Inequality, Incentives, and Industrialization: Why Countries are Rich and Poor
Why are some countries so much more prosperous than others?
It’s arguably the central question at the heart of any attempt to make sense of the world as it is today. For a little context, a 2011 UNICEF paper found that the top 20% of the world’s population held 70% of the wealth. By contrast, the bottom 20% held only 2% of the wealth.
Of course, it’s not as if this inequality is distributed evenly across the world. There’s a pattern to global inequality that is probably familiar to most of us: developed nations include the United States and Canada in North America, the Western European nations, Australia and New Zealand, Japan, arguably South Korea and Singapore; developing nations include pretty much the rest of the world.
There are all kinds of reasons why this question matters, from the practical — ways to combat global poverty, for example — to the purely academic, i.e. how to make sense of it. Speaking as both a fantasy writer and an enthusiast of world history, I have an intellectual interest in this question, but I also think it speaks powerfully to principles of world-building societies.
The first thing that we need to understand about this question, though, is the nature of the thing to be explained here. There are some popular misconceptions about development, and the reasons some countries are rich and others poor. If you’ve ever talked to people about this, you’ve probably heard people talking about global inequality in terms of natural resources, or historical legacies of colonial exploitation, etc.
Development, however, is not the default condition for human societies. There’s an island in the Indian Ocean, North Sentinel Island, entirely inhabited by uncontacted hunter-gatherers. For these people, the Paleolithic, the so-called “Old Stone Age”, never ended. They live much as their ancestors have for tens of thousands of years (at least).
We need to understand, then, that we’re not simply comparing different countries around the world: we are also comparing the pasts of those respective countries with their respective present circumstances.
The interesting thing, though, is that we’re not necessarily talking about large time scales. Most of the progress in the Western world has occurred within the last two hundred years, and most of the period before that was characterized by general economic stagnation. What made the difference was a little thing called the Industrial Revolution.
How much of a difference? Well, take a look at this excerpt from William Rosen’s book The Most Powerful Idea in the World:
“A skilled fourth-century weaver in the city of Constantinople might earn enough by working three hours to purchase a pound of bread; by 1800, it would cost a weaver in Nottingham at least two. But by 1900, it took less than fifteen minutes to earn enough to buy the loaf; and by 2000, five minutes.”
All countries were relatively poor, by our modern (Western) standards, before the Industrial Revolution. The world of, say, 1500 had many relatively civilized countries from Western Europe to China, and, to a lesser degree, in certain parts of sub-Saharan Africa and the Americas. Some were richer than others, but the disparities in national incomes were not remotely what they have become since the West innovated the economic “perpetual motion” machine of exponential, end-over-end growth in the Industrial Revolution.
Despite the aforementioned global disparities, the benefits of development have not remained confined to the Western world. As Matt Ridley explains in The Rational Optimist:
“Taking a shorter perspective, in 2005, compared with 1955, the average human being on Planet Earth earned nearly three times as much money (corrected for inflation), ate one-third more calories of food, buried one-third as many of her children and could expect to live one-third longer.”
So what changed? Why did the Industrial Revolution occur where it did, when it did?
As Acemoglu and Robinson explain in their excellent book Why Nations Fail, institutions are the key. Industrialization and the prosperity it brings is dependent upon the existence of a very particular set of institutional and sociopolitical circumstances. Some institutions are superior to others as guarantors of personal and property rights, and it is these rights that are crucial for making sense of industrialization.
The reason industrialization started in the 18th-century United Kingdom as opposed to, for example, contemporary Russia, had everything to do with the United Kingdom’s relatively advanced institutions for the time. In particular, the UK had robust protections for innovation in the form of important reforms to patent law.
The significance of patent law to industrialization is rather profound: it protected the rights of inventors to have exclusive use of their ideas for a limited period of time. This gave inventors an incentive to invent, because they had reason to think they might profit. The incentives were important, too, because as William Rosen explains in The Most Powerful Idea in the World, invention often took many years of hard, thankless labor.
Other factors were important too. The fundamental reason industrialization started in England was that in addition to the incentives provided by patent law, fruitful partnerships were established between the tinkerers, clever men from the working classes who knew how to make things — and who were often the main inventors — and wealthy men from the aristocracy, who could fund ventures with the expectation of profit. Another factor, too, was that the social gulf between the aristocracy and the working classes was much greater in France than it was in the United Kingdom.
By way of comparison and contrast, France had many of the same essential features as the United Kingdom, but with a few important institutional differences. The French crown’s approach to patents was to grant inventors pensions for whatever ideas the crown deemed to be of possible merit. This model incentivized inventors to come up with ideas, but its dependence on royal support made it inherently more limited than the British model.
In the French system, the king picked the ideas he thought might be worthwhile, paid their inventors, and that was that — sometimes the innovation was adopted, sometimes it wasn’t. In the British system, many different financiers picked the ideas they thought could be profitable, and then the market decided which ones were actually worthwhile.
Still, once industrialization began to take off, many other Western European nations, including France, the Netherlands, much of Germany, and what became Belgium were swift to follow. Russia, however, lagged behind, thanks to its relatively backwards institutions, including serfdom and a prebendal-type aristocracy under an autocrat.
Institutions, then, are fundamental determinants of the wealth and poverty of nations. They’re by no means the only determinants, but they are some of the most important. Seeing institutions, and the incentives they create, is crucial to any understanding of global inequality.
Of course, we’ve barely scratched the surface here: there’s a wealth of material on this subject, far more than I can do justice to in this post. I’ll try to unpack more of it in later blog posts, and perhaps get into some of the non-institutional reasons for global inequalities. Check out the great and potentially life-changing books below for more information:
Acemoglu, D., & Robinson, J. A. (2012). Why nations fail: The origins of power, prosperity, and poverty. New York: Crown Publishers.
Ridley, M. (2010). The rational optimist. New York: HarperCollins.
Rosen, W. (2010). The most powerful idea in the world: A story of steam, industry, and innovation. New York: Random House.