THE BLOG
10/03/2014 10:55 am ET Updated Dec 03, 2014

The Reason Why Countries Rise and Fall

Today's world is going in circles seeking the antidote of growing their countries' economies, not realizing this very fact, which is also the reason why certain countries cannot produce multinational corporations. Politicians are not the solution, they are rather part of the challenge; this is a phenomena only mastered by the few who live in first world countries and very few from emerging markets.

Taking into consideration great thinkers like Dr. Tom Palmer and some professors from MIT, one notes when we look at all the wealthy societies of the world: Luxembourg, Switzerland and Japan. Not long ago they were desperately poor by contemporary standards. What made them rich?

Take Ghana and South Korea in 1960, when they had roughly equivalent per capita incomes. Not anymore; what was different between the two, why did Ghana stagnate and South Korea increased per capita income by over 30 times in one generation?

South Korea opened the market and joined GATT in 1965. Until then, you see flat economic performance and then there's an inflection point. It's really quite unmistakable. Look at the economic data from Fraser Institute of Canada -- they have an Economic Freedom of the World report, which finds consistently that countries that prosper are those that get the institutions right.

Oil is not a source of prosperity. Resource-rich countries, like Nigeria or the Democratic Republic of Congo stagnate. And then there are resource-poor countries that become fabulously wealthy like Hong Kong, and the Netherlands. There's nothing in the Netherlands, not even land, which they have to build out of the sea. But they've got the institutions right.

Since 1977 when the classical article of Meyer and Rowan was published, "Institutional Theory" surfaced and many intellectuals ran with the theory which underpinned the adaption of multinationals in different countries and further evolved as a template for countries to prosper economically. Institutional Theory has been the most successful theory to unlock unprecedented growth in any country, yes, taking note of different economic framework and political environments which affects how the theory is applied.

What are institutions exactly? North (1990, p. 3) offers the following definition: "Institutions are the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction". He goes on to emphasize the key, implications of institutions since, "In consequence they structure incentives in human exchange, whether political, social, or economic".

A theory is not an answer in itself; a good theory doesn't change its mind, it doesn't apply only to some countries or companies, and not to others. It is a general statement of what, and why; rather than an answer, it's a directive statement for application like a formula that leads to an answer.

Countries with weak institutional theory applied find it challenging to produce globally competitive companies, and it's rare if they do. Many Zimbabwean multinationals are mostly headquartered in South Africa to expand globally.

Although, some recent contributions to growth theory emphasize the importance of economic policies, such as taxes, subsidies to research, barriers to technology adoption and human capital policy, they typically do not present an explanation for why there are differences in these policies across countries. Of primary importance to economic outcomes are the economic institutions in society such as the structure of property rights and perfection of markets.

Therefore, societies with economic institutions that facilitate and encourage factor of accumulation, innovation and the efficient allocation of resources will prosper; however, economic institutions are driven by political will power.