Virtuous Cycles of Development: Why Institutions Matter More Than Aid

According to reports released this past summer, 80 percent of the Sustainable Development Goals (SDGs) are off track for the UN’s 2030 target, and progress on more than half of the goals has been “weak and insufficient.” About 30 percent of the SDG initiatives have either been abandoned or “gone into reverse.” 

Development debates are on the rise, thanks in part to the recent release of Ezra Klein and Derek Thompson’s book, Abundance (2025), along with Marian Tupy and Gale Pooley’s previous publication, Superabundance (2022). Both these books emphasize advancement, but distinguish the role of government and how factors for progress are assessed.

The determinants of growth are a tricky matter, making the study of development as frustrating as it is fascinating. In the introduction to Johan Norberg’s latest book, Peak Human (2025), Norberg asserts that “Golden Ages are not dependent on geography, ethnicity, or religion but on what we make of these circumstances.” This assertion harks back to the field of development studies when Ragnar Nurske (Problems of Capital Formation in Underdeveloped Countries, 1953) argued that the process for economic growth is not one that can be standardized. In Nurske’s own words, “economic development has much to do with human endowments, social attitudes, political conditions — and historical accidents.”  

Assessing the past and mapping the potential future is a worthwhile endeavor, even though it is impossible to predetermine what is the right path.

Vicious Circles to Virtuous Cycles

Historically, countries that progressed quickly in productivity and living standards benefited from industrializing the domestic market and leveraging scale economies from manufacturing processes (obvious examples being the United Kingdom, the United States, Germany, and Japan). Investment inflow and human capital formation enabled the sharing of competencies and technologies, and this spurred a stronger environment for wealth creation.

Essentially, the transfer of knowledge, along with the creation and sale of assets, incentivizes infrastructure development and fosters a more diverse and robust market. Industry formation ignites opportunities for increasing returns since businesses serve as each other’s customers. Indeed, companies require backward linkages for materials and services along with frontward connections for distribution and sales. The larger the company, the larger its networks.

Paul Rosenstein-Rodan’s big push theory (1943) proposed that such networks can help break the vicious circle of poverty and replace it with a virtuous cycle of demand and supply. Similarly, Albert Hirschman’s theory of unbalanced growth (1958) also drew attention to the benefits of linkages, in that such connections encourage technological advancements to be harnessed.

Hirschman, among other prominent theorists in development studies, believed that efficacious industries rely on strong linkages, and the better the industry, the better the demand derived from it. And the better the demand, the greater the likelihood of job opportunities and the expansion of complementary as well as competing firms. This process is said to trigger ‘dynamics of development’ and, as demonstrated throughout Norberg’s work, individual liberty and credible institutions are positive prerequisites for getting it started.

Individuals and Ownership

According to Nurske, societal progress is largely dependent on the individuals within it.

Capital formation can be permanently successful only in a capital-conscious community, and this condition, which is just as important for the continued maintenance as for the initial creation of capital, is promoted by a wide diffusion of investment activity among individuals. Nothing matters so much as the quality of the people.

Ayn Rand also emphasized the role individuals play for economic advancement.

America’s abundance was not created by public sacrifice to the common good, but by the productive genius of free men who pursued their own personal interests and the making of their own private fortunes.

It is important to note, though, that the attainment of “private fortunes” necessitates the establishment of property rights. Hernando de Soto, the influential Peruvian development economist, proposed that a formal system of property rights is a must for promoting prosperity. Property devoid of title is what de Soto calls “dead capital,” since individuals are unable to engage in capital formation or utilize their assets as collateral.

Norberg also emphasizes de Soto’s point in stating that, for citizens to be “free to experiment and innovate,” the society in which they live must also have “peace, rule of law, and secure property rights.” Thus, formal and informal institutions play a major part in economic performance, particularly legal infrastructure and a stable business environment.

When both market systems and corporate governance structures are weak, risk-averse producers are unlikely to upgrade or invest, and entrepreneurs are unlikely to gamble with profit and loss potential. “Institutions provide the incentive structure,” as aptly put by Douglas North, and so the stability and legitimacy of a country’s political economy is of great importance.

Institutional vs. State Capacity

Market expansion relies on credible institutions. The concept of an institution and its impact upon the business realm is broad, spanning from laws and standards to culture and expectations. Institutions set the ‘rules of the game’ and scholars such as John Locke, Adam Smith, and John Stuart Mill have all argued that institutions serve as a primary determinant for why some countries are rich and others are poor.

Institutional capacity-building can help attract investments and investments tend to be of great interest to politicians as well as their constituents. Instead of focusing on how to make it easier and more secure to do business, however, politicians often focus on how to incentivize business activity, and those incentives may hurt development more than they help. Whenever grants, subsidies, preferential treatment, etc. are used as incentives for entrepreneurial activities, individuals are tempted to curb their aspirations or shift their efforts toward that which is being offered. Attention gets redirected to competing for rents, rather than being alert to market opportunities. And, if government assistance is attained, further actions may be guided (or tainted) by the strings (or stipulations) attached to what is received.

As businesses become accustomed to bestowed benefits, efforts to retain assistance and demonstrate a persistent need will supplant aspirations for a thriving bottom line. Political elites, instead of customers and investors, will determine who gets rewarded in the marketplace.

Frédéric Bastiat said it best when declaring that “Everyone wants to live at the expense of the state. They forget that the state lives at the expense of everyone.” So, with all this in mind, it seems the primary question for abundance advocates is — who determines the mode for advancement?

Spontaneous Order or Central Planning

As tempting as it is for those with power to think they can spur on progress, entrepreneurship does not function under force or imposition — it comes from the ground up. And, when markets are tampered with, price and demand signals get muddled and the application of individual know-how gets pushed to the side. To be sure, government action only entrenches procedural processes toward collective ends rather than private interests.

F.A. Hayek, in The Use of Knowledge in Society (1945), cautioned that a paternalistic state can dampen an entrepreneurial spirit and impede the development of spontaneous order. Hayek claimed that sustainable development relies on individual intuition.

If we can agree that the economic problem of society is mainly one of rapid adaptation to changes in the particular circumstances of time and place, it would seem to follow that the ultimate decisions must be left to the people who are familiar with these circumstances, who know directly of the relevant changes and of the resources immediately available to meet them.

Truly, the ability and opportunity to earn, while having autonomy when doing so, can serve as a powerful force for the progression of markets. When value is produced, so too is the creation of wealth — and the accumulation of wealth and assets can have a spillover effect elevating the status of society at large. And, as pointed out by Donald Boudreaux, we are currently living “better than ever.”  

Matt Ridley attests, in How Innovation Works (2020), that innovation “is the reason most people today live lives of prosperity and wisdom compared with their ancestors.” According to Ridley, “innovation is the child of freedom, and the parent of prosperity.”

“Prosperity, peace, and progress,” however, according to Norberg, have been “rare in human history” and in the closing chapter of Peak Human, Norberg exclaims that “if we want our culture to thrive, it is necessary to think about what makes that possible and what ruins it.” As such, the current buzz about abundance is a good thing as long as debates focus on principles more than politics. And while the path to progress will inevitably vary for each community, one aspect seems to hold true — society is best served by those free to transact in accordance with their abilities and their personal desires for abundance.