2024 Nobel Prize in Economics Review

Acemoglu et al. propose that most poor countries are poor because they are stuck in poverty traps (i.e. being poor makes you poorer).

Imagine you’re a laborer whose child falls ill. To cover medical expenses, you incur debt, leaving you poorer than before. Now, envision the opposite scenario: you own a modest business and are financially stable. A new law opens access to additional markets, increasing your income to the point where you contemplate expanding to another city. Your concerns shift from meeting basic needs to strategic growth decisions. This transition exemplifies the theory underpinning many RCTs in development economics:​

*There are specific barriers that prevent poor individuals from increasing their incomes, but beyond a certain threshold, these barriers diminish, allowing for sustained economic advancement.

This is true for individuals, but it is also true for groups of individuals; like countries.

Nobel Prize in Economics 2024 review

The 2024 Nobel Prize in Economics was awarded to 3 laureates who studied why countries are poor. Their research went something like this: ¹

Colonizers were in search of higher profits from mineral-rich regions (remember, this is before colonialism, so there weren’t any “countries” so to speak)

Densely populated regions offered high resistance so the colonizers only got friendly with the local elite so that they could mobilize the commoners and exploit their labour. The colonizers used that labour to extract minerals and sell them for profit. They shared some of those profits with the local elite to appease them and keep operations going. The colonizers only invested in short-term growth (extracting useful minerals as fast as possible) in that region. They didn’t invest in long-term growth because they did not have plans of settling there. This means they didn’t build useful infrastructure like schools and hospitals. Once the colonizers left, these regions were left under the mercy of the local elite, who continued to exploit the commoners for higher profit. After all, they had seen that it worked out for the colonizers.

Fewer European settlers (colonizers who wanted to make some place their new homeland) moved to densely populated colonies. Places that were more sparsely populated offered less resistance but also less labour to exploit. This means that settlers (who in some cases were more, in number, than the locals) had to setup inclusive economic institutions that incentivized them (settlers) to work hard and invest in their new homeland.

How to escape poverty traps

Countries can escape poverty traps by engaging in peaceful protests. The masses can challenge the underperforming local elite by protesting; forcing the local elite to either relinquish power or risk being overthrown via a revolution. The protests have to be peaceful so that it attracts the most people; since there is power in greater numbers.

“As long as the political system benefits the elites, the population cannot trust that promises of a reformed economic system will be kept. A new political system, which allows the population to replace leaders who do not keep their promises in free elections, would allow the economic system to be reformed. However, the ruling elites do not believe the population will compensate them for the loss of economic benefits once the new system is in place. This is known as the commitment problem; it is difficult to overcome and means that societies are trapped with extractive institutions, mass poverty and a rich elite.”

How do you solve a commitment problem? A commitment device is a way of changing incentives so as to make otherwise empty threats or promises credible. ²

As a rather extreme example: members of the Cosa Nostra (Italian mafia) making a “vow of silence” (code of omerta). Anyone who breaks this code is killed in a painful way.

“With such credible threats, prisoners will not assume that their payoff from confessing is always better than the payoff from remaining silent. Thus, if the threats are successful, the game matrix is transformed to one in which the dominant strategy is to remain silent.” ²

So this raises the question, what are some effective commitment devices developing countries can adopt?

• Independent institutions: like independent central banks ³, anti-corruption commissions and independent electoral commissions
• Constitutional reforms: like term limits, judicial independence, protections civil liberties (like freedom of speech, freedom of the press, freedom of assembly in case you need to peacefully protest)
• International agreements that punish non-compliance and effectively bind a country to certain policies regardless of domestic political changes⁴

Conclusion

One thing you notice with all the devices listed above is that they already exist in most developing countries. The problem is that they are usually either weakly enforced or already captured by the local elite ⁵. They are prone (and often subject) to manipulation ⁶so they are effectively useless in the eyes of citizens in these countries.

I think a simple solution to this is political pluralism. A political environment where power is not concentrated among a select few will reduce the risk of capture and make the above commitment devices viable. You can argue this is why most successful countries are successful.⁷