An ‘iron law of oligarchy’ means that even when oligarchs are overthrown, the revolutionaries, like the pigs in Animal Farm, often come to resemble them.
‘New leaders overthrowing old ones with promises of radical change bring nothing but more of the same’.
Understanding how change doesn’t happen is as important as understanding why it does.

Switzerland's GDP per capita in 2023 was over $89,000, which is a staggering 712% of the world's average. Sudan, on the other hand has a per capita income of $495.

Why are some countries so overwhelmingly rich, while some barely manage to survive?

Is it geography, culture or just pure luck? AJR disagree. They think it is the British.
And they also won a Nobel Prize for it.

(PS. Economists Daron Acemoglu, Simon Johnson, and James Robinson are collectively known as AJR)

Traditionally, most economists study the growth of countries by exploring factors like labor, machinery, education, technology, savings etc. These are what are known as the "proximate causes" of growth as they directly impact the economy. For example, if a country builds more factories or improves on education, its economy will most likely benefit.

But AJR focus on a deeper question: What determines how much a country invests in education or factories in the first place? They argue that the answer lies in institutions—the systems and rules that structure society.

They broadly categorize institutions into two types : Inclusive and Extractive institutions.

As the name suggests, inclusive institutions are those which ensure fairness, protect property rights, and create opportunities for everyone, while extractive institutions favor a small group of elites at the expense of the majority.

Inclusive institutions create modern, wealthy economies that are driven forward by technological innovation, not merely propped up by having won the natural-resources lottery.

We interviewed Prof. Abhijit Banerji, from the Economics Department at IIT Delhi about AJR's key ideas, why their research is so pivotal, yet so controversial and how it may apply to India.

So, what were the ideas that won this year’s Nobel prize in economics?

In their famous paper, The Colonial Origins of Comparative Development (2001), AJR examined how colonialism shaped modern institutions. They studied historical data to understand why some former colonies, like the United States and Canada, became wealthy, while others, like many African and South Asian countries, remain poor.

Their findings revealed an interesting pattern: in places where European settlers faced low mortality, such as the US and Australia, they established inclusive institutions to benefit themselves and future generations.

Diseases like malaria and cholera that spread in countries like India were deadly for the British, who didn’t have the immunity that the indigenous people had developed over the years. In regions where settler mortality was high due to such diseases, colonizers focused on extracting resources and wealth, setting up extractive institutions.

Also, in countries like India, Brazil, Mexico and many parts of Africa, a large population and higher protests or resistance made it difficult for them to maintain control. But once they held on, they exploited these large populations for cheap labour and resources. And since there was plenty of labour already, fewer European settlers moved to these places. The systems they set up, known as extractive systems, benefitted the colonisers at the expense of the local population.

Even after independence, it was too costly for the new governments to overhaul these exploitative systems. So in some places, they continued using forced labour to maximise production, even if that meant keeping their economies stuck in poverty.

On the flip side, places like Australia, Canada, New Zealand, the US, Hong Kong and Singapore had smaller populations, so European settlers moved into these places to make up for the labour shortage. The systems they created were more inclusive and benefited everyone since there wasn’t much they could exploit. And thus, these countries went on to prosper.

This legacy still affects these countries today because institutions change very slowly over time. In their research, AJR used statistical methods to show that good institutions directly lead to higher GDP per capita.

“AJR” also argue that nations with democratic institutions have the most economic growth. In a dictatorship or monarchy, political power is narrowly distributed and relatively unconstrained. In such cases, AJR argue, a small ruling class will tend to use its power to restrict competition and extract wealth for itself. By contrast, if political power is widely distributed across diverse groups in a society, then their common interest in doing business, and competition among them, will result in prosperity-generating economic institutions.

AJR claim, decentralized democratic systems such as those found in the U.S., Germany, and Switzerland foster economic prosperity by improving a nation’s ability to innovate. Democracies with more centralized power are less productive. (Think of countries such as France, Portugal, and Greece, which have less separation of powers, fewer checks and balances, and relatively weak state and local governments.) Finally, one-party states and authoritarian regimes—those with even more centralized and less competitive political systems—breed stagnation.

But, it’s been so long since colonialism. Why haven’t extractive institutions changed with independence?

Prof. Banerji highlighted an important point from AJR’s research: institutions are difficult to change, especially when there are conflicts between elites (the powerful) and ordinary citizens. Elites often resist changes that could threaten their privileges. Extractive institutions favour those in power, so those in power ensure that things stay as they are.

“The luddites in the presidential palace or the chamber of commerce do far more damage than the protesters on the streets.”

Also, commitment problems—when parties fail to keep their promises—make it challenging to reform inefficient institutions.

Wait, what about China?

One of the biggest challenges to AJR’s theory is the case of China. Since the late 1970s, China’s economy has grown rapidly, even though it remains an authoritarian state.

Prof. Banerji explains that China has implemented some policies that mimic inclusive institutions, even under a dictatorship. For example, in the late 1970s, China moved from collective farming to a system where farmers were given long-term leases on land, incentivizing productivity.

Similarly, town and village enterprises allowed local governments to manage businesses and keep the profits, fostering entrepreneurship. Additionally, state-owned industries were permitted to sell surplus production at market prices.

However, AJR have raised concerns about the sustainability of China’s growth and predict that over time, its economy will decline. Centralized political control and the suppression of entrepreneurs, such as Jack Ma, could stifle innovation in the long run.

What About the United States?

AJR often describe the United States as a model of inclusive institutions. Over centuries, its democratic system, protection of property rights, and open markets have driven innovation and prosperity.

What then has caused the state of democracy to be how it is right now in the USA with the current President denying the last election’s results? What has led to the downfall of democracy considering it seemingly had inclusive institutions? How can an inclusive system fall apart?

Political polarization and challenges to democratic norms, raise questions about the future of US institutions. Prof. Banerji suggested that institutional imbalances, like lifetime Supreme Court appointments and excessive power in the executive branch, could weaken inclusivity. Additionally, economic discontent among workers displaced by globalization has eroded trust in institutions, fueling populist movements.

To stop our slide into national dysfunction, political leaders need to focus on those who've been left behind and give them a leg up and a stake in the system.

What do Inclusive Institutions look like, here in India?

Prof. Banerji cited examples from India to show how inclusive reforms can help.

In the 1980s, farmers in West Bengal were given long-term land leases through Operation Barga, which incentivized them to invest in agriculture. Combined with the introduction of high-yield rice varieties, this reform significantly improved productivity and incomes. Inclusive institutions can also reduce barriers to education and employment, enabling upward mobility.

However, he emphasized that continuous innovation and targeted policies are needed to address systemic inequalities. For example, in the US, inadequate retraining programs for workers displaced by globalization have deepened economic divides.

We have decentralized democracy here in India. Why have we lagged behind?

India is a democratic country with a decentralized system, but it has often lagged behind in creating inclusive institutions. Prof. Banerji pointed to several challenges, including historical legacies like the caste system and zamindari system, which concentrated power and wealth in the hands of a few, restricting social mobility.

Also, in the mid-20th century, India prioritized heavy industries like steel and cement at the expense of light manufacturing and exports, diverting investments from sectors with higher potential returns.

Additionally, crony capitalism, where a few large firms dominate the market, stifles competition and innovation, creating extractive tendencies even in a democratic system.

How can we apply AJR’s research in policy?

When asked how policymakers could use AJR’s insights, Prof. Banerji stressed the importance of incremental change rather than radical revolutions. Institutions take time to evolve, and abrupt shifts often face resistance. He suggested strengthening property rights and reducing bureaucratic red tape to encourage entrepreneurship and investment. Additionally, investing in education, healthcare, and infrastructure can create equal opportunities for all. Encouraging entrepreneurship through fair competition and access to credit is another way to foster inclusivity.

Why Are Nobel Prizes in Economics So Concentrated?

A recent study found the institutional and geographic concentration of awards in economics is much higher than in other academic fields. Almost all the winners of major awards have had to journey through one of the top US universities (limited to less than ten) in their career.

Prof. Banerji explained that economics research often requires significant funding and access to large datasets, which are more readily available at top institutions. He also noted that India’s education system, with its focus on rote learning, may not encourage the kind of independent thinking needed for groundbreaking research.

Why India Lags Behind in bringing a Nobel

India’s underrepresentation in Nobel Prizes extends beyond economics to other disciplines as well. Prof. Banerji suggested several reasons, including a lack of investment in research, limited state support for structuring and funding research, and an education system that prioritizes rote learning over creativity. Talented individuals often move abroad for better opportunities, contributing to a concentration of expertise in countries like the US.

Bringing Change to India

AJR advocate for "quiet change"—small, steady reforms rather than radical revolutions. Prof. Banerji suggested focusing on improving investments by ensuring resources flow to the most promising sectors, such as technology and light manufacturing. He also emphasized the need for reforms in voting systems to balance representation and decision-making and building human capital by strengthening education and healthcare systems to create a skilled and healthy workforce. Even incremental steps, he argued, can lead to significant progress over time.