What causes prosperity?

[CAMBRIDGE] Why have some countries grown rich and others not? The three winners of this year’s Nobel Prize in Economic Sciences – Daron Acemoglu, Simon Johnson, and James A Robinson – offer a simple answer: institutions. Countries with “inclusive” institutions – which underpin an open society, accountable government, economic freedom, and the rule of law – do better than those with “extractive” institutions that reward those in power.

The World Bank’s institutional-quality rankings seem to support this assessment. Based on six governance indicators – control of corruption, voice and accountability, government effectiveness, political stability and absence of violence, regulatory quality, and the rule of law – these rankings are highly correlated with national income per capita, from top (Denmark and Finland) to bottom (Equatorial Guinea and South Sudan).

But correlation does not mean causation. Showing that inclusive institutions led to prosperity – not the other way around – is no easy feat. After all, many countries pursue, for example, reforms to their tax and regulatory systems as the economy becomes more developed, not before. South Korea climbed in the World Bank’s institutional-quality rankings during its period of democratisation, which came after its economic takeoff, suggesting that high-quality institutions were more likely a result than a cause of growth.