AJR’s economics Nobel is a partial victory for institutions

By Ryan Young of CEI.

"This year’s economics Nobel Prize winners are Daron Acemoglu, Simon Johnson, and James Robinson. They are frequent collaborators, often collectively called AJR. Much of their work is about institutions. Institutions are things like the rule of law, a country’s regulatory process, or the way it treats property rights. Think of institutions as the rules of the game, rather than the game itself.

Those of you familiar with CEI’s work, especially on regulatory reform, know that one of our policy mantras is that institutions matter. Since Nobels often honor a sub-field or a research program more than the individual honorees, from that perspective this is a gratifying prize. In many ways, AJR’s work complements previous institutions-matter economists like Douglass North, Oliver Williamson, Elinor Ostrom, and James Buchanan. And yet, it feels incomplete.

While AJR are right that institutions matter, they do not explore institutions’ deeper roots. They have also fallen for recent political trends, especially Acemoglu. These trends include populist anti-tech animus, cozying up to illiberal governments, and asking the fashionable questions about inequality instead of the right ones.

The first AJR paper to make a big splash was 2001’s “The Colonial Origins of Comparative Development: An Empirical Investigation.” They argued that deadly disease rates in colonial-era Africa help to explain many African countries’ economic performance today. The general rule is that the higher that European colonists’ disease mortality rates were in a given country during the 19^th century, the worse that country does today. The reason why is institutions.

In places with high mortality rates, European colonizers set up extractive institutions. Rather than take on a long-term project like building a sustainable liberal democracy, colonists instead extracted resources as quickly as they could and got out. After independence, these countries’ new governments kept these extractive institutions, which are keeping their people poor to this day.

European colonizers in countries with lower disease rates tended to think more long-term. They built more inclusive institutions, which also persisted in post-independence governments. As a result, low-disease mortality countries in the 19^th century are more likely to have relatively stable and liberal governments today.

When I was in grad school, the economics discipline was gushing over how AJR used such a subtle correlation to tell such a big story. One professor of mine called it the “killer variable” of the last twenty years. Journals were saturated with copycat articles. AJR were already on the Nobel short-list, and the main surprise is that it took them until 2024 to win.

Acemoglu and Robinson have coauthored three books on institutions, starting with 2006’s Economic Origins of Dictatorship and Democracy. Their second book, 2012’s Why Nations Fail, brought them popular acclaim. As with their previous work, they contrast extractive and inclusive institutions. Countries with extractive institutions tend to be corrupt, oppressive, and poor. Countries with inclusive institutions tend to be freer and richer.

Their chapter on Nogales, a city that has the US-Mexico border running through it, is a fantastic example of the effect institutions can have in otherwise identical places.

Even more vivid is the difference between North Korea and South Korea. Like the two halves of Nogales, the two Koreas share the same language, culture, and geography, and over a thousand years of history. But the country split into communist and liberal halves in 1950.

Extractive North Korea may be the only place on Earth that still regularly experiences famines in peacetime. Inclusive South Korea transformed in two generations from one of the world’s poorest countries to one of its richest, and it has become a stable democracy.

Acemoglu and Robinson’s third book, 2019’s The Narrow Corridor, tells a similar story. But instead of repeating Why Nations Fail’s black-and-white story of institutions being either extractive or inclusive, Acemoglu and Robinson fill in some of the colors and shades of gray. Their onslaught of terminology, distinctions, and metaphors makes it a bit of a muddle, but the general picture is clear enough.

A country should have a government powerful enough to protect people’s rights, but not powerful enough to abuse them. That is the narrow corridor within which states should be kept. My review of The Narrow Corridor takes a deeper look.

My colleague James Broughel argues that the economics Nobel is an insiders’ club, with the same few universities and dissertation trees winning in most years as friends reward their friends. AJR teach at MIT and the University of Chicago, which are both in the club. Johnson is also the IMF’s former chief economist.

Even for insiders like AJR, it often takes a fair amount of lobbying to get the prize. Researchers’ ambition to win can color their research agendas and the positions they take. This may explain why Acemoglu in particular has lost the plot in the last few years.

Acemoglu and Johnson in 2023 coauthored Power and Progress, which is about inequality. They argue that technological innovations over the last thousand years have tended to benefit powerful people at regular people’s expense. Like other voguish inequality analysts such as Thomas Piketty, they focus on levelling income ratios, but not on making poor people richer. This is opposite to the approach Iain Murray and I favor in our paper “People, Not Ratios.”

Acemoglu has had two other slipups recently.

One is his signing onto an open letter endorsing the Brazilian government’s ban of Twitter for political reasons. Whatever one’s opinion of Twitter or its owner, Brazil’s ban was outside of the narrow corridor Acemoglu endorses in his book with Robinson.

In a separate incident, Acemoglu showed a poor understanding of the knowledge problem. The short version of the knowledge problem is that nobody has all the knowledge they need to plan or direct an economy. This makes life extremely difficult for policymakers, however well-intended.

As early as the 1920s calculation debate, aspiring planners have argued that advances in computing technology would overcome knowledge problems. This was in the age of mechanical calculating machines. The predictions repeated themselves with the transistor, the mainframe computer, the PC, the Internet, and the search engine. Yet each time, the knowledge problem remained unsolved.

Maybe this time will be different, Acemoglu argues. In a 2023 Twitter thread about artificial intelligence, he writes: “Coming back to Hayek’s argument, there was another aspect of it that has always bothered me. What if computational power of central planners improved tremendously? Would Hayek then be happy with central planning?”

The answer is no. The knowledge problem isn’t about the amount of knowledge. It is about the type of knowledge. The type of information Hayek wrote about is tacit, qualitative, hyper-local, difficult to verbalize, and often impossible to quantify. It is inaccessible to planners, no matter their computing power.

Think about the factory worker who knows the quirks of the machines he works with. Or the teacher who knows her students’ learning styles. Or the entrepreneur who spots a hole in the market and has an idea for how to fill it that comes from their unique life experiences. Computers can’t model that. AI cannot generate those human discoveries. Acemoglu misunderstands the knowledge problem at a fundamental level, which in turn affects his and his collaborators’ policy prescriptions.

The Nobel Committee could have made a worse choice than AJR. Despite their inconsistencies and trend-following, all three understand the importance of institutions, at a time when many academic economists in top-five departments do not."