Why nations fail? The authors present another theory:
… the economic institutions are critical for determining whether a country is poor or prosperous, it is politics and political institutions that determine what economic institutions a country has.
The prosperity is ultimately driven by the advancement of productivity with exceptions for resource-rich countries such as Saudi Arabia. The farmers and workers could be incentivized to work hard, or discouraged to slack by the economics institutions. More importantly, innovation requires a skilled workforce, which depends on the political institutions providing the public services. Innovations can also be disruptive to create winners and losers, which may pose challenges for the political institutions to accommodate.
Extractive vs Inclusive
There are two types of economic and political institutions:
- extractive: such institutions are designed to extract wealth from one subset of society to benefit a different subset.
- inclusive: the opposite of extractive, the institutions are designed to represent the common interests, aka pluralism.
The authors argue that the poverty is caused by the elites who make explicit choices, such as extractive economic and political institutions to create poverty. This seems counterintuitive at the first glance, but in the Dictator’s handbook, we already know the politics is about getting and keeping political power. A dictator only needs to buy out a small winning coalition, even at the cost of public wellbeing.
Case study: Mexico vs. United States
This theory explains why United States prospers while Mexico is less developed. Both of them are victims of unfortunate geography according to Jared Raymond’s theory. Mexico, i.e Aztec empire was more advanced in terms of economic and political development, but why it lost the edge after colonization?
After some 500 Spanish conquistadors captured the Aztec emperor Montezuma II by 1519, they managed to establish an extracting economic institution encomienda to demand tributes of gold and silver, and forced labor. During the Mexican War of Independency, Agustin de Iturbide rose to the top, proclaimed president in 1821, then Emperor in 1822. The dependency of Mexico did NOT stop the extracting economy, instead the succeeding dictators, such as Porfirio Díaz consolidated his power by privatizing the indigenous landholdings.
The English settlers tried to replicate the extracting economic institutions in Jamestown, NC in 1607, but failed miserably. There were no centralized political power to coerce, or precious metals to extract, or indigenous tribes for forced labor. They figured out to make this colony successful, they must provide incentives for settlers to work harder. This paved the foundation for a more inclusive institution. The Independency war opened the door for industrialization.
Almost all of the poor countries today can link to the extracting economic institutions:
- Sub-Saharan Africa: the colonization of Scrambled for Africa, and slavery trade.
- Latin America: various extracting economics institutions, such as encomienda in Mexico, mita in Peru.
- Middle East: colonization by Ottoman Empire.
- South and South East Asia: the European colonization.
Since most nations went through some kinds of extracting institution, such as the feudalism in medieval Europe and sub-Saharan colonies, why some managed to escape the vicious cycle, while other did not?
The German sociologist Robert Michels called it the icon law of oligarchy. On the juncture when the old regime was overthrown, the new leader might find it convenient and effective to leverage the extracting institution to secure the financial sponsorship for his supporters. This vicious circle can be broken only if the newly established political institution was inclusive, and some non-extractive economics were developed, and of course luck.
Before the Glorious Revolution to deposit James II and James VII on 1689, the Magna Carta had been in place on 1215 to limit the royal power: the royalty could not have a monopoly for the trans-Atlantic trade, and had to beg parliament to raise tax. Also the William III of Orange had no intention to dictate just like George Washington.
On the contrary, Spain had influx of massive wealth from Latin America, the royalty did not need to rely on tax raise and could have a tight grip of power. The monopoly of power prevented the Spain to embrace the industrialization and cost their world leader role.
Jeffery Sachs consider the clinical economic approach not only could stop the hyperinflation, but end the poverty with the financial aids from developed countries. In the reality, the financial aid was vastly wasted, and often siphoned by the dictators to consolidate their powers.
The economy can grow under the extractive political institutions, such as Soviet Union by relocating resource from agriculture to industry. But the growth could not sustain because the common interests are not aligned with the authoritarian government.