How Nations Succeed - A Review of the Reversal of Fortune Thesis

Abstract

This paper reviews the methodology and theory supporting Acemoglu, Johnson and Robinson's (2001) famous “Reversal of Fortune” thesis. Their thesis provides a simple and linear explanation to why some countries are rich today, while some are poor. It argues that European colonialists settled and introduced “good” institutions in countries that were poor in 1500, while they did not settle in countries that were rich in 1500, and “extractive” institutions were introduced instead. AJR argue that the types of institutions introduced had persistent effects on economic growth in the countries colonized. They argue that countries where “good institutions” were introduced, meaning private property rights for a large section of society, were able to take advantage of industrialization opportunities, and develop, whereas those countries with extractive institutions are poor today. This paper finds significant flaws in the methodology employed by Acemoglu et al., both with the proxies used for wealth in 1500 and with the oversimplified historical framework employed. Strikingly, re-running their regressions with better data causes much of the reversal to disappear. Furthermore, by examining the development trajectories of countries of countries in the West, East Asia and Africa, suggests that it is the creation of a nurturing environment for industrial development that has allowed countries to develop, and institutions of private property only come into place after countries have reached a certain level of development. Thus, this paper recommends a closer examination of how countries have managed to successfully develop throughout history. Although this paper does not launch a thesis as simple and appealing as Acemoglu et al.'s, it uncovers important weaknesses in the reversal of fortune thesis, and suggests alternative policy recommendations.