The role of institutions in driving economic prosperity

Today, in an era of globalization where technology, information and people flow across countries more than ever before, the gap between rich and poor countries persists. So what causes and perpetuates this gap?

Institutions — the fundamental structures that determine how societies organize themselves — determine the rules that govern who gets what and on what terms. Whether those institutions are inclusive or exclusive is at the core of why some countries grow rich and others stay poor.

Nobel Laureates Daron Acemoglu and James A. Robinson have spent their academic careers researching the impact of institutions. In 2024, the two were awarded the Sveriges Riksbank Prize in Economic Sciences for their groundbreaking work on how inclusive and extractive institutions shape national prosperity.

“Inclusive institutions offer people both incentives and opportunities. They empower broad participation, reward innovation, and adapt to change. Extractive institutions do the opposite,” says Acemoglu. “They hoard power, suppress initiative, and lock out dissent, even if it comes at the direct expense of prosperity.”

“If you look at the Korean peninsula at night, you see South Korea blazing with light and North Korea black,” says Robinson. “It’s not because they don’t know about light bulbs in North Korea. It’s because the place is extremely poor, people don’t have access to electricity, and you have this highly extractive society.”

What are the barriers to inclusive institutions, and why aren't they more common?

Some are purely economic. In a situation where there is a monopoly, introducing competition can be seen as a threat. Some of it is more political, however. A dictator might resist new technology even if it promises to bring economic growth, because that same technology could erode their power.

The core reason inclusive institutions are uncommon comes down to who has power. “Power is rarely relinquished willingly. Certain nations and their leaders would rather preside over scarcity than risk opening the door to potentially destabilizing creativity. Growth under extractive systems is often short-lived,” ex;lains Acemoglu.

Robinson says it can also be down to how societies have chosen to organize themselves, based on ethical, ontological or even religious beliefs. Land ownership in parts of Africa, for example, isn’t always valued in terms of monetary potential but rather in terms of ancestral patrimony. This can have a significant impact on how, when and why people may sell or buy land. In turn, this is likely to influence the role that institutions play in that particular facet of society.

Unfortunately, these ideational foundations and the concept of the collective imagination have long been overlooked in efforts to understand how institutions evolve and endure. These same ideas and cultural foundations that may influence the sale of land in Africa are also enormously important for getting support in institutions: “People have to believe in them,” Robinson says. “People have to come together.”

What creates institutional change?

Institutional change can happen at a glacial speed, or it can happen very suddenly. A sudden shock often triggers rapid change. Demographic changes, new economic opportunities, wars, and, at times, new technologies that spread very fast (like the printing press) are just a couple of examples of shocks.

“They destabilize existing orders and create a mismatch between existing institutions and people's aspirations,” says Acemoglu. “Industrialization, for example, was such a critical juncture because new industrial technologies were met with very different types of approaches across different countries that were not so different,” he says. “France embraced them. Russia resisted; they thought they would destabilize the existing order.”

The role of technology and institutions

Today, we face an avalanche of new technology with the type of impact potentially rivalling that of the Industrial Revolution. How institutions and technology work together, and how that innovation is harnessed, will be the key to economies thriving — or not.

“Technologies work much better for society when they create new opportunities for people, new capabilities for workers, new tasks, new products and new services”, says Acemoglu. Automation could bring great economic benefit, but the opposite could also be true, he says.

Indeed, Nobel Laureates have some key advice when it comes to dealing with automation, including nurturing soft skills such as maintaining flexibility, good and effective communication and a sense of adventure and optimism in the face of all the change.

In 2025, Economist Joel Mokyr was recognized for his work on innovation-driven growth. Mokyr argued that there were conditions necessary for innovation to take root and flourish, including the importance of a society that is open to new ideas and permits change.

What questions do we need to ask to create inclusive institutions?

There are ways for society to keep its own checks and balances on power. The key is to ask the right questions. This is especially important today as AI and other shifts usher the world into a new age of unknowns.

Institutions should be updated as technology advances because once they fall behind, it can be very difficult to catch back up. “Are we updating our institutions the right way? Are institutions creating countervailing powers to those who are shepherding technology, who have an oversized effect on the direction of technology? And are we choosing the right direction of technology?” lists Acemoglu.

“If in doubt, I think we have to err on the side of letting the market work, because we have many examples of historical societies that have tried to control technology, as a result, they did become barriers against technological developments and led to mass-scale underdevelopment,” he adds.