We recently celebrated the accension as the world’s 4th largest economy. We also saw the barrage of voices on media calling this achievement ‘hollow’ and ‘empty’ as there is still so much to be achieved. This celebration has been called hypocritical and obscene as basically, we still are a very ‘poor’ nation.
Let’s stop at this. This is the question. Why are certain nations ‘rich’ and others ‘poor’? Why can certain economies afford universal health, free education, innovation at work and a clean climate while others struggle with basic hygiene and human needs? What is further surprising, is that poverty index seems independent (to a very large extend) of GDP.
It’s not that the poor nations are not working hard. As often in life, the system indeed is ‘rigged’ against them. In this article, I shall try to speak, in as simple terms as possible, to what are extractive institutions, how they were formed, worked and how the ghost of colonisation, still manipulates the wealth of nations.
The richest 20% of the world’s countries are now around 30 times richer than the poorest 20%. Colonisation reshaped the world’s political, social, and economic landscapes. As European powers expanded between the 16th and 20th centuries, they established systems – some aimed at development, others at exploitation. These systems, known as institutions, laid the groundwork for centuries of economic divergence.
In 2001, Daron Acemoglu, Simon Johnson, and James Robinson empirically explored this relationship in their seminal paper, The Colonial Origins of Comparative Development, highlighting how colonial choices continue to determine long-run prosperity. Their contributions focus especially on the distinction between inclusive and extractive institutions. This earned them a Nobel prize in Economics for the year 2024.
They have provided new insights into why there are such vast differences in prosperity between nations.
Inclusive vs. Extractive Institutions
What Are They?
• Inclusive institutions promote broad participation in economic and political life. They protect property rights, encourage innovation, and limit executive power – creating fertile ground for sustained economic growth.
• Extractive institutions, in contrast, concentrate power and wealth in the hands of a narrow elite. They suppress the rights and economic potential of the majority, prioritizing immediate extraction of resources over long-term prosperity.
The Colonial Roots
Acemoglu, Johnson & Robinson show that colonial powers established different institutional regimes based on settler incentives and local conditions. One important explanation for the current differences in prosperity is the political and economic systems that the colonisers introduced, or chose to retain, from the sixteenth century onwards. The places that were, relatively speaking, the richest at their time of colonisation are now among the poorest. And thus, The ‘sone ki chidia’, our country, became one of the poorest when the colonisers (the British in our case) left.
They also demonstrated that the higher the mortality among the colonisers, the lower is today’s GDP per capita. Why is this? The answer is settler mortality – how ‘dangerous’ it was to colonise an area – affected the types of institutions that were established.
• High settler mortality (e.g., in dense tropical regions) discouraged colonization. Europeans avoided settlement and instead set up extractive systems to exploit existing wealth – seen in parts of Latin America, Central Africa, and India.
• Low settler mortality (e.g., temperate climates in North America, Australia) encouraged permanent settlement. Colonizers founded inclusive institutions with rule of law, property rights, and eventual democratic structures, which led to long-term growth.
Empirical Evidence and the “Reversal of Fortune”
Settler Mortality as an Instrument
Using historical mortality rates of European settlers as an instrumental variable, a causal link was demonstrated: areas with higher mortality were more likely to produce extractive institutions and, centuries later, face lower GDP per capita.
Reversal of Fortune
One striking finding is the “reversal of fortune”: regions that were rich before colonization (densely urbanized economies under empires like the Aztecs, Indians, Incas) are poorer today, while previously poor settler colonies (e.g. North America) are richer. Industrial-era technical innovations could only realize their full potential in places with institutions that benefited the broader society.
This reversal mainly occurred in association with the industrial revolution. As late as the mid-eighteenth century, for example, industrial production in our county was higher than in the USA. This has changed fundamentally since the start of the nineteenth century, which speaks to the reversal primarily being a result of differences in institutions. The technical innovations sweeping across the world were only able take hold in places where institutions had been established that would benefit the wider population.
Paradoxically, this means that the parts of the colonised world that were relatively the most prosperous around 500 years ago are now those that are relatively poor.
Let’s examine this with a unique example.
A Tale of Two Cities
Nogales, Arizona (USA) vs Nogales, Sonora (Mexico)
Both share geography and demography, but diverged wildly in economic outcomes due to institutional differences:
- Nogales, Arizona enjoys stronger governance, rule of law, and economic freedom—benefits of inclusive institutions.
- Nogales, Sonora faces higher poverty and weaker institutions—a legacy of extractive colonial influence.
Nogales is cut in half by a fence. If you stand by this fence and look north, Nogales, Arizona, USA stretches out ahead of you. Its residents are relatively well off, have long average lifespans and most children receive high school diplomas.
If you look south instead, you see Nogales, in Sonora, Mexico. Even though this is a relatively wealthy part of Mexico, the residents here are in general considerably poorer than on the north side of the fence. Organised crime makes starting and running companies risky. Corrupt politicians are difficult to remove, even if the chances of this have improved since Mexico democratised, just over 20 years ago.
Why do these two halves of the same city have such vastly different living conditions? Geographically they are in the same place, so factors such as the climate does not apply. The two populations also have similar origins and many common ancestors. There are also similarities in food and culture.
The decisive difference is thus not geography or culture, but institutions. The people who live north of the fence live in the USA’s economic system. South of the fence, residents live under other economic conditions, and the political system limits their potential to influence legislation.
The contemporary differences in living conditions between Nogales, USA, and Nogales, Mexico, are thus largely due to the institutions that were introduced in the Spanish colony that later became Mexico, and in the colonies that became the USA. This pattern is similar across the colonised world and does not depend on whether the colonisers happened to be British, French, Portuguese or Spanish.
Lasting Impact on National Economies
Colonial-era institutions have shown remarkable persistence. Even after decolonization, extractive regimes created path dependencies—political elites resist reform unless faced with upheaval—leading to cycles of corruption, weak rule of law, and persistent poverty.
Political and economic institutions tend to be very long-lived. Even if the extractive economic systems provide short-term gains for a ruling elite, the introduction of more inclusive institutions, less extraction and the rule of law would create long-term benefits for everyone. So why don’t the elite simply replace the existing economic system?
If the political system benefits the elites, it seldom changes. A political system, which allows the population to replace leaders who do not keep their promises in free elections, may reform the system. 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.
The inability to make credible promises can also explain why transitions to democracy do sometimes happen. The masses can mobilise and become a revolutionary threat. The model for explaining the circumstances under which political institutions are changed has three components.
- Conflict over how resources are allocated and who holds decision-making power in a society (the elite or the masses).
- Masses sometimes having the opportunity to exercise power by mobilising and threatening the ruling elite.
- The final is for the elite to hand over decision-making power to the populace (commitment problem).
Policy Implications for Today
The findings suggest that development is not just about resources or policies—it demands institutional reform:
- Promote political inclusion: Ensure broader civic voice, checks on power, legal protections, and equitable opportunity.
- Tame entrenched elites: Deep-seated reforms often follow moments of crisis or credible democratization threats.
- Align institutions with growth goals: For foreign aid and development programs to succeed, they must support empowerment and accountability—not just infrastructure.
Conclusion (And a Current Exception)
Decades after their 2001 study, Acemoglu, Johnson, and Robinson’s research remains a cornerstone in understanding global inequality. By empirically linking colonial-era institutions to today’s economic disparities and saving a clear theoretical framework, they help the world confront one of its toughest challenges: breaking cycles of extraction and forging inclusive, enduring prosperity.
Their Nobel Prize in 2024 not only honours their academic achievements but affirms a paradigm shift in economic development—one that recognizes institutions, not just capital and geography, as the architects of national wealth. Its also my privilege, that I had attended a lecture by Daron Acemoglu, and heard all this in person, and I can’t do justice to their passion simply by writing about it.
One notable exception; however, remains, our neighbour, the People’s Republic of China. China’s rise in the global economic sky and sustained growth under authoritarian institutions, challenges the centrality of democracy. It’s a dynamic world and no impact can be permanent or understood in whole. However, we must march on and create equitable models, for inclusive growth and sustained development.