right, you’re saying to understand say, Peru today or anybody…not to pick on Peru, but anybody in Latin America, we have to go back to the 1500’s, because we need to understand the original system that was birthed in that moment. And, as I understand it from your book, what really caught me was this idea that there was this highly extracted model that was being run. This is what the Spaniards understood in the 1500’s and the Portuguese, and they would go to a place…of course extract all the gold and silver that was available, that’s fine…but once that’s done, the resource was human capital that could be used to farm. And so they would allow, if I could paint with a broad brush…they would allow enough of the farming produce to exist with the populace so they basically could reproduce and not die, but the rest, the surplus, would be harvested off and that was the model. So it was a highly extracted model, which gave no individual property rights, no incentives for personal development, no incentives even for necessarily bringing in new technology. The model was really just one that extracted the labor of humans and that’s what they understood. Is that fair?

Daron Acemoglu: That’s an excellent summary. The key thing is exactly like you say, these extractive systems have very little inducement for people, for society to increase its productivity and you see that in places like Barbados, which were based on an extreme version of the system you described…slavery. Or, you see that even in the US south before the Civil War, to some degree even after the Civil War. Even when these places are economically thriving, for example the Caribbean plantation colonies such as Barbados, Cuba, Haiti…they did extremely well for a while because sugar was a very, very valuable commodity in the world and US south did very well…cotton, tobacco…but even during that period they had very little in terms of innovations and, as a result, even if they could generate some surplus that did not translate into economic growth. In fact, it was worse than that.

Many of these societies, and again US south is an example, but not the most extreme one…they were so worried, and rightly so, about controlling the slaves, controlling the people who were doing the production under repression and under the threat of a gun, that they did not even want to teach them anything. In many of the Caribbean plantation colonies, it was illegal to teach how to read and write to the slave, and if you look at it with our own eyes, where human capital…the capability of works to actually understand what they’re doing and improve over it is so crucial it’s going to be no surprise that these places are not going to do very well economically, especially in the long run.

Chris Martenson: Now that critical bit of difference though that I loved in that book where you described where there was a culture that sort of was allowed, if I can use that term for the Spaniards to come in and have their way, but in Jamestown, the Virginia Company was coming in and wanted to run that same model…I think you eluded to that earlier. They weren’t any more enlightened, I think you said. They said…Hey, here’s a model. You go in, there are people living there, see if you can set up this extractive system and that’s what they were first thinking to do. Is that right?

Daron Acemoglu: Absolutely, I mean…how could it be different? Look at it this way. Even though they killed, some estimates suggest, up to 90% of the population because of diseases and various other things, from their viewpoint what the Spaniards were doing was a huge success. The Spanish empire was thriving; was the strongest in the world. It’s coffers were full of silver, it’s agents, it's captains and colonialists in the Americas were extremely powerful and prosperous and everybody wanted to emulate them. Everybody was competing and that’s why European power started fighting, because they all wanted to have part of the loot.

When the English ended up with their own sort of part of the colonial world, the north, which actually wasn’t so great from their viewpoint, because everybody wanted the south…the north was sort of the leftovers…no matter, what they wanted to do was exactly what the Spaniards did, so they emulated them. And the Virginia Company, founded in 1607, had a slightly different model. It wasn’t a crown monopoly, but it sort of sold its shares to people in London, and people were willing to put a lot of money in the Virginia Company, because they thought…Look, these guys are doing what the Spaniards did and they’re going to make money just like the Spanish crown did, so we want to have a piece of it. And then the Virginia Company gets these funds, sends three ships to the north of the United States, and it turns out they had targeted Jamestown, which is an island off Virginia that seemed like a good place to start, but things didn’t work out that way, because they couldn’t find anybody to do the work for them. Their model was to go and overpower whoever we’re going to find just like the Spaniards overpowered the Aztecs or Incas, put them to work, take their gold and silver. But more importantly, as you said…make them work for your benefit. Well, there’s nobody there or there’s only these hunter/gatherers, very sparsely settled mobile Indians, and they’re not going to do your bidding for you and so there’s an impasse.

They come up with the idea of bringing people from Europe…there were lots of poor people in Europe at the time. This is before the Industrial Revolution. Population is increasing and not much more productivity…so they collect people. It’s a costly voyage for them. They bring them there. They’re going to be the lower strata of society, doing the production for the benefits of the governors, and the soldiers, and the elite of the Jamestown colony and the owners of the Virginia Company, but those people that come in…as soon as they say…No, no, we’re not going to be repressed like this. They start running to the Indians or start just going off by themselves and that’s when Virginia Company realizes…Look, we’re just not going to be able to replicate what the Spaniards did, because the conditions in the north are different than the south. The population density and the complex civilizations that could take over are not there, and that’s when they throw in the towel and introduce things like the private property rights and general assemblies that I hinted at before.

Chris Martenson: If they had found a large subjugatable population, your argument is of course history is entirely different, because then they just replicate the model and…

Daron Acemoglu: Exactly, it’s what they did in India. That shows that it’s not the enlightened values of the British. When the British colonized India, India in some sense was even a more complex and more densely settled place. They adopted a colonization strategy very similar. Based on military might, they fought many wars against the Indians and subjugated them. And their causation strategy, although the details differed a little bit, because this is happening 200 years later, and the terrain is different, but as broad outlines it’s very similar to what the Spanish and Portuguese did in South America.

Chris Martenson: The emerging pattern here then is that when individuals are properly incentivized, you can have things like rapid increases in productivity and bursts of creativity that come through a new technology and other things like that. The story of history is really one of fairly minor differences a long time ago resulting in these wildly different emergent behaviors, but that when we parse back through that, we can see that the piece that really seems to be the critical bit here is that unless individuals are appropriately incentivized, whatever system you install around them either has a limit it can’t get beyond or is just destined to fail at some point.

Daron Acemoglu: Absolutely. If I could paraphrase what you said, our thesis is that everywhere geographically and historically, what matters are the institutions and the incentives that they create. If you want to understand modern day Egypt, or North Korea, or France, or Argentina, you have to look at how the institutions are structured today and what sorts of incentives, what sort of opportunities they provide to their population. But in many cases, not every but many cases, those institutions are shaped historically. They go back to a time where small differences during critical periods, which we sometimes call critical junctures, created some cumulative process of institutional divergence between many of these societies and that’s where we see the institutions being shaped and that’s why we have to look at the historical process for all the institutional formation. You cannot understand modern day Mexico, you cannot understand modern day Haiti, you cannot understand modern day United States without looking at how things worked out in the first 100 years or so after their sort of modern history started with the colonization attempts. If you want to think about European nations, their histories of course were not shaped just in the last five years. You have to go back even further to 12^th century, 11^th century, perhaps even earlier. For some other cases, there are key events that have taken place over the last 60 or 70 years.

The example we sort of talk about in the early chapters of the book is South versus North Korea, where a fairly homogeneous nation is suddenly broken into two at the 38^th parallel because of the deal between China, Russia, and the United States. Now you create, during their own critical juncture, two societies that are so different and then you see them diverge because their institutions are so, so divergent.

Chris Martenson: And those critical junctures -of course, history is littered with them – and no guarantees right, if you approach one, that you’ll go to the north or to the south in the Korean example.

Daron Acemoglu: That’s where latency matters a lot, small differences matter, the key characters matter, sometimes leadership plays a central role and the other thing that we do emphasize in the book but perhaps we should have emphasized even more given the situation that the world is in right now is you can even more quickly destroy institutions than you can build them. We give the example of Venice, which had some of the most sophisticate and inclusive institutions of the Middle Ages but then they totally sort of turned them into oligarchic, extractive structures and so their economic fortunes reversed so that sort of pattern is unfortunately all too common in history, too.

Chris Martenson: This is a really important area that I want to turn to now. Good theory has great explanatory power. I love your theory of development, because a lot of things just clicked for me and that’s one of my tests for a good theory is things begin to make more sense now. But a good framework can add that predictor. I’d like to turn now to how we might map your works explanatory, and maybe predictive power into these current events, specifically what if we think of rich versus poor nations, not as binary toggle switch that’s either on or off…it’s either true or false…but instead it’s a smooth dial, and it can stop at any point along a continuum, spanning the very poorest nation to the very wealthiest. Do current events in the United States, in your view, support the idea that core concepts of building towards more inclusive economic and political institutions…which way is that dial turning? Are we heading towards the wealthy side or the other side? Does your framework map into current events like that?

Daron Acemoglu: Yeah, I think it does, but of course you’re always taking chances when you try to comment on events that are unfolding as we speak. But, you know, if you want to summarize what we say about the United States in the book, a fair summary would be US is an example of inclusive economic and political institutions, but it’s always had its own challenges, starting with slavery, then building up to great inequality, both economic and political, during the Gilded Age which saw robber barons and huge monopolization of American business. Then segregation and still sort of sidelining of a significant fraction of US population in terms of economic opportunities.

All of these are extractive elements, emphasizing that it’s a gray, nothing is black and white. So, even though the US is broadly inclusive it has these very problematic areas, has it's very extractive elements within its institutional framework. But what it has done until now is it has not smoothly, but after some struggle, after some back and forth…has been able to solve some of the major problems that it was facing. It got rid of slavery, and franchised African Americans, then dealt with the issues of monopolization of business and their political influences, then during Civil Rights extended opportunities more broadly within society, both to Blacks and earlier to women also an ongoing process to women. But today, I think we are facing an entirely new set of challenges and I think it's still unclear whether we are going to be able to rise up to these challenges.

I would, in particular, highlight two areas although I think one could add to these. One area that I would highlight is that the entire world, but also the United States in particular, is in the midst of another economic revolution. New technologies and globalization providing huge opportunities for increasing our productivity, increasing our ability to produce goods economically and increase the variety of goods that we produce for our consumers. But these opportunities are also creating very unequal gains. Globalization for example, or trade with less developed economies such as China are reducing labor costs, but in the process destroying a lot of jobs. And these gains that accrue to companies or some subset of consumers are not necessarily automatically spreading to the rest of society.

The problem is even more dire when you come to new technology such as artificial intelligence, robots, which are coming online right now, but over the last 25 years we have a broader process of automation going on which, again, took a lot of jobs and made them more efficient but in the process created both unemployment and downward pressure on the wages of a significant fraction of Americans. All of these are creating challenges about how do we take the gains that are being created by this amazing globalization and technological changes, and make sure that the rising tide lifts both…both in terms of gains so that we don’t create huge inequalities and therefore huge discontent within society, and also, importantly, in terms of opportunities so that we don’t destroy the relatively level playing field that the United States has, compared to other countries. So that’s the first challenge.

The second challenge, perhaps not unrelated, is that every society continuously struggles with limiting political inequality. Politically inclusive institutions, which I mentioned earlier on…they rest on the premise that no single individual or no group of individuals is going to become so powerful as to dictate the political choices of society. One-person one vote, one-person one voice. Of course, it’s not going to be perfect but broad distribution of political power. Well, that’s never true in any society but it also becomes harder and harder sometimes as certain groups, certain individuals, start accumulating more political power. I mentioned Venice. That’s how the decline of Venice started. Some people said…Okay, we’re going to monopolize the Venetian Parliament. We’re going to not allow other people to come in and become politically powerful actors in the society. And then the whole thing unraveled. In the United States, we have the same thing coming from the fact that money matters a lot in politics, a lot of people have become disinterested in politics, a lot of people don’t have their voices heard in politics. And I think how do we create the institutional structures to make sure that society maintains its economic vibrancy, while at the same time the economic inequalities that are inevitable in an age of major economic transformations. We make sure that they don’t translate into huge political inequalities.

Chris Martenson: Now, Daron, as you wrote here on page 113, and I’m speaking probably a little bit to the first and the second challenges you just mentioned, you wrote here that in Venice, they ultimately transformed themselves into extractive institutions under the control of a narrow elite that monopolized both economic opportunities and political power. A number of years ago, I was interviewing a Senator and noted that 90% of the letters they had received at the time in 2008 had been heavily against the idea of bank bailouts. And yet, of course, we had bank bailouts and so this is one of the key pieces that I’m feeling at this point in time. You talk about the economic and political inequality. It really seems that this statement you said about a narrow elite beginning to monopolize the economic and political power…that’s the part at least in the financialization of our economy that most, I think, is obvious at this point in terms of being fairly extractive and non-inclusive.

Daron Acemoglu: Absolutely, and I think the zenith of this came this year when Sheldon Adelson made Rpublican presidential hopefuls come to his home and make sure that they all swore their allegiance to his policy agenda. How can that be truly in a politically inclusive society?

Chris Martenson: Well, that’s a pretty obvious example of Sheldon, but that same story is being played out, I think, very aggressively across the political landscape at this point in time.

Daron Acemoglu: Absolutely…I certainly don’t mean this is specific to republicans. I think Sheldon Adelson is an extreme case but the same is true for Democrats. Two political scientists, Martin Gilens and Larry Bartels, in separate works, have been looking at the landscape of political power in US society and they both, using different methods, conclude that both for Republicans and Democrats, and mostly looking at Senators and Congressmen, they have become much more responsive to the wishes of the wealthier, better, more affluent constituents so it’s not like this is a problem for republicans and not for Democrats…it’s true across the board.

Chris Martenson: This is why I think that, if I can characterize them as more youthful, that the Bernie supporters, but especially the new generations really need to read this book because what you’re describing here is that it’s not like you’re either a rich nation or a poor nation. The United States has made it to some exclusive club, to which it has permanent pass to or any other nation, but rather that at any moment in time it really matters what’s happening with your institutions and whether they’re drifting towards openness, fairness, freedom, inclusiveness, or whether they’re drifting in the other direction. I think this is an important point that has to be understood because it's really important…this is really important.

Daron Acemoglu: Absolutely! I think you’ve put it so well and I think it’s even more urgent in some sense because even though any society, especially when it starts with relatively inclusive political and economic institutions such as the United States can tolerate some deterioration in its institutions, they might reach such a point that it would be very difficult to reverse them. United States politics became very, very poisoned at the beginning of the 20^th century, for example. Many people thought the Senate for example, which was not directly elected at the time, was in the pockets of the robber barons, but before the whole thing lost its legitimacy and started disintegrating, there were major reforms under Teddy Roosevelt, Taft, and then Wilson and the whole thing sort of recovered. But unless you took that sort of action, it might have continued to deteriorate and at some point you might reach a point of no return. We can’t rest on our laurels. We are a great society. We have prosperity, we have freedom, we have innovation, we have horizon of new ideas and entrepreneurship, and risk taking that’s just absolutely great from the viewpoint of creating economic gains and social gains, but the whole thing could collapse unless we really tackled these two areas that are, I think, so central for the future of our institution.

Chris Martenson: I thoroughly agree and that was very well said. I want to see if there’s a third piece to this. I do want to turn to resources if we can because I do a lot of research on resource depletion and so here’s the thing…I can’t help but notice Daron, the wealth of the rich nations is really also based on an extractive model, but instead of extractive political and economic institutions that are aimed at individuals, they’re none the less highly extractive but of natural systems and resources. The extraction has merely been placed somewhere else in the story, instead of what on humans is what I’m saying so the question for you…is it possible, in your view, that the wealthy nations may end up winning the race but losing the contest, as it were?

Daron Acemoglu: Right, so I mean…if I could go back one second or one step, what I would say is that we certainly did not intend to and hopefully we did not, write a morality play. It’s not like inclusive institutions or societies that support inclusive institutions are superior in some general sense. Inclusive institutions are only as good as the people who are included, so British institutions were already very inclusive and were becoming much more inclusive in the 19^th century but during that period, Britain was also a vicious colonial power in India and parts of Africa. How come? Well, the people who are included had voice, they could defend themselves, they could get better and better opportunities but the people in the colonies did not and were not included and they would not benefit from sort of the same treatment. Well, the environment more broadly, not just the resources that we draw from the ground, but the environment more broadly…until very, very recently, did not have any voice. We could be a very inclusive system. We could