Extractive Institutions Defined

EXTRACTIVE INSTITUTIONS (p. 76): We call such institutions, which have opposite properties to those we call inclusive, extractive economic institutionsextractive because such institutions are designed to extract incomes and wealth from one subset of society to benefit a different subset.

Inclusive Institutions Defined

INCLUSIVE INSTITUTIONS (p. 74): Inclusive economic institutionsare those that allow and encourage participation by the great mass of people in economic activities that make best use of their talents and skills and that enable individuals to make the choices they wish.

More on Inclusive Institutions

(p. 75): Inclusive economic institutions foster economic activity, productivity growth, and economic prosperity. Secure private property rights are central, since only those with such rights will be willing to invest and increase productivity. A businessman who expects his output to be stolen, expropriated, or entirely taxed away will have little incentive to work, let alone any incentive to undertake investments and innovations. But such rights must exist for the majority of people in society. (p. 76): Inclusive economic institutions create inclusive markets, which not only give people freedom to pursue the vocations in life that best suit their talents but also provide a level playing field that gives them the opportunity to do so. Those who have good ideas will be able to start businesses, workers will tend to go to activities where their productivity is greater, and less efficient firms can be replaced by more efficient ones.

SO WHY DO INSTITUTIONS MATTER?

Creative Destruction

As noted in Why Nations Fail New technology replaces past technology (i.e. creating new ideas destroys past ideas). Therefore, the process of create destruction tells us that people who benefit from existing technology will see new technology as a threat. If the people who benefit from existing technology are making decisions for society, that society will not tend to adopt new technology. And therefore, that society will not see economic growth.

The Importance of Inclusive Institutions

Just to review

economies can only grow persistently if new technologies are adopted leaders in a society dominated by extractive institutions will see new technology as a potential threat

Therefore only societies that adopt inclusive institutions will see persistent economic growth.

Why Extractive Institutions Dont Lead to Growth

Why Nations Fail (p.430) What is crucial, however, is that growth under extractive institutions will not be sustained, for two key reasons. First, sustained economic growth requires innovation, and innovation cannot be decoupled from creative destruction, which replaces the old with the new in the economic realm and also destabilizes established power relations in politics. Because elites dominating extractive institutions fear creative destruction, they will resist it, and any growth that germinates under extractive institutions will be ultimately short lived. Second, the ability of those who dominate extractive institutions to benefit greatly at the expense of the rest of society implies that political power under extractive institutions is highly coveted, making many groups and individuals fight to obtain it. As a consequence, there will be powerful forces pushing societies under extractive institutions toward political instability.

Political Monopoly?

KEY IDEA: If one group has a political monopoly, then a society will not likely embrace technological change. In other words, there has to be a possibility that everyone in society can enjoy a leadership position.