Why Nations Prosper?

Different societies reward different actions differently. In developed countries, the wealthiest are often those who have contributed substantial value to society, whereas in third-world countries, wealth often accumulates in the hands of those who more effectively use deception and coercion to exploit and oppress others. As a result, they produce vastly different amounts of wealth. Societies that evolve and adopt better incentive structures prevail.

Throughout history, competition over resources and dominance has shaped the evolution of humans, tribes, and societies. Societies with superior knowledge, technologies, and inventions have been more likely to survive, thrive, and dominate others. They can pass their knowledge and inventions down from one generation to the next. One important category of inventions is contracts. Contracts are promises that can incentivize people to work, collaborate, produce, build, create, innovate, and generally invest and postpone pleasure in anticipation of future gains. People invest for the expected return, considering the expected risks.

Fundamental Inventions: Contracts

Here, I identify two types of contracts: consensual (voluntary) and non-consensual (social). Consensual contracts, such as employment contracts and partnerships, require unanimous consent from all participants. Therefore, they always result in Pareto-superior outcomes. On the other hand, social contracts such as social traditions, standards, and laws do not require consent from all members of the society but are imposed on all members.

One crucial social contract is property rights. It was invented to incentivize investment and the creation of valuable properties. Intellectual property rights incentivize innovation and the creation of technologies. The other natural rights (i.e., the right to life and liberty) also incentivize long-term planning and investment for the future. Generally, we have natural rights because the societies without them did not make long-term plans and investments and were dominated by those with them.

Figure 1 shows two neighboring countries, one with property rights and one without. They have substantially different levels of prosperity.

Figure 1: North Korea vs. South Korea (Credit: PLANETOBSERVER / Science Photo Library)

Transactions are two-sided consensual contracts to transfer and exchange property rights. If we consider someone’s body and time as their property, working for food is also an exchange of property rights. The invention of transactions resulted in the emergence of markets and productive competitions, bringing about economies of scale and specialization, leading to more and better (i.e., more efficient) investments.

Another important invention was money. Money is a fungible, portable asset (property) that is not perishable. It gives us prices and more market liquidity compared to bartering. Price is the most efficient aggregation of dispersed information (Hayek, 1945) and is a sufficient statistic that summarizes the information about scarcity, supply, and demand. This invention led to more and better investments.

Standards are social contracts that have led to fungible assets, homogenous markets, and equilibrium prices. For example, the price of a standard type of gold per ounce is almost the same for any amount of gold anywhere. Money is also an example of a standardized asset. Therefore, different currencies have universal equilibrium prices against each other.

Firms, created through consensual contracts, were invented to facilitate collaboration and investments by multiple individuals. They serve as a centralized point for stakeholders to contract with the firm rather than with each other individually. They allow for separating ownership and control so that investors and managers can specialize (Fama & Jensen, 1983).

Firms receive capital, labor, and revenue through consensual contracts. They brought about equity capital markets, enabling investments in large-scale projects. Hiring is a consensual contract that results in labor markets and organizations.

A government is an organization that has revenue through non-consensual contracts (taxes). A constitution is a non-consensual contract invented to structure the government and specify how the other non-consensual contracts (e.g., money supply) are decided or legislated. This results in more predictability and less risk for investment.

Figure 2 summarizes the contracts and their outcomes.

Figure 2: Contracts and their Outcomes

Making Promises Credible

Enforcement mechanisms make promises credible by imposing deterrent costs on violations (Khaledi, 2018). The expected costs of violating a contract should outweigh the expected benefits. The cost imposition can be before the violation (ex-ante) or after it (ex-post).

Ex-ante Costs

Such costs rely on information asymmetry and physical barriers. For example, the passcode to a front door makes it costly for a burglar to enter a house. The ex-ante costs have evolved with technology, from physical keys to passwords and digital keys. Ex-ante costs have limitations and cannot deter many serious violations.

Ex-ante Costs

Such costs provide Credible Threats. Punishments and penalties are ex-post costs. An example is a fine for trespassing on a property. The ex-post costs and credible threats have evolved from simple social reciprocity to complex systems like religions and government institutions. The following paragraphs provide further details.

Social Reciprocity is the oldest and the most common ex-post cost. We have evolved and been hard-wired to feel anger and revenge when our natural rights (and other contracts) are violated. Those without such (biological) genes have gone extinct because they (or their families) were easy targets and, thus, easy victims.

However, this mechanism has many limitations. Sometimes, the threats are not credible because revenge is too costly or impossible. For example, if a gang murders a whole family, no one may have enough incentives to retaliate. On the other hand, the retaliations are sometimes disproportional, leading to never-ending conflicts and vengeance. Ultimately, reciprocity can result in anarchy and chaos.

Moral Principles and Values have emerged to make threats and promises credible, thereby incentivizing investment. That is why we have “right” and “wrong”. Generally, we have evolved to consider the violation of contracts as “bad” and the protection of contracts as “good” precisely due to their effects on investment. And that is “justice”.

Moreover, that is why most humans have some level of conscience and rectitude towards others. Societies with members possessing particular selfish genes (Dawkins, 1976), such as a strong sense of teamwork, integrity, righteousness, conscience, and patriotism, have been more likely to prosper, even though such traits may not help with individual survival. That is why we naturally abhor the acts of murder and theft.

Values and moral principles, in many cases, have no explicit consequences except emotional costs (guilt). Therefore, they are only sometimes effective and only for some.

Cultures and Norms have evolved to protect natural rights and contracts on a larger scale. Theft and murder are frowned upon in almost every culture. People respect those who keep their word and those who defend the natural rights of the helpless. A bad reputation increases the cost of future opportunities. This incentivizes the fulfillment of consensual contracts.

Societies with better norms and cultures have survived and passed them down to the next generations. One may consider norms and cultures the invisible genes of societies. Some are more effective than others in enforcing contracts and helping a nation to survive, thrive, and dominate other nations.

However, cultures and norms mainly control people’s behavior in small communities and are ineffective in large societies. Moreover, while cultures and norms emerged to help societies survive, many became cages, hindering the further progression of societies (Acemoglu & Robinson, 2019).

Religions were yet another attempt to make essential promises credible, enforce contracts, enforce natural rights, and thus incentivize long-term investment. The invention of “God” has been a crucial competitive advantage for many societies. It has convinced many people to refrain from thievery, murder, and violating contracts. Also, believers (in the afterlife) are more inclined to risk their lives to defend their nation’s natural rights against foreign invasion. Consequently, societies with religious beliefs and faith had more robust protection of natural rights and, hence, a safer environment for investment than “godless” societies. One may thank (the concept of) “God” for the abundance of food before having dinner.

Several factors have contributed to the perceived legitimacy of religions. For instance, the placebo effect of prayer has helped heal moderately ill believers (Lindenfors, 2019). Also, we only hear the stories of the survivors. This selection bias amplifies the illusion of divine intervention. Similarly, tribes who prayed before war fought with greater bravery and thus were more likely to win. Again, we mostly hear the success stories of the survivors even when others had prayed, too.

Religions attained some credibility by providing the early theories to explain the universe. However, many religions survived even after their theories were debunked and evidence-based theories (e.g., evolution) overtook them. That is because religions still help protect contracts in many societies by controlling a segment of the population. Interestingly, many societies have benefited from ignorance because, as several studies have shown, knowledge weakens religiosity (Arias-Vazquez, 2012; Zuckerman et al., 2013; Barber, 2014). Nevertheless, one can only get so far with false premises (and promises).

Like cultures and norms, religions can be considered invisible genes of societies. However, they are selfish genes and use societies as hosts for their survival and expansion. Their initial help is like a loan that society pays back with high interest. The dominant religions we see today have evolved to attract and retain followers to stay financially viable, not to advance society or help it prosper and progress. So, as expected, they usually favor people in power (Figure 3) and are against critical thinking. Many religions even allow violating natural rights and other contracts if it serves the religion or its leaders.

Figure 3: Islamic clerics kissing the hand of Iran’s queen in 1974 (Credit: sabq.org/world/bpnqck)

Governments emerged to protect citizens’ natural rights against domestic crimes and foreign invasion. Almost all societies have some sort of government with judiciary institutions, law enforcement, and the military. Societies lacking such institutions have had weaker protection of natural rights and less effective enforcement of contracts, and as a result, they have not survived or thrived.

Governments rely on human agents such as law enforcement officers and judiciary officials to make threats (laws) credible and impose ex-post costs. However, they have to incentivize them to do their jobs. That would be via consensual employment contracts (credible promises). Such contracts should be enforced (credible threats) by other agents who require other consensual contracts. Ultimately, we need a contract that can enforce itself and other contracts. We refer to such a contract as a constitution (Khaledi, 2018). A constitution, whether implicit (as in the UK) or explicit (as in the US), is a non-consensual contract that should enforce itself via a Subgame Perfect Nash Equilibrium (Armani, 2023).

Unfortunately, most government structures (e.g., autocratic, oligarchic) do not have proper mechanisms to control power. Acemoglu and Robinson (2012) referred to such structures as extractive institutions (as opposed to inclusive institutions). Extractive institutions pose various risks to citizens' investments and natural rights. They result in biased courts, which are ineffective in enforcing natural rights and contracts over people with political ties. Their unchecked power culminates in excessive regulations, unnecessary restrictions, and unrestricted money supplies, leading to lower investment, less innovation, and unpredictable inflation (Figure 4).

Generally, we can identify four sources of risk: Nature, Foreign invasion, Domestic violation, and Government oppression. While government institutions can control and limit the other three, we need mechanisms to control the government's power.

Figure 4: A banknote from Zimbabwe in October 2015 (Credit: bloomberg.com)

Democracy and Inclusive Institutions hold government officials accountable and their power in check, protecting people’s rights and investments from those in power. As an essential element of democracy, independent courts bring about impartial enforcement of contracts and reliable property rights.

Moreover, the competition among candidates under democracy gives rise to more competitive leaders and policymakers who can enact better laws and policies. This brings about a more stable economy, reasonable taxation, lower risk, and, thus, more investments.

Additionally, the majority-elected leaders have a larger pool of supporters from which to select competent individuals for key decision-making positions. This larger supporter base also legitimizes and empowers the government to address and resolve critical issues rather than adopting demagogic policies to appease a narrow group of supporters.

Inclusive institutions foster fair competition and free markets, encouraging investment, innovation, and creative destruction (Acemoglu and Robinson, 2012). In contrast, authoritarian regimes often protect certain businesses from competition, granting them monopolistic privileges that lead to higher prices, reduced quality, and less innovation.

Furthermore, democracy provides a peaceful avenue for people to change those in power without violence, destruction, and revolution (Figure 5). That means long-term political stability, more reliable property rights, and lower risks for investment. Conversely, under a dictatorial regime, the prospect of a revolution poses a substantial risk to long-term investments.

Figure 5: Nixon resigned following the Supreme Court's decision against him in 1974 (Credit: history.com)

Nonetheless, democracy is susceptible to the tyranny of the majority. Perhaps the most important minority in every nation is the investors. Socialism is a prominent example of how populist policies undermine property rights and destroy incentives for investment.

However, even under socialism, democratic countries still have much better protection of natural rights and attract much more investment than nondemocratic ones. That is because the tyranny of the minority and dictatorship is much more destructive than the tyranny of the majority.

Figure 6 shows the channels (mediators) through which the rule of the majority (democracy) can lead to prosperity. This figure proposes several hypotheses that an empirical researcher may test with historical data. But it is beyond the scope of this short article.

Figure 6: Democracy leads to prosperity via several channels (Daniel Armani)

Republicanism and Federalism aim to control the power of the majority-elected governments via different mechanisms. Under federalism, local governments have the authority to decide on local issues, limiting the power of the central (federal) government, however democratically elected. In a republic, a system of checks and balances tries to protect each citizen’s natural rights against the (local or federal) government, however democratically elected.

Limiting the government’s power leads to fewer regulations and, thus, more consensual contracts and investments. While all consensual contracts (by definition) benefit all participants, social contracts, such as regulations, do not necessarily benefit all those affected. Many social contracts (e.g., tariffs, licensing, and unions) benefit some (special interest groups) and cost others (Mercuro & Medema, 2006). They can prevent consensual contracts, resulting in less competition and less investment.

Generally, we need laws that protect the natural rights of individuals and minorities against the majority and their elected governments. Nevertheless, those laws are usually decided by the majority or their representatives. Also, it is the central government that determines what issues fall under its authority and jurisdiction and what falls under those of local governments.

Artificial Intelligence can augment government institutions and control their power in the near future. Then, we may delegate some parts of legislation, decision-making, and policy-making to AI because it is more reliable, less biased, and more trustworthy than many politicians. Soon, AI will be able to design better policies and laws and even judge court cases based on laws, reasons, and evidence. Computers will be better judges than humans because not only are they faster and more accurate, but they also are incorruptible. They cannot be threatened or bribed and do not misinterpret the law.

Defining objective, non-ideological criteria within legal jurisprudence is a crucial step in using AI for governance. Laws and policies should not be based on personal values, beliefs, and ideologies because personal values and beliefs vary from culture to culture and individual to individual. However, the level of investment provides a pragmatic measure for assessing and comparing different policies and laws. Roughly speaking, the laws and policies that more effectively incentivize and facilitate long-term investments can be regarded as “better” and more “just.” Perhaps if we instruct AI to maximize investment, it will protect the natural rights of the majority and minorities at "optimal" levels.

Now, we face several questions. Who will program and control the AI? Who controls the computers and servers on which the governing AI runs? Is it a government entity? What if they manipulate and tamper with the AI code? Or with the inputs, outputs, or decisions?

Generalized Blockchains such as Ethereum or Solana can enforce Smart Contracts in their eco-systems. Blockchains are, in fact, electronic constitutions and can eventually enforce all the contracts that a constitution can enforce (Armani, 2023). However, blockchains are faster, more reliable, more efficient, and more effective than traditional constitutions in enforcing contracts. Controlling the supply and stabilizing the value of a currency (Armani, 2021) is just one application of blockchain technology.

Origin(s) of Natural Rights

Most societies protect the natural rights of both adults and children but for different reasons. The adults are mainly protected because such protection incentivizes longer-term planning and more investment, leading to a more prosperous and powerful society than societies with looser protections. That is why there are laws protecting human life but no such laws for animals. Animals would not behave differently if protected under the law. Hence speciesism!

Such protections can not incentivize babies but would incentivize their parents to invest in them. So, children are protected as investments and properties. However, people are usually allowed to destroy their properties and kill their animals. Why killing one’s child is prohibited? Does this protection incentivize more investment in the society? The answer is yes. The origin of this protection is in the value of workforce and manpower, especially in conflicts. Societies with larger populations could produce more and have had a higher chance of survival in wars. As expected, most religions are against abortion, especially after a substantial amount of resources are spent on the fetus. In other words, babies are protected as investments for society, not just for their parents.

What if babies were not worth the investment? In pre-Islamic Arabia, female infanticide, often through burying newborn girls alive, was a common practice (Milner, 2000). Parents were not only permitted but also encouraged to kill their infant daughters as they were regarded as “bad luck.” That was because the female offspring were not very effective in wars but would make a tribe a more attractive target for invasion and raid. Therefore, families preferred to spend their limited resources on male children as they were better investments for future protection. There have been similar practices in Classical Greece (Ingalls, 2002), Ancient Rome (Bennett, 1923), India (Hundal, 2013), China (Milner, 2000), and many other places around the world (Figure 7). While they had some laws protecting babies’ lives, it seems that their “right” to life (if any) was actually their parents' right to their property. Babies would not behave differently if protected under the law, but parents behave (invest) differently if their children are protected under the law.

Figure 7: Burying Babies in China in March 1865 (Credit: Wesleyan Methodist Missionary Society: p.40)

References

1923, H. Bennett, “The Exposure of Infants in Ancient Rome,” The Classical Journal.

1945, F. A. Hayek, “The Use of Knowledge in Society,” American Economic Review.

1976, Richard Dawkins, The Selfish Gene, Oxford University Press.

1983, E. F. Fama & M. C. Jensen, “Separation of Ownership and Control,” Journal of Law & Economics.

2000, Larry S. Milner, “8. Female Infanticide,” Hardness of Heart / Hardness of Life: The Stain of Human Infanticide, Lanham/New York/Oxford: University Press of America.

2002, Wayne Ingalls, “Demography and Dowries: Perspectives on Female Infanticide in Classical Greece,” Phoenix.

2006, Nicholas Mercuro & Steven G. Medema, “Institutional Law and Economics,” Economics and the Law: From Posner to Postmodernism and Beyond, Princeton University Press.

2012, Daron Acemoglu & James Robinson, Why Nations Fail: The Origins of Power, Prosperity, and Poverty, Crown Business.

2012, F. Javier Arias-Vazquez, “A note on the effect of education on religiosity,” Economics Letters.

2013, Sunny Hundal, “India's 60 million women that never were,” Al Jazeera.

2013, M. Zuckerman & J. Silberman & J. A. Hall, “The Relation Between Intelligence and Religiosity: A Meta-Analysis and Some Proposed Explanations,” Personality and Social Psychology Review.

2014, Nigel Barber, “Why Are Educated People More Likely to Be Atheists?,” Psychology Today.

2018, Hamed Khaledi, “E-Constitutions: Conceptualization, Theory, Design Model and Experimental Evaluations,” Ph.D. Dissertation. Michigan State University, ProQuest Dissertations Publishing.

2019, Daron Acemoglu & James Robinson, “ 11. The Paper Leviathan,” The Narrow Corridor: States, Societies, and the Fate of Liberty, Penguin.

2019, Patrik Lindenfors, "Divine Placebo: Health and the Evolution of Religion", Human Ecology.

2021, Daniel Armani, "A Fundamentally Stable Coin," PaperScore.

2023, Daniel Armani, “Blockchain: The Quiet Revolution,” PaperScore.

In Pursuit of Credible Promises ('Justice')