Editors note: the Albanian version of this article can be read here.
It finally happened; Daron Acemoglu, Simon Johnson dhe James Robinson (AJR) were awarded the Nobel prize for their work on the long run effect of institutions on economic growth. Every economist I know, even those not particularly fond of their central thesis, was certain that this was eventually going to happen. The prize is for research that tackles a truly big and important question: “Why are some countries so poor and some others so rich?”. The differences in incomes across countries are staggering; as the Nobel Prize committee press release notes, the top 20% of countries are 30 times richer than the bottom 20%. The question is as difficult to answer as it is of great importance, finding a formula for growth would lift billions out of poverty, and it has baffled economists for the better part of a century. Early answers to the question concentrated on factor accumulation, specifically on the savings rate, which determines the capital available for production, or on the efficiency of capital and labour in the production process (productivity). On average, the Dutch are much more productive than Albanians, GDP per hour worked in the Netherlands is nearly five times higher than in Albania. But why? Albanians don’t seem to have trouble being productive when they’re outside of the country. In fact, if one looks at median household income in the US by ethnicity, Albanians rank 16th out of 71, a pretty good performance given that Albanian migration to the US is fairly recent compared to others[1]. The productivity explanation is useful but remains a bit of a black box. Some countries are more productive than others in their use of labour and capital, but why? As the above point makes clear, once Albanians move from Albania to the US their output increases significantly, so what is it about the US that makes them so much more productive?
One answer, proposed by Douglass North, another Nobel prize winner, was institutions[2]. In economist speak, institutions are the ways human beings organize society, more specifically, in his words:
“Institutions are the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction.”
What does this mean in practical terms? Institutions are basically the formal and informal guidelines that shape how people interact, make decisions, and conduct business. Think of them as the underlying structure that determines whether a society tends to reward or discourage certain types of behavior.
These institutions come in two main flavors:
Economic institutions: These govern things like property rights (can you keep what you earn?), contract enforcement (will courts uphold business agreements?), and market access (can anyone start a business or are there unfair barriers?). For example, in some countries, it might take months of paperwork and bribes to start a legal business, while in others you can do it online in an afternoon.
Political institutions: These determine who has power in society and how they can use it. For instance, are there checks and balances on government power? Can citizens vote leaders out of office? Do courts operate independently?
The key insight from AJR is that these institutions aren’t just background details – they’re actually the main reason why some countries prosper while others struggle. When institutions encourage innovation, protect property rights, and prevent powerful people from simply taking what they want, you tend to see economic growth. When they don’t, you often see stagnation or decline.
This way of defining institutions, although clear, is sufficiently broad and difficult to pin down, but we can go through an example to fix ideas.
Example: Suppose that a commodity exploration company believes there are substantial copper deposits in some remote area of northern Albania. The company’s geologists need to set up camp and start collecting samples in order to prove their hypothesis. They contact the Albanian government, write a contract of exploration which stipulates that if substantial deposits are indeed found the company will have the right to either build the mine themselves or sell exploration rights. The contract also stipulates the amount of royalties the government is to collect in case the project is feasible. The area in question is public land, so the government has all rights to it. Suppose that after a year of collecting samples, substantial deposits are found and, as soon as this information becomes public, a private party makes a claim that the land is theirs by law and that the contract with the government is void. The company inquires with the appropriate government office and finds that the register for this piece of land has disappeared. Moreover, a judge that has been paid off finds in favour of the complainant and the company is basically left without any claim to the fruits of their labour. Not only that, but another company starts drilling sideways, close to the area, just outside the defined boundaries thus extracting the copper that belongs to the original company. The competing operation is not efficient because no proper mine can be set up so little copper is extracted. In the end the original explorer leaves Albania taking the loss.
This example highlights two important economic outcomes governed by institutions: property rights and contract enforcement[3]. In the example above property rights are not well defined since the government is unable to implement them. Contract enforcement is also non-existent since judges can be bought to find in favour of bogus claims, so any contract is not worth the paper it is written on, even if it is signed by a government official. What is the result of all this? Projects that require substantial investment will not be undertaken since one may not be able to reap the benefits due to lack of property rights and contract enforcement. So the overall amount of investment is reduced thus reducing total output. If one thinks of the outcome in which the government behaves properly, a big mine would have been built that would have employed hundreds of locals and lots of copper would have been extracted. Additionally the government would have received royalties for the copper sold that could have gone to services and education. That did not happen. The institutional arrangement in this example is one in which courts and judges do not apply the letter of the law but serve their own private interests and government officials are not accountable for the contracts they sign.
AJR’s insight is that economic institutions are endogenous, that is to say they are not incidental, but are determined by who holds political power. If a country has a choice between efficient institutions that foster growth and some other set of institutions that do not, the choice will depend on the private interests of those who hold political power. And where does political power come from? According to AJR it comes from the distribution of resources. If the distribution of resources is fairly broad, the political power of the elites will be constrained and their decisions will be more inclusive. In this vein, AJR defined two types of institutions; inclusive and extractive institutions.
Inclusive institutions distribute power and opportunity broadly across society. They ensure political participation and accountability, equal application of law, and protected rights for all citizens, while fostering economic systems where anyone can start a business, invest, innovate, and keep the rewards of their work. Markets remain competitive, property rights are secure, and success depends on merit rather than connections.
Extractive institutions, by contrast, concentrate power and wealth in the hands of a small elite. They limit political voice and accountability while creating economic systems that funnel resources from the broader population to the privileged few. Success depends more on connections than merit, property rights are weak for most people, and innovation is often discouraged since it might threaten existing power structures.
The main insight of AJR’s work, and the one that restarted the literature is that both types of institutions tend to be self-reinforcing – inclusive ones typically support further inclusion, while extractive ones usually perpetuate extraction. They empirically show that in areas in the new world where colonial institutions were inclusive, economic growth was substantial and political representation much broader than in other locations where these initial institutions were extractive[4]. So there is path dependence in institutional arrangements, and historical conditions matter for why some countries are poorer than others.
To recap; in order to answer the question as to why some countries are much richer than others, we have to think about the way individuals organize society, something we have loosely called institutions. Institutions can be inclusive (good) or extractive (bad) and whether a country has one or the other depends on its particular history and how political power was and is distributed. There is a lot of material on the web on the central thesis and the empirical work of the authors, they have written four books on the subject, so my marginal contribution here is relatively small when it comes to the overall thesis. However, one can ask the question: How can Albania’s current economic performance be evaluated from an institutionalist point of view? What would this framework have to say about Albania? Even our prime minister has often mentioned the Ottoman roots of the modern Albanian state as a reason for its underdevelopment, which may be seen as an institutionalist reading of our current predicament. In what follows I will attempt an institutional explanation of Albania’s poor economic performance over the last three decades.
Albania’s path:
Albania’s independence in 1912 marked the creation of a new state with its own power structure, though much of the political and economic framework was inherited from the Ottoman Empire. At the time, Albania was a largely rural and impoverished country, with very low levels of education. The majority of the population relied on subsistence farming. The nation’s elite, however, were composed of a small group of large landowning families (latifundia) who had access to Europe’s finest educational opportunities. For most Albanians, though, access to both education and property was extremely limited.
In Why Nations Fail, AJR identify latifundia in Latin America as a particular form of extractive institutions. There are two main effects of large landowning that delay development.
Economic effects: Large landholding creates several key economic barriers to development. Large landowners typically underutilize their holdings, favoring extensive agriculture like ranching over more intensive farming methods that could boost productivity. Since they have ready access to cheap labor, these landowners have little incentive to invest in mechanization or technological improvements. At the same time, the concentration of land in their hands prevents small farmers from building capital or making their own investments in agricultural improvements, further limiting overall economic development.
Political effects: The political consequences of concentrated land ownership further entrench underdevelopment. Large landowners routinely leverage their economic power to maintain political influence, using this position to block reforms that would benefit broader economic development. They actively resist investments in public goods like education and infrastructure that might reduce their access to cheap labor or diminish their political control. Through these mechanisms, powerful landowners can effectively prevent the emergence of more inclusive institutions that would threaten their privileged position in society.
During King Zog’s reign, attempts were made at land reform, but they largely failed for two primary reasons: first, the political elite was strongly opposed to land redistribution, and second, the Albanian state lacked the capacity to enforce its will across the entire country. Apart from a brief, unsuccessful revolution, the state was unable to address the land ownership issue, with much of its institutional framework intentionally serving the interests of the large landowning class.
Unsurprisingly, after World War II, the communist regime capitalized on the land reform issue as a central aspect of its agenda, knowing it would garner widespread support. However, the reform was short-lived, and the subsequent collectivization, along with the elimination of private property rights, removed any incentives for economic development and growth. Although state capacity was strengthened, it stifled private investment and innovation, ultimately undermining long-term economic growth. The early communist push for industrialization did succeed in establishing a range of self-sufficient industries, but the reliance on central planning, state control and foreign aid, eventually led to a prolonged period of economic decline. Mehilli’s book is an excellent and extremely detailed chronicle of the early days of Albanian socialism, and an exhaustive account of the early industrialization effort.
The collapse of communism left Albania once again in a state of extreme poverty. Most of its industrial base had been dismantled, and agricultural production remained highly inefficient. The end of communist rule also eradicated what little state capacity remained. Since I’ve mentioned state capacity before, it is useful to define it here. State capacity refers to the ability of the government to enforce its decisions across the entire territory of the republic. This concept is crucial within the institutionalist framework because, without state capacity, meaningful reforms cannot be implemented, and the state struggles to function effectively. Whether in a monarchy or a well-functioning democracy, strong state capacity is essential. The primary distinction lies in how it is used: in an absolute monarchy, state capacity typically serves the interests of a small, wealthy elite, whereas in a democracy, it is (in principle) directed towards the benefit of the broader majority.
In the nineties, Albania became a political entity based on pure clientelism, the use of the state for private and political ends. The state became tentacular in its presence but only as a threatening entity. The ambiguity of property rights became a powerful tool for political manipulation. Where formal property rights were initially weak or nonexistent, political parties established local machines dedicated to the selective enforcement and recognition of land claims. Rather than competing on ideology or broad policy platforms, parties primarily attracted support by promising to protect or formalize the property claims of their constituents among other services offered by the state. Voters, in turn, aligned themselves not with parties that best represented their overall interests, but with those that could most credibly guarantee their tenuous claims to land and property[5]. This created a perverse equilibrium: while parties rhetorically championed property rights reform, they had little actual incentive to establish universal, clearly defined property rights, as doing so would eliminate the very mechanism – selective enforcement and recognition – that secured their voter base. The result is a persistent informality in property rights, where security of tenure depends more on political patronage than on legal frameworks. Thus, the lack of secure property rights was a feature, not a bug, of the system. The state made itself indispensable in resolving contract and property disputes, by promoting an opaque system of property rights and regulations, thus giving itself the final arbitration power that it dispensed as a tool for garnering votes.
Local politicians, unwilling to subsist on the meager wages of an impoverished state, supplemented their income through bribes extracted for services that would be free in a well-functioning bureaucracy. These politicians depended on their national party for protection, requiring them to channel a portion of these illicit gains to party leadership. This patronage network strikingly resembles the Ottoman Empire’s Timar system, perhaps one of the most enduring legacies of Ottoman rule. In this environment, the average citizen does not see the state as a solver of problems but rather as an impediment to be bypassed or coopted for private gain[6]. This institutional arrangement has been persistent because neither the politicians nor the governed have the necessary incentives to change it. For the ordinary citizen, voting for the politician that promises to use the state for your private gain is optimal, and for the politician, maintaining the rules of the game opaque enough to remain the final arbiter of state power is the only way to garner votes.
The institutionalist perspective suggests that Albania has no historical experience with inclusive institutions, either in recent memory or the distant past. Instead, the country has consistently labored under extractive institutions that constrained development while maintaining political power through coercion. An Albania with inclusive, growth-enabling institutions and broad-based prosperity remains untested – our failure to create such a state may stem from this very lack of historical precedent. This institutional void perhaps represents our fundamental weakness, explaining the persistent weakness of our economic growth.
Wrap it up please
Writing about big questions like these is difficult because fitting world history into a particular narrative or model is bound to produce examples where the narrative is lacking. Many researchers have pointed out that AJR’s model has difficulty in explaining the Chinese or East Asian experience of development. Early critiques highlight the role of human capital accumulation as the primary driver of growth, as a competing narrative. Many modern scholars argue that institutions have limited explanatory power. My personal view is that institutions may be necessary for development, but they are not sufficient. Countries that do not seem to produce enough human capital that can compete in a global stage tend to get stuck in the middle income trap, and that when it comes to long term growth, institutions are not a substitute for human capital.
The way I think about institutions, in simple terms, is how the system responds to overreach by an eager and popular executive. AJR use the example of how two leaders, Perón in Argentina and FDR in the US, tried to change the composition of their supreme courts in order to get some legislation passed. In Argentina, when Perón faced opposition from the Supreme Court in 1946, he responded by impeaching four of the five Supreme Court justices through his political allies in Congress. He then replaced them with loyalists, effectively destroying the court’s independence and weakening Argentina’s institutions. In contrast, when FDR faced similar frustration with the Supreme Court blocking his New Deal programs in the 1930s, he proposed his “court-packing” plan to add more justices. However, this plan faced strong opposition, including from within his own Democratic Party, and ultimately failed. The existing institutional framework prevented Roosevelt from undermining the Court’s independence, even though he was an extremely popular president during a crisis period. Having functioning and stable institutions prevents short term thinking from weakening long term stability, and forces the executive to work within firmly established guidelines that prevent large oscillations in public policy that can damage policy making in the long run.
[1] It is possible there is selection bias in the sample of Albanians who move to the US, but, given that a lot of recent immigration is due to the visa lottery, the sample is sufficiently random to give one pause.
[2] For a good overview of the intellectual history of this idea this thread is really comprehensive.
[3] I concentrate heavily on these two as examples of institutions in the AJR mould. This is an oversimplification but a useful illustrative tool for a short piece.
[4] The empirical methodology followed by AJR is not without its detractors. I won’t get into the weeds here, but for those brave enough to want to follow the details, I would start with Albouy and AJR’s responses.
[5] This is only part of the story that fits into the institutionalist understanding of the world. Of course some voters received more direct transfers in terms of jobs and public services.
[6] I have written about this long term consequence of Ottoman rule where the average citizen views the state as predatory a long time ago in this very magazine.
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