Inclusive institutions as Linchpin to prosperity

Economic growth is not just a process of innovative technologies, better machines, more and better educated people, but also trans- formative  and destabilising processes associated with creative destruction. Powerful groups with vested interests often stand against engines of prosperity and economic growth.

We see in our daily lives at individual level that achievers do things differently as compare to non achievers. On magnified scale this is valid for companies, organisations, communities and countries. Failed states or third world countries are primarily plagued by certain analogous attributes. which include authoritarian style governments, lack of political centralization, extractive institutions, absence of pluralism, vertically integrated political system.

Economic and political institutions configure incentives for businesses, individuals and politicians, each society operates by set of certain economic and political rules created and enforced by state and citizens collectively. We see this in more detail by taking different examples and see how the industrialised countries evolved from retrogressive to progressive societies.

Lets start by looking at industrial revolution which started in England . its first success was to revolutionise cotton cloth production using new machines which were powered by water wheel and later by steam engines.

First country to experience sustained economic growth was Britain union of England, wales and Scotland after 1707. Growth emerged in later half of 18^th century with industrial revolution and it outspread  to more than 30 countries which are now amongst the richest countries in the world.

Broad distribution of political rights in US have created equal opportunities to access finance and loan, and people can have check at politicians and their cronies who create monopolies for themselves. 

City of Nogales for example is divided between Arizona, located in santa cruz county in US and Sonora in Mexico. Household average income in Sonora Nogales is one third that of Nogales in santa cruz county in Arizona US .

There is a little relationship between religion and economic successes of modern era, France which was predominantly catholic country mimicked economic performance of Dutch and English in 19^th century, made road to prosperity. This happened due to inclusive institutions and by creating incentives for common people and public participation in decision making after French revolution.

Economic success has nothing to do with Race, creed or ethnicity. Uruguay and Argentina have far more bigger population of European descendants but both of these countries are poor. While Singapore and Japan have barely any European descendants but these countries put together remarkable progress.

Korean Peninsula:

South Korea has living standards close to Spain and Portugal while North Korea is close to sub Saharan African countries.

South Korea was not democratic country in the beginning . Both Rhee and his successor General Park Chung- Hee were authoritarian presidents. General Park in 1961 despite being an authoritarian leader put his weight behind the market economy. In south Korea investment was encouraged and politicians invested in education . South Korean industries were quick to pick educated people within the country which boomed industrialisation and resulted in higher exports and innovation.

Rapid industrialisation took place in South Korea where General Park came into power after coup in 1961 with US support. General Park was not a democrat but he made economic institutions more inclusive which manifested in the form of growth. 1980s South Korea transformed politically after the assassination of General Park in 1979. Assassination of General Park was followed by another military coup by Chun Doo-Hwan . Chun’s successor Roh Tae Woo initiated political reforms which led to consolidation of political pluralistic democracy. This thing didn’t happen in Soviet union and their growth ran out of steam in 1970s. Although USSR showed industrial growth between 1930 and 1970 under extractive institutions.

South Korea is a market economy with free institutions where people get good education and get incentives which encourage them to exert effort and excel in chosen field. Inclusive political and economic institutions encourage people to exhibit their talents, skills and make the choices freely. Government ensures level playing field where people can exchange and contract.

In North Korea people had no property rights so they had no incentive to invest or put an effort to increase productivity. In 1990 there was 10 fold gap between south and north Korea. In North Korea education curriculum is a mere propaganda, much to shore up the legitimacy of the regime where everyone has to spend 10 years in Army after finishing the education.

Countries with similar environment, culture, race, dietary habits are so different , answer is to be looked at institutions. Difference is lack of public participation in decision making and giving them respect as the biggest stake holders.

Inclusive institutions:

Secure property rights are central to inclusive economic institutions. Since only those with such rights will be willing to invest and increase productivity. A businessman who expects his output to be stolen, expropriated and entirely stolen by taxes will have little rational motive to work.

Inclusive institutions pave the way for two other engines of prosperity i.e technology and education. Sustained economic growth is almost accompanied by innovation.

The low education level for poor countries is caused by extractive economic and political institutions that fail to force the government to build, finance and support schools and the wishes of parents and children.

Inclusive political institutions distribute power broadly in society, instead being vested in a single individual or narrow group, political power rests with plurality of groups. On the other hand in Somalia there is no political centralisation. Power is so pluralistically distributed in antagonistic clans. This infighting between clans, tribes and groups with vested interest destabilise the country.Power of one clan is constrained by the guns of another clan. This lack of political centralisation and antagonistic pluralism results in chaos.

Botswana got independence in 1966, At that time it had 12 km of paved roads, 22 students graduated from university, 100 from secondary school, in next 45 years Botswana became on of the fastest growing country in the world with highest GDP in sub-Saharan Africa. It is by virtue of inclusive political and economic institutions. As compared to other African countries where majority of people have no food, clothes, clean drinking water and deprived of basic amenities of life, Botswana made real progress. Education rate is more than 80% ,Students are provided with full scholarships with living expenses in the University, elections are held regularly. Institutions are free from political influence. Due to inclusive political and economic institutions there is good political centralisation in the country.

USSR: After the death of Lenin came  joseph stalin came to power in 1927 who diverted resouces towards industry at the cost of agriculture . Bolsheviks built powerful centralized state and allocated all resources towards industry. people were not allowed to have their own land, Which led to decline in agriculture output and finally Soviet union suffered worst famine and more than 6 million people died because of that. Mikhael Gobachev started to move from extractive economic institutions after 1987, the power of communist party crumbled and with it, Soviet union.

Extractive institutions:

Extractive institutions are parasitic in nature. Its a parasitic relationship between two segments of societies, where one subset is benefited at the cost of other . Absolutist or Authoritarian regimes discourage inclusive institutions and don’t want economic institutions to prosper, because pluralism and public empowerment would eventually tone down their political might.

Extractive institutions by their very logic create growth to give benefit to the ruling elite. Growth under extractive institutions is different from growth under inclusive institutions. Because it is not sustainable as it is based on existing technologies and lack innovation. While in inclusive institutions growth involves technological advancement, encouraged by public participation and innovation.

The extractive institutions can not generate sustained technological change for two reasons. Lack of economic incentives and resistance by elites, based on protectionism so that Elitist of elites and their cronies can benefit from the system.

Extractive institution create extra ordinary incentives for the ruling elite. Which encourages other elite to replace the current elite. Infighting and instability are thus inherent attributes of extractive institutions. This creates political decentralization and further inefficiencies leading to break down of law and order and descent into chaos.

Afghanistan, Haiti, Somalia and Nepal are located in different parts of the world but they have much in common institutionally with most nations in sub Saharan Africa, thus more of the poorest countries in the world.

Economic growth and prosperity:

British soceity which evolved politically by people empowerment and this led to the industrial revolution driven by textile industry. Like an emotional contagion this also revolutionized the world economy. Industrial revolution made biggest strides in England because of its inclusive political and economic institutions. It was glorious revolution that made political institutions that strengthened and rationalized property rights , improved financial markets, undermined state- sanctioned monopolies in foreign trade and removed the barriers to the expansion of industry. Glorious revolution actually opened up the political system and made it receptive to the economic needs and public aspirations .

After Glorious revolutions in England , inclusive institutions came into being and industrialisation started. US and Australia followed the suit and joined the path to industrial growth and prosperity.

French revolution in 1789 led to end of absolutism and opened the way for inclusive institutions. This happened not only in France but in other European countries as well.

Once in a society pluralism and rule of law is established, there would be demand for even greater pluralism and greater participation in the political process. Not all radical changes are doomed to failure. Glorious revolution was one of the most important political revolution of known history. French revolution was even more radical with its chaos and excessive fierceness and ascent of Napoleon Bonaparte.

England didn’t become democracy by Glorious revolution of 1688 . A pluralistic society started developing. Once pluralism was enshrined . there was propensity of institutions to become more inclusive overtime.

Inclusive economic and political institutions enforce property rights, level playing field, encourage investment in new technologies and skills that are more conducive to economic growth. Inclusive economic institutions are backed up by inclusive political institutions . political rights are distributed, resulting in political centralisation helping to establish law and order foundations of secure property rights and inclusive market economy. 

Note: Inspired by the work of Thomas Friedman, Micheal Mendelbaum, Paul collier, James Robinson and Daron Acemoglu.