Mitt Romney don't know much about economic history.

"Culture makes all the difference," Mitt Romney told an intimate gathering of Israeli businessmen at Jerusalem's posh King David Hotel. "And as I come here and I look out over this city and consider the accomplishments of the people of this nation, I recognize the power of at least culture and a few other things."

The U.S. Republican presidential hopeful, whose own net worth is estimated at roughly $250 million, went on to compare Israelis' economically comfortable existence with the more straitened circumstances in Palestinian areas. The comment predictably drew the ire of Palestinian leaders, with one senior official deriding it as "racist."

Despite the controversy, Romney then doubled down on his argument in a short op-ed for the National Review, asking, "But what exactly accounts for prosperity if not culture?"

Unfortunately for Romney, the answer is: quite a lot. True, his cultural explanation for why Israel is richer than Palestine has sparked an important debate that rarely occurs in the parochial, U.S.-centric world of American presidential elections. And given the important role the United States plays in global affairs, a presidential candidate's views about why the United States is more economically successful than most parts of the world are an important indicator of how he would approach the job.

Unfortunately, Romney's views are seriously out of sync with those of the great mass of social scientists. For one, as his more extended argument in the National Review illustrates, he confuses "culture" with institutions. By culture, social scientists mean people's values and beliefs. Romney refers to Americans' "work ethic," which is cultural, but he also claims that political and economic freedoms are the real keys to economic success. But political and economic freedom are not guaranteed by (or even related to) culture but by institutions, such as the U.S. Constitution or its system of property rights. Romney did cite Harvard University historian David Landes, who did indeed argue that values and beliefs are crucial for economic development, as providing the intellectual origins of his views -- but his focus on institutions is much more in line with our book Why Nations Fail than with Landes. Indeed, the facts on the ground in the Middle East illustrate the power not of culture, but of institutions.

It is true, of course, that living standards are much higher in Israel than in Gaza or the West Bank -- the gap is even wider, in fact, than Romney claimed. Israelis have much higher levels of educational attainment and better technology, and they benefit from much better provision of public services -- for example, roads, health care, and water -- than their Palestinian neighbors. There is also no denying that there are important cultural differences between Palestinians and Israelis: For instance, the former are primarily Muslims, while the latter are primarily Jewish.

But is there any cause-and-effect relationship between these cultural realities and differences in prosperity? The evidence suggests not. In fact, as economists Maristella Botticini and Zvi Eckstein point out in their recent book, The Chosen Few: How Education Shaped Jewish History, the origins of the high human-capital levels of Jews are in the historical adoption of educational institutions in Jewish society that induced people to become highly educated. This decision then led Jews to have a comparative advantage in trade and commerce -- specializations that have served them well in the modern world. This is where the roots of Israel's current prosperity lie, because these highly educated people migrated there, bringing their institutions with them. There was no cultural proclivity that led Jews to introduce or sustain these rules forcing Jews to educate their children. Rather, they emerged out of a political struggle between the Pharisees and the Sadducees to control Jewish society.

These new Israelis migrated to a place that had suffered a long history of colonial exploitation under the Ottomans and the British, who created extractive political and economic institutions -- in order words, political institutions that concentrated power narrowly and economic institutions designed to redistribute income and power to themselves at the expense of society. The Israelis replaced these with mostly inclusive institutions that encouraged technological progress and economic growth and created the Middle East's first democracy, but did not spread it to the Palestinians.

This happened for several reasons, none of them cultural. Let's start with the long history of Arab-Israeli enmity: The existence of the state of Israel was contested by the surrounding Arab states, leading to a long series of conflicts and Israel's capture of the West Bank and Gaza in 1967. It is hardly surprising that the Palestinian territories -- under occupation and geographically separated from each other -- were unable to develop inclusive political and economic institutions under such circumstances. The effects of the conflict haven't just been limited to the Palestinians: Several authoritarian Arab governments have used it to divert the attention of their citizens and consolidate their corrupt grip on power.

The Middle East conflict extracts political and economic costs on the Palestinians to this day. Israel continues to expropriate large tracts of land in the West Bank for settlements, and of course such insecure property rights have been disastrous for investment and prosperity on the Palestinian side. Both territories have also had serious economic restrictions imposed on them by the Israeli government, not to mention the destruction of infrastructure and buildings.

All this may be justified as necessary to maintain the security of the Israeli state, but it has obvious consequences for Palestinian prosperity. In addition, the Palestinians have not done well at creating the type of inclusive political institutions that are critical for generating economic development. This is mostly because the conflict and struggle for statehood damages accountability and creates serious political polarization, not due to any innate cultural differences.

Leaving aside the case of Israel and Palestine, we show in Why Nations Fail that Romney's ideas about "freedom" are much closer to the right way to think about relative prosperity than his ones about "culture." Rich countries are those that have created inclusive political and economic institutions. These spread political power broadly in society and make it accountable; they create an economy that can harness the talents, skills, and creativities of the vast mass of their citizens. We also show that cultural differences simply cannot account for the differences in economic prosperity we see today. They are either irrelevant, as in the case of the Israelis and the Palestinians, or they are themselves the product of institutional differences.

The most dramatic example of this is the divide between North and South Korea -- a previously cohesive cultural entity driven apart by war and radically different institutions. Since their split six decades ago, the South has prospered under its inclusive system, while the North -- with its extractive institutions based on central planning and continuous repression -- has been driven to the brink of famine. Bizarrely, Romney cites the case of the Koreas to support his culturalist argument. But the divergence of these two countries obviously cannot be blamed on deeply rooted cultural factors -- the only explanation is institutional differences and geopolitical realities. If Romney truly wants to understand the irrelevance of cultural factors to countries' success or failure, it's not Jerusalem he should've visited -- it's the Demilitarized Zone.



Emerging Power Crisis

Will India's massive blackouts put an end to the South Asian miracle?

India wants to be a power on the world stage, but back home it's having power troubles of a more mundane variety. On July 31, sweeping blackouts struck the country's north and east, leaving an estimated 600 million people -- nearly 10 percent of the world's population -- without electricity.

While it is still too early to say what the exact cause of this crippling power outage was, the crisis underlines how dependent India's economy is on electricity -- and how unreliable these economic sectors can be. More importantly, this week's events are a stark reminder of the broad reforms needed for India to finally emerge as an economic superpower.

Some have suggested that the failure of India's electricity grids was the result of a number of states overdrawing electricity in recent months. Although a few grid operators and at least one state have denied this claim, such an explanation is plausible: India has had an atypically dry monsoon season, leading farmers to use more electricity to draw on water wells. As the country's agricultural sector receives heavily subsidized -- if not free -- electricity from the government, unusually large electricity consumption during a period of extreme drought should be no surprise.

The bigger story, however, is the institutional deficiencies and legacies of decades of poor policy that make India's electricity sector a weak link in the country's economic development. In India, nothing captures the attention of the government like a crisis, and the global attention engendered by this power outage -- the largest in world history by some measures -- should be channeled into enacting long-overdue reforms.

Many analysts -- including the authors of this article -- have long warned of a looming Indian electricity crisis owing to a yawning gap between electricity supply and demand. India's entire electricity supply chain, from natural resource production and distribution to electricity generation, transmission, and distribution, is plagued with problems. Domestic production of coal, which is responsible for roughly two-thirds of India's electricity supply, grew at just 2.6 percent a year between 2001 and 2011 -- compared with nearly 8 percent annual growth in electricity demand during the same period. India has abundant reserves, but disputes between local environmental and rural groups, and Coal India, India's national coal corporation, have prevented their development.

Bureaucratic red tape and logistical hurdles bedevil the process at every turn. Land acquisition struggles and a byzantine regulatory system hinder coal production, and transportation bottlenecks prevent coal from easily getting from the major production sites to the major demand centers. As a result of the domestic production shortfall, India has had to rely on more expensive imported coal. However, because Indian states sell electricity at low, heavily regulated rates, electricity generators have been largely unable to pass on the higher cost of imported coal to consumers. The ultimate result is a crippling shortage of coal.

India's natural gas industry, five years ago a sector of great optimism, is struggling from similar domestic production shortages and infrastructure limitations. As a result, it is also forced to increasingly depend on expensive imports of liquefied natural gas to cover supply shortfalls. But again, because India's state utilities are unable to pass on higher costs to consumers, imports provide little respite from supply shortages.

Although nuclear and renewable energy, including wind and solar power, are often discussed as potential solutions to India's electricity shortages, these sources face substantial hurdles of their own. Despite a historic cooperation agreement between India and the United States, political and logistical hurdles have once again intervened to limit interest in investment in new nuclear facilities. Renewable energy, while seeing impressive growth rates, is still expensive and dependent on government support -- and in any case, it will not be able to come anywhere near meeting the country's burgeoning energy demand.

Exacerbating the lack of supply is India's desperate need for investment in its electricity transmission and distribution (T&D) network. T&D losses of electricity supply in India are still roughly 25 percent, an abysmally high rate for an emerging economy. These losses are only aggravated by rampant electricity theft and poor billing and collection standards. (Anyone who has ever been to an Indian city will be familiar with the tangle of jury-rigged wires leading from electricity pylons to houses and apartments.)

Improving the performance and efficiency of this sector will require immense investment. The International Energy Agency, the OECD's energy think tank, predicts that India will need to invest a whopping $632 billion between now and 2035 to meet the demands of its growing populace.

How can India meet these needs? To encourage investment, its entire energy and electricity sectors must undergo pricing revisions that adequately reflect market prices. Starting with the pricing of fuels, the government must stop subsidizing (directly and indirectly) the cost of energy and electricity. This would give private-sector companies with more advanced technology and more efficient processes an incentive to invest in production and distribution of fuel products.

The same should be done for India's electricity sector, which currently subsidizes the bloated agricultural sector -- which accounts for 15 percent of India's GDP but 50 percent of its labor force -- at the expense of industry and businesses. With adequate revenues -- most state utilities are essentially bankrupt -- public- and private-sector firms would have incentives to invest in the T&D infrastructure. With more reliable electricity, industry and businesses may rely less on captive generation (off-grid power installations) and provide further revenues for state utilities.

This argument is not new; pricing reform has long been raised as one of the necessary steps for fixing India's energy and electricity sectors. Nor is it an untested theory: The state of Gujarat, once host to one of the country's worst-performing electricity sectors, reformed electricity prices and cracked down on electricity theft beginning in the early 2000s. While the human rights credentials of its chief minister, Narendra Modi, are dubious, his electricity reforms have undoubtedly been a success. Today, Gujarat is one of India's best performing economies and remains an attractive investment destination in spite of the bleaker economic picture in many other Indian states.

Will politicians in New Delhi let the current crisis go to waste? Until now, the appetite for reforms has been disappointing, and the Indian economy has reflected this slowdown: In June, Standard & Poor's publicly speculated that India could be the first BRIC "fallen angel."

It would be a mistake, however, to underestimate India. At times, its political institutions have shown the ability to act quickly and effectively to resolve crises -- most notably in 1991, when then Prime Minister Narasimha Rao responded to a foreign exchange crisis by enacting a host of economywide reforms and liberalization measures. In the two decades since the crisis, however, India's reformist nature has subsided, and a number of proposed liberalization measures -- including the 2003 Electricity Act -- remain half-implemented.

Once again, India is experiencing a crisis that underscores the treacherous foundation sustaining its economic growth. We can only hope that this summer's blackouts are the wake-up call the country needs.