Two Cheers for Growth Under Extractive Institutions

Enjoying inclusive institutions in Copenhagen, Denmark

Photograph courtesy Wikimedia Commons.

I’ve written about Why Nations Fail: The Origins of Power, Prosperity, and Poverty before and I think it’s an amazing book that everyone should read and buy. That said, since finishing it, I do have a niggling concern.

The basic framework of the book is to lay out the relationship between economic institutions and political institutions. Some countries (Canada, Denmark, Japan) have “inclusive” political institutions and consequently develop “inclusive” economic institutions. When your economic institutions are inclusive, everyone gets a chance to go to school and learn, everyone has a chance to switch jobs or start a new business, and everyone has the opportunity to save and invest. But where countries have “extractive” political institutions they end up with “extractive” economic institutions. The president’s wife’s brother’s son gets an exclusive license to import exercise machines (mostly used in hotel gyms since local people are too poor to use them) and earns a nice living do so free from competition. Eventually some eager beaver comes along and says, hey if this other guy is earning monopoly rents importing exercise machines then I’ll just build some here domestically. But the eager beaver is naive. The exclusive import license isn’t a coincidence, it reflects the president’s wife’s brother’s son’s privileged position in the political system. Smart hoteliers will know better than to buy from a competitor since it will only buy them regulatory trouble. Smart bankers will know that the new business is doomed and won’t lend him money and even if it weren’t doomed, lending him money would only buy them regulatory trouble. Eventually, the eager beaver’s savvier wife will explain to him why the plan is doomed. Absent opportunity, human and physical capital stagnates and ambitious people focus their attention on climbing the ladder of corruption. Even if the President realizes that on some level he’s running a counterproductively dysfunctional system, he knows that if he starts threatening the economic privileges of the people he counts on to support the regime that his own base will vanish.

So that’s the story. To get rich you need to either land on a bunch of oil (Qatar) or else have the kind of inclusive institutions that allow for “creative destruction” and widespread opportunity. They don’t deny that countries with extractive institutions (the Soviet Union in the 1950s, China in the 2000s) can grow rapidly, but this kind of extractive growth isn’t sustainable.

I don’t disagree with any of that, but I have some qualms with the idea that this properly defines the difference between the nations that are failing and the ones that aren’t. As detailed in the book, Colombia doesn’t have good institutions and this helps explain why its GDP per capita is $10,000 while Sweden’s is $40,000. On the other hand, Colombia’s $10,000 is way better than Syria’s $5,000 or Yemen’s $2,500 or Ethiopia’s $1,000. Huge numbers of people live in countries like China, India, Indonesia, Pakistan, and Bangladesh that are poorer than Colombia. Is the question of “why nations fail” really best described as why Colombia isn’t more like Denmark than why Pakistan isn’t more like Colombia? People have done a lot of conceptual work with the distinction between catch-up growth (applying modern technology to nonmodernized societies) and frontier growth (pushing the boundaries of innovation forward) often in a rhetorical register that seems designed to downplay catch-up growth. But catch-up growth alone—in other words, a well-executed program of growth under extractive institutions—would massively ameliorate most of the world’s most severe problems. It would also reduce the perceived labor market threat to working classes in rich countries and create much larger markets for sophisticated products and thus bolster innovation.