Institutions' Explanation of the Wealth and Poverty of Nations

Institutions are the foundations of some of the most successful civilisations in history. We will examine whether the institutions of the Western world were the contributing factor as to why those nations grew so rich and powerful.

In Guns, Germs and Steel; Jared Diamond argues that geographical endowment was an important factor in explaining the Great Divergence. He states that advanced cultures existed outside of Europe but they were isolated so social and technological stagnation persisted. However, by testing this hypothesis with controls on institutions, no significant evidence was found that germs, crops or tropics directly affects income other than through institutions (Easterly & Levine, 2003). The institution view states that the impact of the environment on economic development is through long-standing institutions. Environments where large plantations effectively produce crops will quickly develop political institutions to benefit the landowners to the detriment of the peasant population through legal protection. As crop production recedes, these institutions endure which further benefits the landowners. (Engerman and Sokoloff, 1997; Sokoloff and Engerman, 2000).

Furthermore, the institutions differed per their environment; colonies that experienced more inhospitable climates and disease established extractive institutions so few colonists could extract the natural resources. In more hospitable climates, similar to those of Western Europe, settler institutions were founded. These institutions remained after the European empires collapsed. A strong effect on income per capita when using percent speaking European and English languages as instruments for institutional variables was found by Kauffman et al. 1999. The findings of Easterly & Levine, 2003 and Kauffman et al. 1999 are consistent with the institution view. The descendants of the first settlers to the North American continent were among the most wealthy in the world by the beginning of the American Revolution. The settler institutions that were founded in the 16th and 17th Centuries led to a wealthy population (Whaples, 1995).

Many smaller states tussled for supremacy on the European continent. David Landes highlights this point in The Wealth and Poverty of Nations, Europe’s fractured political environment was very different from that of China and the Islamic Caliphate where large centres of population were under the constraint of one ruler. The political fragmentation provided the competition between these states. These political institutions had to correct their mistakes quickly to maintain their influence; as shown by the leapfrogging development of empires; Spain was succeeded by France and then by the United Kingdom. The rise of the semi-autonomous city, or ‘commune’, was a very European institution. At the core of the commune were it’s economic functions, ‘governments of the merchants, by the merchants, and for the merchants’.

Also important were the political rights of the residents, these rights allowed the population to conduct business freely. Urban Europe gave rise to a culture that valued novelty and property rights. The east had restrictive policies to trade that went against liberty and did not encourage a free market (Cohen, 1993). This was very different from Europe, where commercial laws and property rights developed to protect the marketplace. In particular, the Chinese state would regularly interfere with the market and stifle innovation (Landes, 2006). The argument that a representative government benefited the population is also applicable here, absolutist governments are detrimental to the development of nations. Rulers that are not held accountable for their policies are bad for property rights and suffocate innovation as seen in China during the 18th Century. Representative governments can be accountable to a greater proportion of the population and thus had to protect property rights, which caused economic prosperity. (Allen, 2011)

Economic prosperity increased greatly in the West from the start of the 19th Century as technological efficiency was improved. Evidence of this was the creation of conveniences that saved time, such as the steam engine, railroads, steam boats and using coal for fuel. These labour saving technologies contributed to the rise in wealth of nations such as the United States and Europe. (Clark & Feenstra, 2003). Developing an efficient and cheaper transport system was an important condition to the Industrial Revolution. In 19th century Egypt steam power was used for manufacturing but, unlike in Western Europe, it was not fully embraced to save the cost of labour. Coal cost roughly the same in Egypt as it did in Champagne or Alsace, both areas with vast coal deposits. The necessary conditions were present for Egypt to rapidly industrialise as well as the conditions to adopt oil as an energy source for the steam engine (Batou 1991). The availability of coal differed from West to East, coal deposits in Europe were saturated with groundwater and it was only possible to extract coal from these deep deposits once the Newcomen steam engine was introduced.

In China, coal deposits were much more accessible. Yet it was in Western Europe that the burning of coal for energy revolutionized production and transport. Embracing technological innovation as institutions played a role in the European nations growing more wealthy through the 19th Century. The attitude towards innovation may have had a big role in the West's advancements compared to the East. The East concerned itself more with experience while the West favoured innovation that led to new and different ways to improve on existing inventions (Lin 1995). For example, China had made use of waterwheels longer, but Europeans took the technology further.

Islamic law could be an argument for the divergence of the Muslim world. Islamic institutions prevented technological advancement by hampering capital accumulation and the formation of corporations. The islamic culture was critical of mass production and impersonal transactions, stifling entrepreneurship. A strong sense of communalism in the Islamic world limited contact with other nations and few institutions developed. (Kuran, 2010). A cultural chasm opened up within Europe after the Protestant Reformation in the early 1500s, tilting Europe’s commercial, scientific, and technological center of gravity away from Catholic strongholds in the south and east and toward Protestant territories in the north and west.

In 1905, the German sociologist and economist Max Weber published a highly influential thesis about the Protestant Ethic and the Spirit of Capitalism, arguing that it was the prevalence of Protestantism in Northern Europe that encouraged a historically exceptional work ethic, secular engagement, and industrial enterprise among the Dutch, French, and especially the English, sowing the seeds of the Industrial Revolution and the rise of modern capitalism itself. In contrast to the Islamic view of capitalist institutions, the protestant work ethic that evolved in Europe influenced large numbers of people to engage in work and to embrace a more secular mindset. The development of institutions and enterprises was encouraged as well as the accumulation of wealth for investing and free trade.

The British weren’t smarter than the Chinese, the Muslims, the Portuguese, or the Spanish. They were just more motivated, and more open to good ideas wherever they might come from. James Watt’s steam engine of 1775 drew on an exceptionally cosmopolitan heritage of scientific inquiry into the nature of vacuums and air pressure that stretched from the work of Otto von Guericke in Germany and Evangelista Torricelli in Italy to Robert Boyle in England and Denis Papin in France, and his ability to patent and personally profit from his invention within the legal framework of Britain was unparalleled. Personal success among the English was prestigious, a cause for admiration, not scorn as in so many other countries.

The contrast with China and the Muslim world that Landes lays out in The Wealth and Poverty of Nations is striking. Even during the so-called golden age of Islam between the 700s and 1300s, when Arabic philosophy and commerce thrived, Landes argues that the threat of religious denouncement remained universal, which stifled innovation and left medieval Muslim scientists more hesitant than their European counterparts to apply their insights, however impressive, to the development of new technology.

Chen (2012) similarly claims that cultural characteristics were a contributing factor of the divergence, arguing that the Enlightenment enabled a mercantile, innovative, individualistic, and capitalistic spirit. In Ming Dynasty China, he claims there existed coercive measures that suppress dissenting opinions and nonconformity. He argued that Confucianism instilled in the chinese people that disobedience to one's superiors was equitable to 'sin'. Furthermore, Chen argued that merchants had less prestige than they did in Western Europe. In addition to this, the imperial examination system incentivised Chinese intellectuals not to learn mathematics or experiment as the European intellectuals did.

In 1660, The Royal Society, the world’s first national scientific institution, was founded to help rationally steward England’s Restoration. The new parliamentary government would rely heavily on its guidance. One of the most conspicuous ways that the Royal Society sought to deploy scientific progress was through technology that would deliver tangible economic gains. “Great emphasis was placed on technological improvements, on mechanical devices intended for industry and agriculture, and on learning from artisans.” (Jacobs, 1997). In 1698, the English inventor Thomas Savery designed the world’s first steam-powered water pump, which worked but proved impractical; in 1712 Thomas Newcomen used Newtonian mechanics and the science of vacuums to invent the first steam powered pump that worked well enough for mine owners to actually buy. Then in 1776, James Watt was ready to install his first, dramatically more efficient steam engines throughout the mines of Cornwall, England. By then, Britain’s Industrial Revolution was getting fully underway.

Economic historians point to high wages in Britain that led to the innovation and creation of labour saving technologies. Parts of 18th Century Europe had higher wages than most of India, China, the Middle East and Japan. Labourers in Beijing and Delhi could only purchase a basket of goods at a subsistence level, compare this to a Labourer in London or Amsterdam who could purchase four to six times the subsistence level. (Allen, 2011). Outside of Europe, population growth led to productivity stagnating as rural areas could not support the population. However, as farming and agriculture became more industrialized in Europe, it was possible for fewer people to produce more food to be sold in market towns.

A growing urban population that worked in factories led to farmers becoming more wealthy as labour saving technology improved. The consumption of luxuries in Europe was a condition for growing cities, as workshops that produced commodities for the wealthy gradually amassed capital to increase their production capacity to serve more consumers and they emerged as large firms in a mass market. Europe’s taste for luxury was unique from the East and helped stimulate the growth of capitalism (Pomeranz, 2000).

Institutions have shaped the development of the modern world for centuries. The institutions that have led to the Western World being incredibly wealthy while other parts of the world are only now experiencing the economic growth comparable to these European nations some 200 years ago. From the culture of productivity and the protestant work ethic, defined by Weber, to the nature of the institutions that were dictated by the environment of the newly discovered world. The difference in attitudes towards scientific development and the willingness to embrace capitalist institutions played a huge role in shaping the Wealth and Poverty of Nations today.