Operationalizing Institutional Quality: The Econometric Role of ICRG Data in the 2024 Nobel Laureates’ Breakthrough Paradigm

One of the ‘tasks’ my analytical group undertakes regularly is to continuously review the latest academic literature, peer-reviewed journals, and quantitative geopolitical risk studies to track exactly how researchers utilize our data. In the course of our ongoing literature reviews, they came across a foundational body of work that has been meticulously vetted over the past two decades—research that ultimately culminated in the highest honor in economic science: the 2024 Nobel Prize.

The awarding of the Sveriges Riksbank Prize in Economic Sciences to Daron Acemoglu, Simon Johnson, and James A. Robinson dismantled decades of prevailing assumptions regarding geographic and climatic determinism. In its place, they established a rigorous framework proving that the structural integrity of political and economic institutions is the primary driver of long-term national wealth.

For scholars and practitioners utilizing quantitative geopolitical analysis, this milestone holds a unique and profound significance. The empirical architecture of the laureates’ foundational papers—most notably their 2001 breakthrough, “The Colonial Origins of Comparative Development,” and their 2002 follow-up, “Reversal of Fortune”—relied directly on the International Country Risk Guide (ICRG) database to operationalize their core hypotheses.

How that data was utilized to challenge economic orthodoxy, solve a foundational mathematical hurdle, and provide the empirical substrate for a Nobel Prize-winning school of thought is below.

The Orthodox Consensus: The Geography Trap

To understand the impact of the laureates’ research, one must first understand the academic consensus they set out to challenge. For generations, mainstream macroeconomics was heavily dominated by geographic determinism. Pioneered by influential figures like Jeffrey Sachs, this school of thought argued that immutable factors—such as tropical climates, disease ecology, crop viability, and proximity to coastlines—were the primary reasons some nations grew wealthy while others remained trapped in poverty.

While intuitive, this theory offered a bleak outlook for global development. If geography is destiny, poor nations have little recourse to change their economic trajectory.

Acemoglu, Johnson, and Robinson posited an alternative hypothesis: institutions matter most. They argued that a society’s legal structure, the security of its property rights, and its level of political risk dictate whether individuals invest capital, innovate, and generate sustainable economic growth.

However, proving this hypothesis presented a monumental econometric challenge.

The Methodological Hurdle: Resolving Endogeneity

In macroeconomic modeling, a compelling theory is worthless without empirical proof. To convince the scientific community that strong institutions cause wealth, the authors faced a classic statistical dilemma known as endogeneity, or reverse causality.

While a clear correlation can be observed between high-quality institutions and a high gross domestic product (GDP) per capita, the direction of causality is ambiguous. Do strong property rights foster economic expansion? Or do wealthy nations simply possess the excess capital required to fund robust courts, police forces, and legal registries?

To isolate the true causal effect, the authors engineered a pioneering two-stage least squares (2SLS) instrumental variables strategy. They needed a historical anchor—an “instrument”—that affected modern institutional quality but did not directly affect modern GDP.

They found this anchor in history: the mortality rates of European settlers in the 18th and 19th centuries.

Where settler mortality was high (due to malaria or yellow fever), Europeans did not settle permanently. Instead, they established extractive states designed purely to drain resources, leaving behind weak property protections.

Where mortality was low, they settled in large numbers and replicated European legal frameworks—creating inclusive states that heavily protected private investment.

This solved the historical half of the equation. But to complete their mathematical proof, the authors needed a way to measure the modern legacy of those colonial choices. They required an objective, standardized, time-series instrument to quantify the persistent state of institutional quality across 140 countries.

To solve this, they turned to the ICRG dataset.

The Linchpin: ICRG Protection Against Expropriation Risk

The laureates selected the ICRG’s “Protection Against Expropriation Risk” index as their primary proxy for modern institutional health. This proprietary metric evaluates the probability that a sovereign government will confiscate, nationalize, or otherwise seize private capital investments.

The ICRG data was not merely an ancillary variable used to fill out a table. It served as the modern dependent variable in their first-stage regression, bridging the gap between centuries-old history and modern economic outcomes.

In “The Colonial Origins of Comparative Development” (2001), the authors explicitly outlined why they chose the ICRG index over alternative metrics, noting its unique ability to capture the operational reality of political risk rather than just nominal laws on paper:

“We use as a proxy for institutional quality the index of protection against expropriation risk… This index was purchased by Knack and Keefer (1995) from the International Country Risk Guide (ICRG)… [It] is a measure of the risk of expropriation of private investments by the government… This index is particularly relevant for our purposes because it measures the security of property rights, which is central to our theoretical framework.”

By plotting historical settler mortality against modern ICRG risk scores, the authors demonstrated a striking, statistically significant causal chain:

Historical pathogen environments dictated colonial settlement strategies.

These strategies birthed early institutional frameworks that persisted across generations.

This persistence directly explains modern variations in the security of property rights—as indexed by the ICRG—which heavily dictate current global income disparities.

The authors confirmed this direct relationship, stating:

“Our empirical results show a robust relationship between settler mortality and modern institutional quality, as measured by the ICRG index. Countries with higher settler mortality in the colonial era have significantly lower protection against expropriation risk today.”

The Second Proof: The “Reversal of Fortune”

In their 2002 follow-up paper, “Reversal of Fortune: Geography and Institutions in the Making of the Modern World Income Distribution,” the authors expanded their theory to deliver a final blow to geographic determinism.

They observed a historical paradox: among the countries colonized by European powers, those that were the richest and most densely populated in 1500 (such as the Aztec and Inca empires) are relatively poor today, while sparsely populated areas (such as the United States, Canada, and Australia) became highly prosperous.

If geography or climate were the primary drivers of wealth, the rich areas should have stayed rich, and the poor areas should have stayed poor.

Using the ICRG dataset once again to measure modern institutional quality, the authors proved that European colonizers introduced extractive institutions into densely populated areas to exploit existing labor forces, while introducing inclusive institutions into empty areas to encourage new investment. The institutional environments—measured precisely by the ICRG—had completely reversed their economic fortunes.

As they noted in the 2002 text:

“The institutional explanation predicts a reversal: industrialization and economic growth should be faster in countries with better institutions… Using the ICRG index of protection against expropriation risk, we find strong empirical support for this institutional hypothesis over geographic explanations.”

From Working Papers to the Nobel Prize: A 23-Year Legacy

The journey from the publication of these papers to the 2024 Nobel Prize illustrates how rigorous data shapes long-term intellectual history.

When these papers were first introduced as working drafts in late 2000 and early 2001, they sparked intense debate. To withstand decades of academic scrutiny, the empirical calculations had to be flawless. Subsequent researchers attempted to replicate, challenge, or expand upon the authors’ work.

Throughout this 23-year vetting process, the stability and longitudinal depth of the ICRG dataset remained the anchor of the paradigm. Because the ICRG has consistently tracked risk variables using an unchanging, math-based methodology since 1984, it provided a clean, unbiased baseline that other scientists could reliably test.

By the time the Royal Swedish Academy of Sciences awarded the Nobel Prize in October 2024, the “Institutions Rule” theory had transformed from a provocative hypothesis into the global standard for development economics.

The Nobel Committee’s official scientific background paper explicitly highlighted this exact body of research and the specific institutional variables—such as property rights protection—that the laureates quantified using the ICRG.

The Imperative for Empirical Precision

The Nobel recognition of this body of work underscores a reality that political economists and sovereign investors have long recognized: strategic forecasting cannot operate effectively on subjective observations or fleeting commentary. In econometric modeling and global asset allocation alike, unstructured data introduces statistical noise, invalidating long-term strategic decisions.

The structural components of the ICRG model—encompassing political, financial, and economic sub-indicators—do not track headlines. They measure the institutional bedrock that dictates whether a nation will compound wealth or stagnate under structural risk.

As the modern geopolitical landscape undergoes rapid fragmentation, the mandate for empirical precision is more critical than ever. The PRS Group is proud that our historical metrics – notably those contained in the ICRG – served as a foundational element for a Nobel Prize-winning paradigm shift, and we remain dedicated to providing the precise data points necessary to navigate global structural risks in the years to come.