We live in a world where some countries enjoy a material abundance beyond the wildest dreams of our forefathers. Such countries are rich because they are productive. The sources of that productivity–growing markets, technological improvement, and investment in human beings (human capital)–all play an important part in increasing productivity. The new growth economics literature has formalized some of these findings, but economic historians, development economists, and specialists in growth accounting have broadly understood them for some time.
By any standard of measurement much of the world's population is still poor, with individuals subsisting on less than two dollars a day. The disparity between the well-being of the average person in the developed world, where per capita annual income may exceed $20,000, and that in low-income countries such as Haiti or most of sub-Saharan Africa, where it may be under $500 a year, is striking, especially when one sees up close the living conditions associated with such poverty.
How do we account for the persistence of poverty in the midst of plenty? If we know the sources of plenty, why don't poor countries simply adopt policies that make for plenty? The answer is straightforward. We just don't know how to get there. We must create incentives for people to invest in more efficient technology, increase their skills, and organize efficient markets. Such incentives are embodied in institutions. Thus we must understand the nature of institutions and how they evolve.
Institutions are the framework that humans create to structure human interaction. They are made up of formal rules (constitutions, laws, and regulations) and informal constraints (conventions and norms of behavior) and the way both are enforced. Well-specified property rights that reward productive and creative activity, a legal system that enforces such laws at low cost, and internal codes of conduct that are complementary to such formal rules are the essential underpinning to productive economies. But well-specified property rights and an effective legal system are the creation of the political structure. Unfortunately, we do not know how to put such a political structure in place. Informal norms of behavior that make for honesty, integrity, and hard work are the product of long-term human interaction; we do not know how to create them in the short run. The result has been that efforts to improve the performance of poor countries have been something less than a rousing success. Sub-Saharan Africa remains a basket case, and our efforts to transform the diverse parts of the former Soviet Union into productive economies have so far been a dismal failure. But we are getting a better understanding of the process of political-economic change. The sources of informal constraints such as norms of behavior are a major modern priority in the social sciences and down the road will result in accelerating the reduction of poverty.
