North and South Korea from space. Source: NASA
A common way for medical researchers to differentiate between genetic and environmental factors is to study identical twins. Identical twins share the same genes, so the effects of different factors can be evaluated. For example, scientists examined 79 pairs of adult identical twins where one twin had smoked at least five years longer than the other. They found that the smokers had more wrinkles, bigger jowls, and bags under their eyes. Smoking ages your face, they concluded.
The same kind of methodology can be applied to nations to separate the effects of culture and geography from institutions and economics. Over the years there have been a large number of natural experiments where people from similar cultural and ethnic backgrounds become divided by administrative borders. The resulting differences across the barrier can be observed and evaluated.
A famous example of this approach is to look at photos of the Korean peninsula taken from space at night. North Korea is almost entirely dark, while South Korea, especially around the capital Seoul, is awash in light. South Korea is now one of the richest countries in the world, while the North grapples with periodic famine and abject poverty. The difference has been 70 years of central planning in the North. South Koreans have a living standard similar to that of southern Europe. Standards in the North are more like sub-Saharan Africa.
A similar example comes from the Western Hemisphere. In the 16th century, Spanish conquistadores reorganized the Inca societies that they conquered to extract silver from the Andes mountains. During the 300-year colonial period, all indigenous males were required to spend time working in Spanish mines. To this day, there are still significant economic differences in neighboring towns based on whether they were part of a mining community or not. The Spanish economic institutions extracted resources and exploited labor.
Spanish mint in the Andes. Public Domain. Source: Wikipedia
Institutions make the difference. Colonial and Communist institutions enriched a ruling oligarchy but made their societies much poorer as a result. They focused on the wrong resources: minerals or class consciousness or labor. The greatest resource in any society, however, is the human spirit – our creativity, ingenuity, and resourcefulness. But it can take decades or longer for investments in human capital to bear fruit.
That’s why having the right mindset is important. Innovation and creative destruction are critical components of successful, wealthy nations. It’s a major problem facing authoritarian governments, like China and Russia. Inevitably, political support comes from the leaders of large, legacy companies – the very companies that innovative disrupters are likely to threaten. Politicians face a choice: gamble on an uncertain future or support the status quo. And we know where that choice usually falls.
That’s why equitable, objective institutions matter so much: courts, education, infrastructure, and a strong social fabric. Ironically, the best way to grow is to start with a level playing field.
Douglas R. Tengdin, CFA