The Colonial Legacy of ARJ’s Institutional Economics | Ajay Kumar Mishra

Abstract

Institutions establish the rules of the game and shape the man-made constraints that help reduce uncertainty. However, social structures play a crucial role in shaping these institutions and how they operate. Institutions that are socially structured have a better chance of surviving and maintaining their momentum. Whether an institution is inclusive or extractive depends on its ability to reflect social realities.

Key Words: Colonial, Institutionalism, Social Structure, Hegemony, Inequality.

Introduction

This year’s Nobel Prize in Economics was awarded to Daron Acemoglu, James A. Robinson, and Simon Johnson (henceforth ARJ) for their study on the long-term impact of various political and economic systems, especially those established during colonial times, on a nation’s wealth. The researchers argue that the reasons for economic prosperity, or the lack thereof, leading to the current global wealth disparities, are not commonly cited factors such as geography, climate, culture, religion, race, or the ignorance of political leaders. Instead, they emphasize our man-made political and economic institutions. However, their work has overlooked the role of social determinism, which posits that society and its historical state guide and shape an individual’s opinions and decisions, influencing institutions. Additionally, it omits the potential influence of geography, climate, culture, religion, race, or political leaders.

Institutions serve as the ’rules of the game,’ acting as humanly devised constraints that shape human interaction. They function to diminish uncertainty by offering a structured framework to daily life. [1] Institutions comprise a set of rules, including explicit laws and implicit social norms such as culture, religion, race, and caste, which dictate human interactions within society. Therefore, structural reforms are vital for economies striving to improve living standards. Such reforms should define the individual’s standpoint concerning the influence of institutional authority. A clear distinction between the analysis of fundamental rules and the strategies of the participants is essential for developing a comprehensive theory of institutions. [2] In the 1970s, new institutional economics emerged as an evolution of neoclassical economics, focusing on the significance of property rights and transaction costs. It attributed the shortcomings of free market reforms in the global South to flawed institutional frameworks that fail to foster growth adequately.

ARJ’s theory contrasts two archetypes: "extractive" and "inclusive" political and economic institutions, which mutually reinforce each other. It posits that citizens can benefit from secure property rights, access to an independent judiciary, and the freedom to develop personal skills, as pluralistic political institutions level the playing field. This environment fosters technological innovation and economic growth, with political freedom paving the way to prosperity. Conversely, extractive institutions are detrimental to growth. Indeed, a nation’s prosperity may hinge on a complex array of factors, many immeasurable or overlooked. In some regions, inclusive institutions were often supported by extractive ones. This was done through racialization, the dismantling of artisan economies, and the establishment of extractive mining and plantation economies in other areas.

For example, following the implementation of Deng Xiaoping’s opening-up policy in 1978, political institutions have played a role in China’s economic transformation, leading to a shift towards state capitalism rather than the market capitalism advocated by new institutional economics. This shift has resulted in the rise of a party state to address the three crises of belief, in contrast to liberal institutions. Indeed, China’s state capitalism has emerged as an alternative to liberal market capitalism. Furthermore, the role of individuals in managing institutions is crucial, as Dr. Ambedkar aptly noted that a constitution is merely a collection of papers without proper enforcement. Constitutional morality is not innate; it must be fostered. We must acknowledge that our people still need to learn it. Democracy in India is merely a superficial layer over a fundamentally undemocratic Indian substrate. [3] The dissatisfaction with parliamentary democracy stems from the recognition that it has not guaranteed the masses their rights to liberty, property, or the pursuit of happiness [4]. Political democracy cannot thrive without the support of social and economic democracies. Furthermore, a democracy that is propelled by short-term populist policies can become as "extractive" as an autocracy catering to a narrow elite aligned with those in power.

Individual entrepreneurs, as agents of change, respond to the incentives within the institutional framework. However, the institutional norms of equality, liberty, and justice are not fully established in society. This leads to a conflict of values where dominant vested interests often influence and steer the rules to their advantage. For example, the widespread neoclassical institutionalism promotes rationality in the spirit of a free market, which allocates rewards and punishments based on marginalistic principles and endorses the institution of unfettered individual property rights.

This non- western recognition of development requirements expose the Euro- centric racist narrative of underdevelopment: Why are developing countries not able to develop, even after decades of efforts to strengthen institutions as per the Eurocentric standard? Because their private property rights and other capitalist institutions are still not strong enough. This narrative suggests that there is something intrinsically good about Western capitalist institutions and intrinsically bad about non-capitalist institutions. [5] This essay explores how we can ascertain whether causality flows from the existence of colonial institutions to economic prosperity, or vice versa. Furthermore, it questions the certainty of any causality existing. It also considers whether the differentiated impact of neoclassical institutions necessitates the presence of supportive social determinants.

The legacy of colonialism significantly influences today’s institutional economics framework. Grasping this influence is vital, as the practices of colonialism have shaped the efficiency of economic institutions in various societies. Through examining this interplay, we can uncover important perspectives on current economic difficulties and potential reforms, aiming for fairer results in post-colonial settings.

New Institutional Colonial Trap

Institution encapsulates a pressing challenge crucial to recognize and address to foster equity and justice in our society. Institutional Economics, with its broad and idealistic recommendations like the rule of law, private property, democracy, and political institutions, often leads to an enforced institutional authoritarianism within capitalism. The truly alarming aspect of authoritarianism is not that it perpetrates ’atrocities,’ but that it undermines the notion of objective truth; it asserts dominion over both the past and the future. [6] The assault on truth and language enables the perpetration of atrocities. When truth is the first casualty, committing atrocities becomes simpler. As people are coerced into silence, compliance, and deceit, it paves the way for authoritarian institutions to distort social realities. AJR’s analysis of European colonization across the globe revealed that "in certain colonies, the objective was to exploit the native inhabitants and extract resources for the colonizers’ gain," whereas in others, “the colonizers established inclusive political and economic structures that served the long-term interests of European settlers”. [7] It exalts the Eurocentric view of private property and the rule of law, while simultaneously absolving colonial powers of blame and responsibility for colonial exploitation. Furthermore, neo-classical institutionalism reinforces the separation between democracies within the polity and competitive markets in the economy to guarantee the efficiency of property rights. This leads to economic inequality despite political equality. However, the institutional entrapment of the free market fails to acknowledge this dichotomy.

It rationalizes and legitimizes the colonial order while overlooking the impact of social determinants on the nature of institutions. Douglas North (1991) contends that new institutional economists attribute the lack of free market reforms in the global South to flawed institutional arrangements that fail to promote growth. This Eurocentric perspective aims to transplant temperate plants into tropical soil. The neoclassical focus on private property has led to primitive accumulation as a means of wealth maximization. Indeed, the concept of inclusive institutions has served as a catalyst for the development of extractive institutions. Furthermore, much of human economic history is characterized by unequal bargaining power, with some maximizing their well-being at the expense of others.

The Euro-centric institutional matrix has shown vulnerability to informal constraints arising from the challenges in culturally transforming values, extending, and applying formal rules to straightforwardly coordinate specific problem-solving. This has led to the development of core-periphery and dependency theories, which suggest the existence of peripheral alternatives. Concurrently, Euro-centric rational choice and efficient market hypotheses have dismissed the effects of incomplete information and the complexity of human reasoning, ideas, and ideologies, which shape subjective opinions. The poverty in the non-Western world is attributed to its unique institutional constraints that define a set of payoffs for political and economic activities, which do not promote productive endeavors. Economies require enthusing institutional incentives suitable to socio- cultural realities.

These facts challenge the viability of the Coase theorem, which posits an efficient solution that yields the highest aggregate income in the absence of transaction costs. This leads to the development of various degrees of efficient institutional frameworks aimed at reducing transaction costs. Consequently, the question arises as to why global economies exhibit similar growth patterns and characteristics. The explanation is found in the trade-related product cycle theory and the concept of increasing returns to scale. The former suggests that advanced technology diffuses to less advanced economies via trade, while the latter implies that ’winners take all’, fostering monopolies. Arthur [8] has delineated four self-reinforcing mechanisms that contribute to the widening of disparities: (i) significant fixed costs, which result in decreasing unit costs as production scales; (ii) learning effects, which enhance product quality or diminish costs as adoption becomes more widespread; (iii) coordination effects, which generate advantages in collaboration among similar economic entities; and (iv) adaptive expectations, which pertain to the principles that shape the evolution of an economy.

These mechanisms are governed by four fundamental principles: (i) multiple equilibria, where various potential outcomes exist, rendering the final result uncertain; (ii) potential inefficiencies, whereby a superior option may not be realized; (iii) lock-in, which manifests when a particular solution becomes entrenched, making change challenging; and (iv) path dependence, that leads one to a particular path.

The Impact of Hierarchical Institutions on Public Opinion

Hierarchical institutions significantly shape public opinion by establishing authority, guiding discourse, and influencing perceptions. Their structured nature allows them to disseminate information and values effectively, ultimately steering societal beliefs and attitudes. Understanding this influence is crucial for engaging with the broader social landscape. Neoclassical institutions uphold universal values essential for achieving allocative efficiency in the Paretian sense, where one party cannot improve their position without worsening another’s. Conversely, adaptive efficiency focuses on the types of rules that govern the evolution of an economy over time [9]. Adaptive efficiency allows for significant experimentation. Institutional rationality, known as developmentality, and Paretian allocation efficiency are presumed to surpass the adaptive efficiency determined by social factors. [10] Recent neoclassical models of growth, which focus on increasing returns and the accumulation of physical and human capital, hinge critically on the presence of an implicit incentive structure. Baumol’s research indicates convergence solely among 16 advanced economies that share roughly similar incentive structures, but not among centrally planned economies or less developed countries, which have distinctly different incentive structures. [11] The argument suggests that an ontological institutional structure will give rise to theories of imperialism, dependency, or core/periphery, which in turn lead to exploitation and/or uneven patterns of growth and income distribution.

China and India are notable exceptions, each challenging the prevailing thesis in contrasting manners. India’s economic underdevelopment is surprising given its robust political institutions, while China’s wealth is unexpected in the absence of democratic institutions. [12] Colonialism plays a role in sustaining certain institutions in areas where colonizers could not settle, leading to a reversal of fortunes for the colonies. This is the essence of ARJ’s paper on colonialism and comparative development. It rationalizes the ethics and practices of the colonial empire at the expense of the colonies’ own ethics and practices. Furthermore, it associates the development of colonies with modernity, thereby monopolizing the discourse on modernity by promoting a Euro-centric view. A clever method to maintain a passive and obedient populace is to narrowly define the spectrum of acceptable opinion, yet permit lively debate within that spectrum — even fostering more critical and dissenting views. This creates the illusion of free thought, while the underlying assumptions of the system are continually reinforced by the constraints placed on the scope of the debate. [13]

The economic influence stemming from social privileges frequently remains unrecognized in the rationalist utilitarian discussions of capitalism. In societies burdened with privilege or those resembling feudal systems, not only are economic rights but also political and social rights withheld from everyone except a select few from elite circles. [14] Economic power can lead to manipulation, fostering a false consciousness that supports capitalist dominance and its trickle-down effects. This situation promotes a flawed sense of superiority within the dominant ideology and beliefs, which suppresses natural dissent in social, political, cultural, and economic spheres. As a result, dominant ideology frequently overrides socio-economic reasoning.

Karl Popper emphasizes the robust foundation of democratic institutions as a means to empower the populace, while not overlooking the influence of vested interests in the short term. In contrast, Herbert Marcuse recognizes the challenges in changing established class consciousness. [15] Thomas Piketty astutely observes that inequality is not rooted in economics or technology, but rather in ideology and politics [16]. Today’s inequality in India is more severe than it was during the inter-war period of British colonial rule, despite India’s adoption of a market economy since the 1990s. Income and wealth disparities in India started to escalate sharply from the 1980s as the country gradually embraced market reforms. For instance, the income share of the bottom 50% in total national income fell from 23.6% in 1982 to 15% in 2022, while the top 10%’s share increased from 30.1% to 57.7% in the same timeframe. Additionally, India’s economic growth was lackluster during the socialist years and only began to accelerate post-1990. Piketty and his colleagues have noted that India’s economy expanded at a dismal rate of 1.6% per year from 1960 to 1990, but grew at a much more robust rate of 3.6% per year from 1990 to 2022. [17] The emergence of illiberal democracies and protectionist economic policies in recent times indicates that liberal institutions have not succeeded in improving people’s living standards or bridging the gap between the feasibility and desirability of new institutional economics.

A privilege of power is the capacity to craft history with the assurance of facing minimal opposition. [18] The proletariat’s acceptance of their exploitation must be "engineered" by powerful groups in society through the creation of a "false consciousness" that upholds the dominance of capitalism, involving both the state and corporate media. Communities at the higher levels of the social hierarchy tailor morality to serve their interests and reflect their social standing. In this context, morality is a construct meant to serve those with social and economic power. When this constructed morality is imposed on those lacking such resources, it becomes a benchmark for being considered morally virtuous. [19]

Conclusion

The institution must adapt to the specific social realities to become both feasible and desirable. A single remedy cannot address all issues. The unrepresentative nature of neoclassical institutions renders them an irrelevant imposition, while also rejecting the emergence of alternative institutions. These institutions are largely Euro-centric and fail to represent the social realities of the non-Western world. The diverse social realities in non-Western contexts necessitate the establishment of different types of institutions. However, AJR’s institutional recommendations appear to follow a colonial approach, imposing systems based on narrowly defined norms such as transaction costs and property rights to distinguish between inclusive and extractive institutions. 

This essay explores whether causality flows from the existence of colonial institutions to economic prosperity, rather than the reverse. It finds a two-way causality, although this does not apply universally. The success of colonial institutions depends on a unique set of assumptions that enable their existence. Moreover, there is evidence that economic prosperity can lead to the establishment of colonial institutions. For example, inclusive institutions in many high-income Western economies developed after achieving economic growth, while China has experienced significant economic prosperity despite having "extractive" institutions. A certain level of economic prosperity is vital for the success of colonial institutions. Additionally, colonial exploitation serves as a precondition for the ongoing survival of these institutions.

Furthermore, the efficacy of neoclassical institutions depends on supportive social factors, which can be enforced through coercion or persuasion. The coexistence of political equality and economic inequality implies that large firms with substantial fixed capital require government support in the form of subsidies, tariffs, and incentives—an arrangement that hardly indicates productive efficiency.

There is a crucial lesson for India: it must shed the colonial legacy of the discredited trickle-down theory. In light of increasing inequality, this year’s Nobel Prize in Economics emphasizes the need for India to decolonize its economic structure rooted in extractive principles and to develop a "Delhi Consensus" that reflects its realities and those of the wider world.

(Author: Ajay Kumar Mishra teaches Economics at Lalit Narayan Mithila University, Darbhanga, India. He has earned a PhD from the Centre for South Asian Studies, JNU, New Delhi, India. )