Why Nations Fail: The Lesson of Venice

Introduction and General Thoughts:

               Today I finished my first audio book titled Why Nations Fail by Daron Acemoglu and James Robinson.  It was an interesting experience and I am glad that I ended up listening to this book.

               This book discussed the economic and political development of a wide array of countries from all parts of the world.  Some of these countries were: Sierra Leone, Liberia, South Africa, Australia, India, China, South Korea, Japan, Russia, Germany, France, the United Kingdom, Spain, (Rome), (Ottoman Empire), Egypt, (the kingdom of Axum), Botswana, (Somalia), the Democratic Republic of Congo, the United States, Mexico, Guatemala, Colombia, Brazil, Argentina, Peru, Zimbabwe, and Paraguay.

               I found it very interesting how the book seemed to end on an extremely optimistic note for Brazil.  It suggested that the recent changes in Brazil show very promising signs for the development of inclusive economic and political institutions.  It also depicted an interesting comparison between the United States under Franklin Delano Roosevelt (FDR) and Argentina under Perón and then Menem.  Whereas the U.S. Congress forbade FDR from overriding the powers of the judiciary and packing the courts, Argentina did just the opposite.  Perón was able to evict 4 out of 5 of the unfriendly Supreme Court justices and Menem eventually packed the court to suit his political objectives.  Even though FDR did not get everything he wanted, the balance of powers in the United States was preserved.

               There are two other points in this book I found particularly interesting.  These are the authors’ prediction for China and their account of Venice.  I will discuss their overall evaluation of China last after I summarize the main themes of their book.  Now I will talk about what they had to say about Venice, which paints a picture for the potential path of the United States.  This association was never explicitly stated, but the implications of the account cannot be denied.

Venice & the United States:

               Before listening to the chapter above Venice again, I decided to search online for exactly what pages retold the story (remember I listened to an audio book).  I found a great editorial from The New York Times, which says exactly what I wanted to say and more.  Even though I am extremely hesitant to use The New York Times to defend or formulate an argument, I will in this case.  (Generally I feel as though entirely way too many people solely read The New York Times, just as another group only watches Fox News.  The danger in this is the complete absence of independent and original thought.)

               I will attempt to briefly summarize what Chrystia Freeland already does an excellent job in explaining through her opinion titled  “The Self-Destruction of the 1 Percent” published in October of 2012.  Very simply put, Venice was an extremely prosperous area of Europe while the rest of the continent was languishing the Dark Ages.  The city-state had inclusive economic and political institutions.  As she explains in her first paragraph, the colleganza was essentially a joint-stock company created to finance a single trade expedition.  Established businessmen financed merchant voyages while risk-taking entrepreneurs actually carried them out.  This arrangement allowed the entrepreneurs to move up through the social ranks upon the return of a success voyage.

               Eventually all of this changed when the elites decided to enact a variety of reforms that made it almost impossible for new entrants to assume political power in the Venetian ruling council.  This was known as La Serrata.  Shortly afterwards, the counsel started cutting off commercial opportunities to new entrepreneurs and eventually destroyed the Venetian economic engine.  Venice is essence became a museum, to be eventually surpassed economically by its once backward neighbors.

               Today, it can be argued the elites in the United States are “kicking away the ladder”, not just for the rest of the world, but also for the domestic population that isn’t exorbitantly wealthy.  My previous article about a book titled Kicking away the Ladder discusses how the developed nations encourage poorer nations to adopt the institutions and policies that blindly follow neoliberal economic principles.  The elites in these countries become educated in developed countries or have courses with syllabi almost completely composed of Western academic sources proposing neoliberal solutions.  In brief, free trade taken to the extreme stiffens innovation and industry in emerging countries and enriches primarily a small sector in “the developed world”.

               Returning to the discussion, a Canadian economist named Miles Corak (who seems to not have a web presence) studies how as the income inequality increases, the intergenerational income elasticity (social mobility) decreases.  Alan B. Krueger, the Chairman for the White House Council of Economic Advisers called this the “Great Gatsby” curve.  In essence, if meaningful social mobility in the United States does not improve soon, we are locked into a Venetian scenario.  Political power solidifies itself, which in turn constricts economic growth, which then in turn allows other countries to surpass us.  What if we allowed the process of creative destruction to fuel the economy instead of using a military apparatus to disguise the deficiency?

               As Warren Buffet explained, creative destruction precludes investment certainty. Creative destruction is not good for those in control.  They need to learn new rules, understand new technologies, and stay ahead of the start-ups.  The Chicago-based Morning Star article titled “Warren Buffet and Time-Horizon Arbitrage” explains one of Warren Buffet’s investment strategies: “Buffet makes far-flung future earnings the most important thing.  He looks for firms with economic moats: sustainable competitive advantages that allow them to endure and thrive in spite of capitalism’s tendency to [undergo] creative destruction”.

               Creative destruction is a fundamental factor for the continued social mobility in the U.S. as well as being the oil of our economic engine.  When elites become entrenched, they become counterproductive forces.  When economic and political power is extremely concentrated in the hands of counterproductive and stagnant forces, this is not good for the country.

The basic argument of the book:

               There have been many theories that have been set forth to explain why some countries are rich and others are poor.  Some of these are the Ignorance Hypothesis, First Welfare Theorem, Lewis’ Dual Economies (related to the Lewis Turning Point), Geography Hypothesis, and the Cultural Hypothesis, among others.  However, the authors of this book think these are all misguided.  Really, countries prosper because of pluralism, the rule of law, and the existence of inclusive political institutions that favor the development of inclusive economic institutions.  Inclusive economic and political institutions allow for the more efficient allocation of resources, while also offering some protections, like those for property rights.  They also permit the process of creative destruction to be carried out.  Elites end up preferring inclusive institutions because they are the more moderate alternative to a revolution.  Gradual change  or “reform” is the better of the two evils from their perspective.

               Once countries have pluralism, the rule of law, and inclusive economic and political institutions, they find themselves in a “virtuous circle”.  This concept applies just as much to life as it does for a country as a whole.  When you are nourished by healthy foods or by surrounding yourself with ambitious, positive people, you are continuously enhanced and less prone to be pulled downstream by a negative current.  However, the same holds true for countries with extractive economic and political institutions.  No one seeks communal advancement because everyone is stuck in the zero-sum game.  Everyone is going downstream, you just don’t want to be the last one.  This is termed the “vicious circle” by the authors of this book.

               The authors also discussed the role of political centralization as prerequisite for the development of inclusive political institutions.  Caution should be exercised as to not oversimplify “political centralization”.  Too much political centralization can actually have the opposite effect, and can put into motion the seeds for extractive institutions.

Prediction for China:

               On another note, now I will summarize the authors’ prediction for China, which previously is very aligned with my own convictions.  Just like the stock market, when everyone runs in one direction, run as fast as you can in the other.  China is experiencing economic growth which is not the same as sustained economic development.

               Private entrepreneurship in China competes with big state companies.  The Communist party there still orders these companies to follow certain business policies.  When the big red phone rings at the front desk, the companies must obey orders.

               Some may argue that sure, the Communist party may be influencing these companies, but the companies still benefit from other economic opportunities.  Private companies can still establish themselves and even seek profit abroad.  China, for now, still has a large supply of cheap labor and has access to technology, foreign finance, and the flows of international trade.  These may be proof of the development of inclusive institutions.

               However, Chinese institutions are still extractive and democracy and pluralism have still not occurred in China.  More importantly, China grows because the economic disparity between it and the West was so vast; the country could not have become any more economically backwards in the 1970s.  Also, the existing technology and massive investment fueled this growth as opposed to the forces of creative destruction.  As China develops future technologies, these will have unpredictable effects and will also unleash the forces of creative destruction.     Just like the when the stocking and knitting frame were presented to Queen Elizabeth  and when Christopher Columbus proposed his voyage to King João II of Portugal, both the invention patents and the voyage proposal were turned down.  Queen Elizabeth was worried about the destabilizing effects the machine could have on the English work force (creative destruction).  King João II was content with his eastern passage to Asia; he saw no need to pursue other trade routes.  Chinese authorities will probably follow Queen Elizabeth’s example, while developed countries currently in the “virtuous circle” might take after King João II’s example.

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