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Saturday, May 25, 2013

Why Nations Fail

“The rights of persons, and the rights of property, are the objects, for the protection of which Government was instituted.” — James Madison, Essay on Property, National Gazette, March 29, 1792.

Some countries fail spectacularly, with a total collapse of all state institutions, as in Afghanistan after the Soviet withdrawal and the hanging of President Mohammad Najibullah from a lamppost, or during the decade-long civil war in Sierra Leone, where the government ceased to exist altogether.

Most countries that fall apart, however, do so not with a bang but with a whimper. They fail not in an explosion of war and violence but by being utterly unable to take advantage of their society's huge potential for growth, condemning their citizens to a lifetime of poverty. This type of slow, grinding failure leaves many countries in sub-Saharan Africa, Asia, and Latin America with living standards far, far below those in the West.

What's tragic is that this failure is by design. These states collapse because120613_SOMALIA 2 they are ruled by what we call "extractive" economic institutions, which destroy incentives, discourage innovation, and sap the talent of their citizens by creating a tilted playing field and robbing them of opportunities. These institutions are not in place by mistake but on purpose. They're there for the benefit of elites who gain much from the extraction — whether in the form of valuable minerals, forced labor, or protected monopolies -- at the expense of society. Of course, such elites benefit from rigged political institutions too, wielding their power to tilt the system for their benefit.

States don't fail overnight. The seeds of their destruction are sown deep within their political institutions. States built on exploitation inevitably fail, taking an entire corrupt system down with them and often leading to immense suffering. Each year the Failed States Index charts the tragic stats of state failure. Here are a few major reasons these states fail.

According to Foreign the number one reason nations fail is the lack of property rights:

“North Korea's economic institutions make it almost impossible for people to own property; the state owns everything, including nearly all land and capital. Agriculture is organized via collective farms. People work for the ruling Korean Workers' Party, not themselves, which destroys their incentive to succeed.

North Korea could be much wealthier. In 1998, a U.N. mission found that many of the country's tractors, trucks, and other farm machinery were simply unused or not maintained. Beginning in the 1980s, farmers were allowed to have their own small plots of land and sell what they grew. But even this hasn't created much incentive, given the country's endemic lack of property rights. In 2009, the government introduced a revalued currency and allowed people to convert only 100,000 to 150,000 won of the old currency into the new one (equivalent to about $35 to $40 at the black-market exchange rate). People who had worked and saved up stocks of the old currency found it to be worthless.

Not only has North Korea failed to grow economically -- while South Korea has grown rapidly -- but its people have literally failed to flourish. Trapped in this debilitating cycle, North Koreans are not only much poorer than South Koreans but also as much as 3 inches shorter on average than the neighbors from whom they have been cut off for the last six decades.”

While FP cites North Korea as a prime example of this factor I believe their view is far too narrow. The lack of protected property rights is a malady that affects almost 2 billion people on earth. Most of them live as serfs on the lands of their feudal lords.

Three years ago I posted a blog on “What Separates the Rich from the Poor” that preceded an article for American Surveyor Magazine. In the article I stated:

“Of the 6 billion people on Earth, 2 billion try to survive on a few dollars a day. They don't build businesses, or if they do, they don't expand them. Unlike people in the United States, Europe and Asian countries like Japan, South Korea, Hong Kong, etc., they don't lift themselves out of poverty. Why not? What's the difference between them and us? Is it that we are smarter or better bred? Is it race or genetics? Or is it something else that these people have that the 2 billion poor do not?

When I was working as a contractor for the World Bank in Sri Lanka I was introduced to the writings of Hernando de Soto, a Peruvian economist through his book; The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else.

In 1999 Time magazine chose de Soto as one of the five leading Latin American innovators of the century. Forbes magazine highlighted him as one of 15 innovators "who will re-invent your future." The New York Times Magazine wrote, "To the leaders of poor countries, de Soto's economic gospel is one of the most hopeful things they have heard in years." The Economist magazine identified his Institute for Liberty and Democracy as one of the top two think tanks in the world.

It's become clear by now the fall of the Berlin Wall and the collapse of communism in most places around the globe hasn't ushered in an unequivocal flowering of capitalism in the developing and post-communist world. Western thinkers have blamed this on everything from these countries' lack of sellable assets to their inherently non-entrepreneurial "mindset." In his book de Soto proposes and argues another reason: it's not that poor, post-communist countries don't have the assets to make capitalism flourish. As de Soto points out by way of example, in Egypt, the wealth the poor have accumulated is worth 55 times as much as the sum of all direct foreign investment ever recorded there, including that spent on building the Suez Canal and the Aswan Dam.

The real problem is that such countries have yet to establish and normalize the invisible network of laws that turns assets from "dead" into "liquid" capital. In the West, standardized laws allow us to mortgage a house to raise money for a new venture, permit the worth of a company to be broken up into so many publicly tradable stocks, and make it possible to govern and appraise property with agreed-upon rules that hold across neighborhoods, towns, or regions. This invisible infrastructure of "asset management" — so taken for granted in the West, even though it has only fully existed in the United States for the past 225 years — is the missing ingredient to success with capitalism, insists de Soto. But even though that link is primarily a legal one, he argues that the process of making it a normalized component of a society is more a political or attitude-changing challenge than anything else.

De Soto states that roughly 4 billion people in the world actually build their homes and own their businesses outside the legal system. But due to the lack of rule of law (and) the definition of who owns what, and because they don't have addresses, they can't get credit (for investment loans) nor pass their ownership on to their heirs or assignees."

In 1792 James Madison, considered to be the architect of our Constitution wrote an essay on property for the National Gazette. In that essay Madison wrote:

“This term in its particular application means “that dominion which one man claims and exercises over the external things of the world, in exclusion of every other individual.”

In its larger and juster meaning, it embraces every thing to which a man may attach a value and have a right; and which leaves to every one else the like advantage.

In the former sense, a man’s land, or merchandize, or money is called his property.

In the latter sense, a man has property in his opinions and the free communication of them.

He has a property of peculiar value in his religious opinions, and in the profession and practice dictated by them.

He has a property very dear to him in the safety and liberty of his person.

He has an equal property in the free use of his faculties and free choice of the objects on which to employ them.

In a word, as a man is said to have a right to his property, he may be equally said to have a property in his rights.”

Not only did Madison believe man had unalienable of life and liberty, but in property. Our Declaration of Independence stated this certainty with the words “We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.--That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed…”

The term “Happiness”, in the view of the signers of the Declaration was not the joyful happiness of a child on Christmas morning, but the happiness as defined by John Locke as meaning “property.” As Madison stated:

“Government is instituted to protect property of every sort; as well that which lies in various rights of individuals, as that which the term particularly expresses. This being the end of government, that alone is a just government, which impartially secures to every man, whatever is his.”

“If the United States mean to obtain or deserve the full praise due to wise and just governments, they will equally respect the rights of property, and the property in rights: they will rival the government that most sacredly guards the former; and by repelling its example in violating the latter, will make themselves a pattern to that and all other governments.”

Our Declaration of Independence stated this principle and our Constitution codified it in our organic law. Without eternal laws to protect one’s property rights on nation can prevail.

Forced Labor

Coercion is a surefire way to fail. Yet, until recently, at least in the scope of human history, most economies were based on the coercion of workers — think slavery, serfdom, and other forms of forced labor. In fact, the list of strategies for getting people to do what they don't want to do is as long as the list of societies that relied on them. Forced labor is also responsible for the lack of innovation and technological progress in most of these societies, ranging from ancient Rome to the U.S. South.

Modern Uzbekistan is a perfect example of what that tragic past looked like.120613_KOREA 2 Cotton is among Uzbekistan's biggest exports. In September, as the cotton bolls ripen, the schools empty of children, who are forced to pick the crop. Instead of educators, teachers become labor recruiters. Children are given daily quotas from between 40 to 120 pounds, depending on their age. The main beneficiaries of this system are President Islam Karimov and his cronies, who control the production and sale of the cotton. The losers are not only the 2.7 million children coerced to work under harsh conditions in the cotton fields instead of going to school, but also Uzbek society at large, which has failed to break out of poverty. Its per capita income today is not far from its low level when the Soviet Union collapsed — except for the income of Karimov's family, which, with its dominance of domestic oil and gas exploration, is doing quite well.

The Big Men get Greedy

When elites control an economy, they often use their power to create monopolies and block the entry of new people and firms. This was exactly Par2305856how Egypt worked for three decades under Hosni Mubarak. The government and military owned vast swaths of the economy -- by some estimates, as much as 40 percent. Even when they did "liberalize," they privatized large parts of the economy right into the hands of Mubarak's friends and those of his son Gamal. Big businessmen close to the regime, such as Ahmed Ezz (iron and steel), the Sawiris family (multimedia, beverages, and telecommunications), and Mohamed Nosseir (beverages and telecommunications) received not only protection from the state but also government contracts and large bank loans without needing to put up collateral.

Together, these big businessmen were known as the "whales." Their stranglehold on the economy created fabulous profits for regime insiders, but blocked opportunities for the vast mass of Egyptians to move out of poverty. Meanwhile, the Mubarak family accumulated a vast fortune estimated as high as $70 billion.

Many in the west believed and told us that he “Arab Spring was about democracy. This was a delusion. It was more about the cost of a bag of wheat for the Egyptian family than democracy. Once they got their wheat they voted in the Muslim Brotherhood and Sharia Law.

Elites Block New Technologies

New technologies are extremely disruptive. They sweep aside old business models and make existing skills and organizations obsolete. They redistribute not just income and wealth but also political power. This gives elites a big incentive to try to stop the march of progress. Good for them, but not for society.

Consider what happened in the 19th century, as railways were spreading across Britain and the United States. When a proposal to build a railway was put before Francis I, emperor of Austria, he was still haunted by the specter of the 1789 French Revolution and replied, "No, no, I will have nothing to do with it, lest the revolution might come into the country." The same thing happened in Russia until the 1860s. With new technologies blocked, the tsarist regime was safe, at least for a while. As Britain and the United States grew rapidly, however, Austria and Russia failed to do so. The track tells the tale: In the 1840s, tiny Britain was undergoing a railway mania in which more than 6,000 miles of track were built, while only one railway ran in vast continental Russia. Even this line was not built for the benefit of the Russian people; it ran 17 miles from St. Petersburg to the tsar's imperial residences at Tsarskoe Selo and Pavlovsk.

This was also the case in the United States with electricity. As America began to electrify with Edison’s new light bulbs John D. Rockefeller’s monopoly on kerosene used for oil lamps began to fade. The difference was that Rockefeller’s Standard Oil foresight and saw many other uses for oil, including gasoline. This was due to Rockefeller’s entrepreneurial spirit, vision and his freedom to succeed.

No Law and Order

One must-have for successful economies is an effective centralized state. Without this, there is no hope of providing order, an effective system of laws, mechanisms for resolving disputes, or basic public goods.

Yet large parts of the world today are still dominated by stateless societies. Although countries like Somalia, Afghanistan or the new country of South120613_SOMALIA (2) Sudan do have internationally recognized governments, they exercise little power outside their capitals, and maybe not even there. Both countries have been built atop societies that historically never created a centralized state but were divided into clans or tribes where decisions were made by consensus among adult males. No clan was ever able to dominate or create a set of nationally respected laws or rules. There were no political positions, no administrators, no taxes, no government expenditures, no police, no lawyers — in other words, no government.

This situation persisted during the colonial period in Somalia, when the British were unable even to collect poll taxes, the usual fiscal basis for their African colonies. Since independence in 1960, attempts have been made to create an effective central state, for example, during the dictatorship of Mohamed Siad Barre, but after more than five decades it's fair and even obvious to say they have failed. Call it Somalia's law: Without a central state, there can be no law and order; without law and order, there can be no real economy; and without a real economy, a country is doomed to fail.

Our Founders realized this when the wrote and adopted our Constitution that gave us a form of federalism where they instituted a central government with limited enumerated powers and left the rest to the people and the states. No other nation on this planet has been able to replicate this form of government and probably never will. This is why we are unique and exceptional.

A Weak Central Government

Colombia isn't Somalia. All the same, its central government is unable or unwilling to exert control over probably half the country, which is dominated by left-wing guerrillas, most famously the FARC, and, increasingly, right-wing paramilitaries. The drug lords may be on the run, but the state's absence from much of the country leads not only to lack of public services such as roads and bridges, but also to lack of well-defined, institutionalized property rights.

Thousands of rural Colombians have only informal titles or titles lacking any legal validity. Although this does not stop people from buying and selling land, it undermines their incentives to invest — and the uncertainty often leads to violence. During the 1990s and early 2000s, for example, an estimated 12 million acres of land were expropriated in Colombia, typically at gunpoint. The situation got so bad that in 1997, the central government allowed local authorities to ban land transactions in rural areas. The result? Many parts of Colombia essentially fail to take part in modern economic activities, instead languishing in poverty, not to mention proving to be fertile havens for armed insurgents and paramilitary forces of both the left and right.

Bad or Non-existent Public Services

Calca and nearby Acomayo are two Peruvian provinces. Both are high in the120619_peru mountains, and both are inhabited by the Quechua-speaking descendants of the Incas. Both grow the same crops, yet Acomayo is much poorer, with its inhabitants consuming about one-third less than those in Calca. The people know this. In Acomayo, they ask intrepid foreigners, "Don't you know that the people here are poorer than the people over there in Calca? Why would you ever want to come here?"

Indeed, it is much harder to get to Acomayo from the regional capital of Cusco, the ancient center of the Inca Empire, than it is to get to Calca. The road to Calca is paved, while the one to Acomayo is in terrible disrepair. To get beyond Acomayo you need a horse or a mule — not due to any differences in topography, but because there are no paved roads. In Calca, they sell their corn and beans on the market for money, while in Acomayo they grow the same crops for their own subsistence. Acomayo's people are one-third poorer than Calca's as a result. Infrastructure matters.

Political Exploitation

Bolivia has a long history of extractive institutions dating back to Spanish times — a history that has brewed resentment over the years. In 1952, Bolivians rose up en masse against the traditional elite of land and mine owners. The leaders of this revolution were mostly urbanites excluded from power and patronage under the previous regime. Once they seized power, the revolutionaries expropriated most of the land and the mines and created a political party, the Revolutionary Nationalist Movement (MNR). Inequality fell sharply at first as a result of these land seizures, as well as the MNR's educational reforms. But the MNR set up a one-party state and gradually rescinded the political rights it had extended in 1952. By the late 1960s, inequality was actually higher than it had been before the revolution.

For the great mass of rural Bolivians, one elite had simply replaced another in what German sociologist Robert Michels called the "iron law of oligarchy." Rural people still had insecure property rights and still had to sell their votes for access to land, credit, or work. The main difference was that instead of providing these services to the traditional landowners, they now provided them to the MNR.

Fighting Over the Spoils

Intense extraction breeds instability and failure because, consistent with the iron law of oligarchy, it creates incentives for others to depose the existing elites and take over.

This is exactly what happened in Sierra Leone. Siaka Stevens and his All People's Congress (APC) party ran the country from 1967 until 1985 as their personal fiefdom. Little changed when Stevens stepped aside, passing the baton to his protégé, Joseph Momoh, who just continued the plunder.

The trouble is that this sort of extraction creates deep-seated grievances and invites contests for power from would-be strongmen hoping to get their hands on the loot. In March 1991, Foday Sankoh's Revolutionary United Front, (RUF) with the support and most likely the command of Liberian dictator Charles Taylor, crossed into Sierra Leone and plunged the country into a vicious, decade-long civil war. Sankoh and Taylor were interested in only one thing: power, which they could use, among other things, to steal diamonds, and they could do so because of the regime that Stevens and his APC had created. The country soon descended into chaos, with the civil war taking the lives of about 1 percent of the population and maiming countless others. Sierra Leone's state and institutions totally collapsed. Government revenues went from 15 percent of national income to practically zero by 1991. The state, in other words, didn't so much fail as disappear entirely.

As is evident by these examples the root cause of these failed states if the lack of rights to your property and property in your rights. No matter the amount of foreign aid or technical assistance provided these states they will continue to fail and people will fall ill, starve, and die. They will suffer at the hands of their own governments as the serfs in the middle ages did at the hands of heir feudal lords and masters. Many are no more than tenant farmers seeking out sustenance on land belonging to the rich, powerful, and armed.

No matter what the UN does or how many small arms treaties are signed Ak-47s and RPGs will continue to flow into these countries an fall into the hands of those who want to rule. Tyranny is their goal and the AK-47 is their means.

As long a Mexico, while not a failed state certainly is a failing state. From Villa and Zapata to Juarez and Diaz revolutionaries have promised the Mexican people autonomy of their property rights. Yet none delivered when they reached the Zócalo in Mexico City. As long the iron law of oligarchy and the drug cartels rule Mexico PEMEX’s oil revenues will never trickle down to the peasants who occupy the lands. This will force the continuation of the migration of unskilled and uneducated to cross our southern border looking for prosperity and the benefits of our social welfare system. Without secure property rights this will never change.

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