Posted by Realsociology on 15th October 2014
Developed countries are wealthy because of ‘inclusive economic institutions’ – Basically a combination of state and free market in which
- The state creates incentives for people to invest and innovate – (through guaranteeing private property rights and enforcing contract law)
- The state enables investment and growth through providing education and infrastructure, which private business uses, and
- The state is controlled by its citizens, rather than monopolised by a small elite. Crucially, there needs to be a democratic principle at work in which people in politics establish institutions and laws which work for the majority of people, rather than just working to make them rich.
- The state also needs to maintain a monopoly on violence.
The authors come to this conclusion through a number of comparative studies of countries which are in close geographical proximity to each other such as
- Mexico/ America
- South/ North Korea
- Botswana/ Zimbabwe
They argue that the only factor which can explain why one of these countries is poor and the other rich is because of the institutional infrastructure which has been established through the last few decades/ centuries.
In contrast to the above ‘inclusive economic institutions’ which encourage development, the authors suggest the opposite ‘extractive economic institutions’ (think corrupt dicator and his clique sucking money into a Swiss bank account) can generate growth in the short-term, but in the long term result in poverty.
They also suggest that there has been ‘a vicious circle’ at work in many underdeveloped countries over the last three to four centuries – With their globalised history starting off with extractive institutions established by a colonial power (typically built on already existing internal extractive institutions), which, on independence, became even more extractive under postolonial rulers, which in turn lead to civil war as competing factions fought for control over the extractive institutions – which then led to a decent into chaos and failed states. The authors see little hope for such countries.
In contrast, developing countries such as the US and the UK have benefitted from three to four centuries of a virtuous circle in which institutions have become gradually more inclusive, which has created increasing incentives for entrepeneurialism and economic growth.
The gist of the book is, handily enough, covered in the intro and chapter one….
Countries such as Egypt are poor becuase they have been ruled by a narrow elite that have organised society for their own benefit at the expense of the vast mass of people. (This also applies to North Korea, Sierra Leonne, Zimbabwe)
Countries such as Great Britain and The United States are wealthy because their citizens overthrew the elites who controlled power and created a society where political rights were much more broadly distributed, where the government was accountable and responsive to its citzens and where the great mass of people could take advantage of economic opportunties. (This also applies to Japan and Botswana).
Chapter one – so close and yet so different
Starts with a comparison of the two sides of Nogales, half of which lies in Arizona, in the US, the other half in Mexico.
In the Arizonan half the average income is $30 000 U.S dollars, the majority of adults are high school graduates, the roads are paved, there is law and order, most live until over 65. In the Southern half, the average income is three times less and everything else is similarly worse.
The authors point out that the difference cannot be because of environment or culture, it must be because of politics and economic opportuntities.
They also argue that in order to understand the difference, you need to go right back to early Colonialism in the 16th and 17th centuries.
Mexico was the first to be colonised, under a system of slavery and extraction. In the 15th century, the Spanish basically used already existing systems of slavery to their own benefit and extracted mountains of gold and silver, leaving a legacy of elite-governance and a dearth of politcal rights for the majority.
In North America, settled by mainly the English 100 years later, the absence of slavery amongst indiginous populations and much lower population densities meant that slave systems simply would not work, although this didn’t stop them trying for the first twenty years or so. Eventually, however, the orginal settler company (The Virginia company) back in England realised the only way colonialism was going to work was to provide incentives for the settlers – So they offered them land in return for work. It was this that set the basis for the democratic constitution and congress of the US, which then went on to create problems for the English government.
The rest of chapter goes on to argue that the next 300 years of history are crucial to understanding why the US is now so wealthy, and why most of Latin America is so poor.
America has had 300 years of political stability, where poltical institutions control economic institutions, at least to an extent (the authors cite the breaking up of the Microsoft Monopoly as an example) broadly making them work for everyone. Other factors such as the patent system, credit systems, and education provide opportunities for anyone to make it rich and enjoy the benefits of the wealth.
By contrast in Latin America (Mexico), up until the 1990s most countries saw political turmoil and a series of dicatorships where a series of small elites ruled for their own benefit. This instability has lead to the rise of monopoly power, and it acts as a disincentive for anyone to try and do well and become rich (the next dictator might just take all your money away), also lack of finance and education prevents competition anyway.
Crucially, historical good fortune appears to be central to explaining why a country is rich now, so figuring out how a current poor country can develop is not that straight forward if a culture of monopoly, corruption and lack of political rights are the norm…..
Chapter three – the making of prosperity and poverty
This chapter contrasts North and South Korea, divided along the 38th parellel after world war two. In the late 1940s these had similar levels of development, today, however, their economies have diverged.
South Korea has living standards 10 times higher than North Korea, the former being similar to Portugal, the later similar to sub-saharan African countries. People in North Korea also live ten years less than those in South Korea.
The differences cannot be explained by anything other than institutions.
In the South, private property and markets were encouraged (albeit by dictators initially) and thus investment and economic growth were encouraged. At the same time, the government invested in education and new industries took advantage of a better educated population.
In North Korea, privated property and markets were banned, and a centrally planned economy instigated. This simply led to stagnation.
Extractive and Inclusive economic instiutions
Countries differ in their economic success becasue of their different institutions – the rules influencing how the economy works and the incentives that motivate people. Crucial is private property rights – which needs to be backed by the state…. In South Korea, people know that they will be rewarded for their efforts, in North Korea, there is no incentive to innovate and invest because the state will expropriate the benefits of any such initiatives.
In order to develop a society needs to have ‘inclusive economic institutions’ – A state that guarantees prosperity for the massess – Such a state provides a degree of infrastructure that is necessary for economic growth – for example enforcing private property rights, contract rights for all, not just a minority, and providing education and physical infrastructure such as roads. Private enterprise uses and needs such institutions.
What doesn’t work for development is extractive insitutions – where the state is used to extract wealth from one subset of the population to another…. Such as slave and colonial systems (and the Tories in the UK today?)
Engines of Prospertity
Education for the masses is crucial for innovation in an advanced technological world – This is what all developed nations have, and what many undeveloped nations lack. Education needs to be well financed and parents need to have the incentive to send their kids to school.
Inclusive and extractive political institutions
A state needs to be inclusive for economic growth to occur – that is, it needs to both be chosen by its citizens and have a centralized control over legitimate violence.
Extractive political and economic insituttions tend to support eachother (which then means the masses don’t support them…. there is disincentive!)
Why not always choose prosperity?
The simple fact is that where technological change is the engine of economic growth, this means social change, and with change there are winners and losers… Thus existing elites may resist changes that make institutions more inclusive even if this means greater prosperity for all, because it will mean less prosperity for them. (Think industrial revolutions in Europe).
The long agony of the Congo
The Congo has not developed since independence because it has not been in the interests of the ruling elite to build a centralised state which includes all voices, or in their interests to use the state to provide public services which will benefit the masses – instead the institutions remain extractive.
As an independent polity, Congo experienced almost unbroken economic decline and poverty under the rule of Jospeh Mobutu between 1965 and 1997. Mobutu created a set of highly extractive economic insitutions. The citizens were impoverished but Mobutu and the elite around him (known as the Grosses Legumes or The Big Vegetables) became fabulously wealthy. Mobutu built himself a palace at his birthplace, Gbadolite, with an ariport large enough to land a supersonic Concord jet, a plane he frequently rented from Air France for travel to Europe. In Europe he bought castles and owned large tracts of the Belgian capital Brussels.
The simple truth is that if Mobutu had introduced more inclusive economic institutions he would not have been as rich.
Growth under extractive institutions
Growth can occur under extractive instiuttions – as in Russia and South Korea at first and China today but this is unlikely to be sustained unless both economic and political insitutions become inclusive.
Chapter twelve – the vicious circle
The authors paint the vicious circle as starting off with extractive institutions established by a colonial power (which builds on previous extractive institutions), which, on leaving, becomes even more extractive under corrupt post-colonial rulers, which in turn leads to civil war as competing factions fight for control over the extractive instittions – which then leads to a decent into chaos!
Or in more detail… The British Colonial Authorities built extractive instititions which many post independence African politicians were only too happy to continue in order to enrich themselves. This happened in countries such as Sierra Leone, Ghana, Kenya and Zambia. The postcolonial rulers used their wealth to build personalised security forces which were answerable to them and also to rig elections – money thus became essential to maintain power, with only those who have money able to maintain power. This creates incentives among the opposition to depose the existing leaders in order to gain power and wealth themselves, and to protect themselves from being killed off by the said existing leaders. The point here is that power has become an end in itself rather than as a means to developing a country.
This is best illustrated through the example of Sierra Leone -
All of the West African nation of Sierra Leone became a British colony in 1896. The British identified important rulers and and gave them a new title – paramount chief. In Eastern Sierra Leone, for example, they encountered Suluku, a powerful warrior king, who was made Paramount Chief Suluku.
In 1898 the British tried levying a hut tax of five shillings, which resulted in a civil war known as the hut tax rebellion. It started in the north, but was strongest and lasted longest in the South.
In 1904, the British stopped construction of a railway line from Freetown to the North East and instead diverted it south, to Bo, in Mendeland, to give them quick access to put down this rebellion.
When Sierra Leone became independent in 1961 the British handed power to to the SLPP, which attracted support from the South, and in 1967 this party lost the election to the opposition party, the APC which drew support from the North.
Though the railway line was initially established to rule SL, by 1967, its role was economic – it allowed transportation of the country’s exports – coffee, cocoa, and diamonds, which came mostly from Mendeland in the south.
The then leader of the APC, Siaka Stevens, who drew his political support from the north, ripped up the railway line and sold off the track and rolling stock in order to weaken the oppostion in the south and consolidate his political power. This decimated the SL economy, but when it came to a choice between consolidating power and economic growth, the consolidation of power won out. Today, you can’t take the train to Bo anymore.
There is continuity between Colonial rule and Steven’s government – both extracted wealth from the people.
The Colonial rulers did this through agricultural marketing boards – farmers had to sell their goods to these boards, which typically paid much less than the market price (impovershing farmers and enriching the elite). When Stevens took power, he kept these marketing boards in place, but it got worse – under colonial rule, the colonialists extracted about 50% of the value of agricultral products, under Stevens, the rate of extracting rose to 90%.
Along with marketing boards, the old system of Paramount Chiefs remain in place today…. They control local politics at the village level, and local land rights and taxation – Paramount chiefs are elected, but only members of the ruling house can stand – and in 2005 the victor was Sheku Fasuluka, King Suluku’s great, great grandson.
The combination of these two institutions means there is very little incentive for farmers to increase productivity – because they have insecure land rights due to the paramount chief system and are the victim of extractive insitutions in the form of the marketing boards.
Thirdly, there was the control of the diamond mines – The British essentially set up a monopoloy for the entire country and handed it to DeBeers in 1936, and shortly after independence, Stevens simply nationalised this arrangement, through which he effectively personally controlled 51% of the diamonds in SL.
Stevens used his vast fortune to buy political influence and to set up his own private security forces – the ISU (known locally as the ‘I Shoot You’ and the Special Security Division – known as Siaka Steven’s Dogs).
All of this set the scene for the brutal civil war, outlined below….
Chapter 13 – Why Nations Fail Today
In the year 2000 Zimbabwe held a national lottery for everyone who had kept more than 5000 Zimbabwean dollars in their bank account (following a period of hyperinflation). The fact that it was Robert Mugabe who won this lottery just goes to show the extent of his control over Zimbabwe’s institutions and just how extractive those institutions had become.
The most common reasons nations fail today is because they have extractive institutions – and Zimbabwe illustrates the economic and social consequences of these…. By 2008 its per capita income was half that when it gained its independence, and 2009 the unemployment rate stood at 94%.
The roots of the political and economic instiututions lie in the colonial period. Orginally apartheid institutions were establised for a white elite to extract wealth from the country, but when Zimbabwe gained its indendence, these institutions were simply maintained by Mugabe. Eventually (because of lack of inclusivity) his support waned until by the year 2000 he had to find further resources to buy political support – so he expropriated the farms owned by white people and when that wasn’t enough he printed money, which led to massive hyperinflation.
Nations fail today because their extractive institutions do not create the incentives to save, invest and innovate. In many cases politicians stifle economic activity because this threatens their power base (the economic elite) – as in Argentina, Colombia and Egypt. In the cases of Zimbabwe and Sierra Leone this led to total state failure and economic stagnation. The countries in which this has happened include…
- Sierra Leone
And the civil war, mass displacement, famines and epidemics that accompany them… in terms of development many of these countries are poorer today than they were in the 1960s.
A children’s crusade…
This section outlines the causes of the civil war in Sierra Leone. The authors put this down to decades of extractive institutions by the tyrannical APC government (the economy was collapsing by 1985, and they use the example of the TV transmitter being sold by the minister of information in 1987 and in 1989 the country’s main radio antena collapsed, ceasing radio transmissions.) By this point, the army had been dispanded because of the ruling elite feared it might overthrow them, which meant by the time Charles Taylor’s RPF crossed the boarder in 1991 there was no one there to stop them…. And then that brtual and chaotic civil war carried on for a decade – in which competing factions competed over resources in order to keep fighting eachother – diamonds/ children (soliders) and weapons.
So in summary, the historical precendent of the SL civil war is extractive institutions… the hollowing out the state to the point that was incapable of fending off rebels.
The authors now go on to outline three other countries which have suffered from different types of extractive institutions – Colombia, Argentina and Egypt, and then Uzbekistan…. a country languishing under the absolutism of a single family and the cronies surrounding them, with an economy based on the forced labour of children….
Cotton accounts for 45% of the exports of Uzbekistan. When the country was created in 1991, its first and still only president Islam Karimov, divided up the land among farmers, but each was required to devote at least 35% of their land to cotton, a valuable export crop. However, because the farmers themselves receive only a fraction of the world market price of the crop, they had no incentive to maintain, let alone invest in, cotton harvesting machinery.
No matter, however, because the country has turned to children to harvest the cotton, and every September-November the schools are emptied of approx. 2.7 million schoolchildren. Teachers, instead of being instructors, become labour recruiters.
Each child is required to pick between 20-60KG a day, depending on age, and the lucky ones who live close to their allocated farms can walk or bus to work, but the unlucky ones have to sleep over in sheds, with no toilets or wash facilities. And it’s BYO food.
While the market price for cotton was $1.40 in 2006, the children were paid somewhere in the region of $0.01 per kilo.
All of this has come to pass because Karimov has established a regime where opposition is repressed and there is no free media or NGOs allowed.
Why do nations fail?
What all of the countries loooked at in the book have in common is that they have an elite who have designed economic instiututions in order to enrich themselves and perpetuate their power at the expense of the vast majority of people in society.
Despite differences the bigger picture is that in each of these countries extractive political institutions that have created extractive economic insitutions which transfer wealth and power toward the elite.
The solution is to transform the extractive institutions into inclusive ones…
Chapter fourteen – breaking the mould
This chapter looks at three case studies – Botswana, The South of America, and China, which all managed to move from, or negotiate their way around (in the case of Botswana) extractive to inclusive political institutions which encouraged econonomic development.
Of particular interest to me is the case of Botswana – which today has the same level of development as some Eastern European countries, despite being as poor as most of the rest of Sub-Saharan Africa in the 1960s (at which time there were less than 100 graduates in the entire country).
What’s especially interesting about Botswana is that in that particular region of Africa a broadly inclusive political system was in existence pre-colonialsm – in the sense that any individual could rise up to become head of one the various different chiefdoms in the region, and so chiefdom was not hereditory, it was meritocratic, and someone could only be chief with the will of the people. Thus the principal of ruling with the will of the people, and on behalf of the people had been established for generations.
Another factor which promoted development was the fact that the English weren’t particularly interested in Botswana. In fact in the 1890s, three Twsana chiefs visited England and negotiated with the government to be part of a British Protectorate (different to a colony) – In return for protecting the region against Rhode’s South African expansionary policies (the guy who colonised Zimbabwe and Zambia, and look how they turned out!) all Enlgand wanted was enough land to build a railway in order to open up the intererior. For this the Twsana were pretty much left alone, crucially unextracted and without interefering institutions which had been set up to allow the extraction to take place.
Also signficant is that, following Colonialism and the discovery of diamonds, the Tswana chiefs passed a law that all diamond wealth was to be national property, rather than giving the rights to individuals or Corporations (like neoliberals would claim should be done, and like what happened in Sierra Leone). The effect of this was masses of public money which was then used to pay for public services. Hence development……
Something else emphasised in this chapter is that in all three cases certain key actors made important decisions at crucial junctures in the country’s history (when an existing leader died, such as Mao, creating a power vaccum, or when Independence was gained in Botswana) – The decisions taken at these crucial points in history in these countries involved either fighting the power of entrenched elites (as in China) or establishing laws which would prevent political corruption (like nationalising the diamond supplies in Botswana) – it was these decisions, in contrast to decisions in countries like Sierra Leone where a national railline was sold off to benefit an elite, which led to economic development.
Chapter 15 – understanding prosperity and poverty
The most interesting section of this concerns the predictive power of the theory – which is limited given the role of agency and contingency in said theory. However, the authors do predict that…
America and Europe are likely to get even richer than countries in most of the rest of the world, because these are the most inclusive institutions (I’d beg to differ given Tory Policy). Nations that have undergone no signficant state centralisation such as Afghanistan, Somalia and Haiti are unlikely to witness any development. Some Latin American countries are set two grow – most noteably Brazil, Chile Mexico as are some African countries – Tanzania and Ethiopia for example. Growth will not be sustained in China.
The irresistible charm of authoritarian growth…..
This section reminds us that modernisation theory is flawed – economic growth (more Mcdonalds as Thomas Friedman might put it) does not necessarily lead to to more inclusive political institutions.
Plenty of repressive regimes have pursued and achieve very rapid economic growth in the last 60 years – Germany, for example, Russia, and China.
This chapter also deals with what probably won’t work in terms of development… Firstly, any attempt at engineering policy changes such as those attempted by neoliberalisation throughout the 1980s and 90s – Because if a country is politically corrupt, they just subvert the policy changes – Privatisation happens, but the people winning the contracts are the brothers of the ministers for example, or the country says it implements a policy but they just carries on as normal!
You can’t engineer prosperity
…because the actors within developing countries are constrained by their institutions, and if these are extractive then any programmes designed to engineer change will ultimately result in further extraction.
This is true of two approaches to foreign aid preferred by the West – both the neoliberal ‘restructure your economy’ type approach and the micro-economic approach which focuses on specific institutions.
The failure of foreign aid
As above, any aid money going into a country with extractive institutions will ultimately end up being extracted. The authors do argue, however, that even if only 20% of aid money reaches its ultimate destination then it’s worth it!
The chapter and book round off by going back to the English and US revolutions which resulted in institutions becoming more inclusive – what is required for development is a plurality of voices demanding to be heard by government and actually being heard. This cannot be imposed from above, but seems to have to become from below.
In this sense, any attempt to engineer growth and provide aid seem pointless – the only things that make any sense are programmes oriented towards empowerment and making sure media is free because the later fosters the former.
Thoughts and comments….
The comparative analysis of countries and territories in close geographical proximity does seem to rule out the role of environmental and cultural factors in explaning divergent patterns of development, leaving only political and economic institutions.
It fully recognises the importance of the legacy of extraction identified by dependency theory, however, it also puts more emphasis on the already existing extractive institutions which the early colonisers extracted and it recognises the continuation of extraction post-colinalism, acknowledging the fact that corrupt elites also play a role.
This seems to deny the validity of neoliberal theory – the state seems to be crucial in helping development, and the absence of the state seems to be crucial in explaining the descent into chaos and civil war.
This isn’t a deterministic theory – it stresses the importance of agency and contingency at crucial historical junctures.
This is quite a generalist analysis – ‘extractive’ and ‘inclusive’ institutions are very general, broad terms, and there’s lots of variation possible within these voluminous concepts.
The book only draws on a relatively few case studies – and lacks the statistical rigour of, for example, Paul Collier’s Bottom Billion Theory.
The book doesn’t seem to deal with the globalised context of the nation state today within a ‘world system’ – There is no mention (as far as I can see) of the role which TNCs, trade rules, the World Bank might play in allowing a global elite (rather than nationalised elites) to extract regions of the world.
As a final word, what’s maybe most timely (or not timely?) about the book is its suggestion that some kind of political infrastructure which allows a plurality of voices to be heard and wealth to be distributed so it benefits all is crucial to development – it’s time more of us started asking how we might do this at a global, rather than a national level.