I first began to think seriously about economic development and political institutions as a student at UCSD in 2001. I had spent the previous year visiting over thirty different countries thanks to a ridiculously cheap round-the-world ticket. ($1,800 to travel just about anywhere over the course of a year. I still recall the shock of spending around $10 a day while backpacking around India for a month, and then barely getting by on $150 a day the next week in Japan.)

San Diego and Tijuana from space

While I studied political science and international relations in San Diego, I would often drive down to Tijuana for cheap tacos, cold beer, and a little chaos. The San Diego – Tijuana region is one contiguous metropolitan area divided by a political boundary that was established in 1848. The two cities share access to the same sea, have similar demographics, and nearly identical geographies. So why was Tijuana so much poorer and less developed than its northern neighbor? Why did so many residents of Tijuana want to flee their city to move to San Diego, but not vise-versa?

Why Nations Fail, an ambitious synthesis of political history and economic research by Daron Acemoglu and James Robinson, is the most convincing explanation I have read as to why some nations are rich and others are poor. In fact, it’s one of only a handful of books I have come across in the past few years that have significantly changed my worldview. (James Gleick’s The Information and Daniel Kahneman’s Thinking, Fast and Slow are two others.)

For Acemoglu and Robinson, the most determining factor between rich and poor countries is the effectiveness of their economic and political institutions. They introduce two terms to describe ineffective and effective economic institutions. Extractive institutions “extract incomes and wealth from one subset of society [the masses] to benefit a different subset [the governing elite].” Examples include forced labor, protected monopolies, and the clientelistic relationships between union bosses and political parties.

The antidote to extractive institutions are inclusive institutions, which are designed to create incentives that reward everyone for hard work and innovation. Inclusive economic institutions include the protection of private property rights, predictable enforcement of contracts, regulation to prevent monopolies, access to credit and opportunities to invest. If, for example, a young couple is unsure about the legality of their land title, it’s unlikely that they will invest the time and money to improve their house. If an entrepreneur assumes that the government will not challenge monopolies that unfairly squeeze out competition, then she won’t invest her life savings to develop a disruptive technology. In Mexico, entrepreneurs with innovative ideas related to media, communication, and energy are constantly told that they can’t compete with Televisa, Telmex, and Pemex — three of the nation’s biggest monopolies.

How governments actively discourage innovation

Here’s a sure bet: when a new government administration comes to power in your country, within the first three months it will send a delegation of policy makers to Silicon Valley to understand how they can replicate the region’s success in promoting a culture of innovation and entrepreneurship. During these trips they will come across the “cluster theory” of Harvard professor Michael Porter, which argues that the economic success of Silicon Valley, Cambridge, and North Carolina’s Research Triangle Park has benefitted from the proximity and cooperation between research universities, technology parks, and venture capital investors. Then this delegation will return to their home country to suggest that the government fund a technology park near a “research university” and start up a “seed fund” to give support to early-stage entrepreneurs. At the same time the delegation will tell their wealthy family members and friends that they should buy up property where the government plans on building the technology park. The land speculation forces out the families that live there, but rarely do these industry clusters lead to sustained job creation.

This is what is happening today in Mexico with the promotion of Ciudad Creativa Digital, a downtown re-development project in Guadalajara that has been dubbed “the future Hollywood of digital creativity” by former president Felipe Calderón. Official press releases claim that the “digital city” expects to attract $10 billion of foreign investment from the likes of Disney, Sony, Time Warner, and Viacom while creating 25,000 jobs in the next 5 to 10 years. The press releases are also quick to point out the involvement of Italian architect and MIT professor Carlo Ratti. But they don’t mention how much public money will go into funding the project, nor that there is already an expensive state-supported “digital media park” just 30 minutes away. Guadalajara’s Digital Creative City is largely modeled on Dublin’s Digital Hub, which has been anything but successful.

Washington Post columnist Vivek Wadwha rightly calls these digital hubs strategies “modern-day snake oil,” and Why Nations Fail offers us an explanation as to why they don’t work.

Acemoglu and Robinson insist that sustained economic development depends on bottom-up, entrepreneurial innovation. Top-down economic development can work in the short term — as it did in Latin America in the 1950s and as it does today in China — but will eventually run out of steam when old sectors can no longer compete with cheaper innovations from abroad. Wealthy countries embrace policies that support entrepreneurs that develop products and services that are better, cheaper, and more efficient than the competition. Poor countries support old monopolies in their effort to kill off all competition.

In their response to a sloppy review of Why Nations Fail by Bill Gates, Acemoglu and Robinson note that the US software industry benefited when a court of appeals found Microsoft guilty of monopolistic practices. Unlike the United States, however, Mexico has not constrained Carlos Slim’s telecommunications monopoly. In 2012 the OECD estimated that Slim’s monopolistic practices have cost Mexico $129 billion. Meanwhile Carlos Slim, who inherited the state telephone company at a discount rate from his friend, former president Carlos Salinas de Gotari, is now the richest man in the world with an estimated net worth of $79 billion. Slim’s telecommunications monopoly is the epitome of an extractive institution — Mexicans lose $130 billion and Carlos Slim personally gains $80 billion. Meanwhile, Mexico has the slowest and most expensive internet connection speeds among all OECD countries — a major obstacle to startups like NuFlick that require decent connection speeds.

Though the oil industry’s successful killing-off of electric cars in the 1990s has been well documented, it’s still worth noting that South African entrepreneur Elon Musk chose Silicon Valley as the headquarters of Tesla Motors, an electric car company that hopes to disrupt the Detroit-based car industry. Similarly, a US appeals court recently sided with a disruptive startup, Aero, despite pressure from major broadcasters including Comcast’s NBC, News Corp’s FOX, Disney’s ABC and CBS. The decision means more options and cheaper services for customers and a major challenge to existing content companies. Such a decision would never take place in Mexico where content companies like Televisa and TV Azteca have far more political power than the judges that rule over such cases. (Note: I don’t think that Aero is a brilliant innovation — see Farhad Manjoo’s piece.)

Unless developing countries are able to implement and enforce policies that support disruptive entrepreneurs more than established monopolies, then digital hubs won’t lead to new start-ups or sustained economic growth.

Overstating their argument

I have only one qualm with this book: the authors overstate their argument. We shouldn’t be surprised. Just as Jared Diamond, a geographer, overstated the role of geography in explaining the difference between poor and rich countries in Guns, Germs, and Steel, so to do the economists Acemoglu and Robinson overstate the role of economic institutions. They come off as childish and defensive in their insistence that differences in institutions account for nearly all the differences between rich and poor countries, while disregarding the roles of geography, culture, and access to natural resources.

In his review of Why Nations Fail, Jared Diamond gracefully concedes that differences in economic institutions probably account for 50% of the economic differences between rich and poor nations, but then quite rationally he points out that the vast majority of poor nations are in the tropics where agriculture is often less productive and where tropical diseases are debilitating.

Nor are Acemoglu and Robinson willing to admit that culture and the effectiveness of institutions are inextricably linked; different cultures lead to different types of institutions and differing institutions have diverse effects on how cultures develop. In fact, they cite the example of an inventor who comes to the Roman Emperor Tiberius to announce that he has invented a kind of glass that is nearly unbreakable. Rather than rewarding the inventor, however, Tiberius had him killed; for he was sure that the unbreakable glass would become so valuable that it would diminish the value of his vast reserves of silver and gold. Sure, it’s important that the inventor lacked access to the patent system and venture capital in order to scale up production of his new invention. However, it’s just as important to recognize that the inventor’s first reaction was to present his unbreakable glass to the emperor rather than try to set up his own business. If there aren’t incentives that reward effort, then that leads to a culture of not taking risk. I see that culture all around me in Mexico. We shouldn’t fetishize institutions when behaviors are what must change.

Why Nations Fail should be required reading for all students of international development and world history. But it should be read along with other compelling arguments including Diamond’s Guns, Germs, and Steel, Fukuyama’s Origins of Political Order, and Culture Matters, an anthology edited by Lawrence Harrison and Samuel Huntington.

What can be done

Acemoglu and Robinson conclude their book with a critique of development aid — a critique which has become fashionable lately among economists who see aid as a market-distorting force that inhibits local entrepreneurs from developing their businesses. (African bloggers rallied against a well intentioned business man from Florida who wanted to send one million t-shirts to Africa without considering that such a campaign would surely kill off African t-shirt manufacturers.) Using many of the same arguments as Dambisa Moyo, Acemoglu and Robinson claim that development aid rarely alleviates poverty, and at times it supports authoritarian governments and their extractive institutions.

To achieve inclusive economic institutions, you first need inclusive political institutions. These include representative parliaments, fair elections, competition via regulation, meritocratic access to quality education, and the rule of law applied equally to all. It was no coincidence that the Industrial Revolution took place in England, write the authors. For it was in England where the 17th century Glorious Revolution created new political institutions that would create the incentives that rewarded the invention of the steam engine, locomotive, pneumatic tire, and modern iron mining.

The transition from extractive institutions to inclusive institutions occurs during what the authors call “critical junctures.” These critical junctures could be a new generation of political elites, a political revolution, or a civil war, such as the US Civil War — when the highly extractive institution of slavery was finally abolished. But not every revolution brings about inclusive institutions. More often than not, they merely change the ruling elites that benefit from extractive institutions.

Acemoglu and Robinson refuse to make prescriptions, though they do praise the Brazilian model of development under Lula and criticize the Venezuelan model of development under Chavez. They also praise the role of a free press to make visible acts of corruption and clientelism by the powerful elite. However, even while they stress the importance of a free press, they aren’t so idealistic to expect powerful leaders to change their behavior just because it’s made public. They would likely agree with Mushtaq Khan that development advocates should focus on influencing the next generation of elites to implement inclusive institutions rather than shaming current leaders for their extractive institutions.

Not only does Why Nations Fail offer us a new framework to think about the making of the modern world, but the editorial process epitomizes a major shift in how non-fiction books are published. A recent Op-Ed piece by Mexican entrepreneur Alberto Lujambio points out that the “first draft” of Why Nations Fail was published on their blog, where it benefitted from constant feedback by readers. Then the first draft was polished into book form, which in turn has inspired new debates and discussions on the blog. Lujambio calls the editorial process “open and horizontal,” and notes that “reading non-fiction” these days refers to much more than thumbing pages of a book.

And it’s a good thing that much of the book’s content is available on their website since Mexico’s leading bookseller, Sanborns, doesn’t stock the book. Who owns Sanborns? None other than Carlos Slim, of course.