Inclusive and Extractive Institutions: Raison d’être of Prosperity and of Poverty among Nations
In the book Why Nations Fail, its main thesis focuses on institutions as determinant of prosperity or poverty among nations. But what kind of institutions, you ask? In this case, the book categorized two kinds of institutions: inclusive and extractive. It ultimately associates inclusive institutions with prosperity, and extractive institutions with poverty. But what exactly are these two to be specific? This will be our topic for today’s discussion.
But before we proceed in discussing the mentioned institutions, let’s first grasp why the term “nation” is preferred and not other abstruse political terms like the “state".
Disclaimer: The book as of reading still has not explicitly discussed why the authors preferred “nation” instead of a “state”. So, it is important to note that this discussion is purely my own analysis.
Nation vs. State
First, let’s define the two. Nation is a cultural concept. This term refers to an identity that is common to a group of people such as but not limited to tradition or way of life, language, and history. Pirates or groups of bandits, so long as they are bonded with elements common among them and are etched to their identities, are technically considered nations.
State on the other hand is a political concept. This refers to the sovereign or power of a country, its government, and laws and jurisprudence. Philippines is an example of a state.
Moreover, to deepen the discussion, there are instances where there can be many nations in a state, and vice-versa.
An example of a many nations in a state is the ethnically diverse United States. They have White and Black Americans along with Asian Americans and indigenous native Americans and many more.
Philippines also is an example of a many nations in a state. Why? We are ethnically diverse. We have dominant Filipino-Christians and Filipino-Muslims, and on the minority, we also have hundreds of indigenous and tribes scattered among thousands of islands the country is composed of, not to mention with its hundreds of languages.
Meanwhile, a good example of a many (2) states in a nation is the Korean Peninsula being politically divided in the 38th parallel rendering it into South and North Korea. They share common history, ethnicity, language, and culture. However, they are boldly demarcated in terms of politics, government and ideology: communism and capitalism, and democratic and authoritarian; thereby converting once a unified nation into two hostile states. Hongkong (before the 1997 Handover) and China is also an example of a many (2) states in a nation.
Why nations rather than of a state?
We had already compared the terminologies of a nation and a state and discussed some examples. But why is it that nation is preferred?
As discussed earlier, the prosperity or poverty among nations catalyzed deep into its micro-levels in the form of culture, critical junctures in its history, and among others. But you have posited that it is the kind of institutions (inclusive and extractive) that determine those? Which is which?
It is important to note that no institutions are instantly built in a snap out of nothing and loomed unobliterated over to its subjects. Institutions also are product of a nation. In the book “Origins of Political Order” by Francis Fukuyama exhibited this notion that institutions in the form of political order and stability are product of the complexity of human evolution and its development. Simply put, it is a byproduct of human struggles.
If a nation is enthralled upon divine recognition, they have the tendency to produce monarchical or theocratic kind of government. If a nation experienced critical junctures in its history of accountability, just as during the pre-revolution in United States and the Glorious Revolution in England, they have the tendency to produce a democratic kind of government. Therefore, we can conclude that state is a product of nation. After all, the concept of state is relatively new: a product of the Treaty of Westphalia.
So, if the institutions encapsulated into a state are product of a nation, it is of prudence to scrutinize the factors that lead up to the formation of the kind of institutions different nations now have.
Hence, this answers why nation is preferred because precisely we look at the factors and critical junctures that lead up to the formation of institutions, of either an inclusive or extractive one, rather than looking at a state as a whole.
Inclusive Institutions (Economic and Political)
Inclusive economic institutions are those that “allow and encourage participation by the great mass of people in economic activities that make best use of their talents and skills that enable individuals to make the choices they wish to make.” Inclusive in the sense that it decentralizes by means of considering the people or the public at large in flourishing the market or economy.
To be inclusive, the book further discussed, “economic institutions must feature secure private property, an unbiased system of law, and a provision of public services that provides a level playing field in which people can exchange and contract; it also must permit the entry of new businesses and allow people to choose their careers.”
To be an institution inclusive economically, it needs the government to set the rules and secure order to spearhead this endeavor of inclusivity which will reap prosperity. This can be in form of policies the legislative enacted, the manner in which laws are executed by the executive, and the precedents of jurisprudence the judiciary penned. The economic institutions needed the whole instrumentalities of the government. This means that for a market or economy to be inclusive the kind of politics also needs to be inclusive. Politics is thus an avenue in setting up the rules for the kind of economic institutions to be established.
Extractive Institutions
Extractive institutions on the other hand are institutions that are “designed to extract incomes and wealth from one subset of society to benefit a different subset.” Extractive institutions are an outright opposite to the inclusive ones. It is extractive in the sense that it extracts the opportunities such as wealth and even ideas from the people for the benefit of the few. Extractive institution happens when there is little to no incentives or motivation at all of the people to invest, propose innovative ideas, and participate in the flourishment of the market or the economy in general.
As a tendency, businessmen, entrepreneurs, investors, and the public at large will shy away if there is no assurance that their private property will be protected, there is an institutional biased system in law, and when the policies enacted tend to favor only a particular group such as the elites or the ruling class. As a result, this leads to stagnation and eventually a recession of the economy in which this kind of institutions loom over. Hence, a poverty for the nation.
If inclusive institutions are the template in order for the nation to prosper economically, then why others not or cannot be inclusive?
Creative Destruction
The reason why extractive institutions of a nation tend to persist and sometimes has no sight of transitioning to an inclusive one, which is conducive to prosperity, is because of this reason: the fear of creative destruction.
Extractive institutions are preserved precisely because there are vested interests in which the ruling or the people that greatly benefited from this are afraid to loss if an institutional reform will transpire. This is the reason why countries such as North Korea, a large part in Africa, and many other countries tend to preserve their extractive institutions at the expense of their public at large because solely the classes that controls the power immensely benefitted from it.
They fear creative destruction because when there is a reform or innovation, not just isolated in form of technology, it has the potential to destruct the current status quo. It is creative destruction in a sense that it creates and thus replace the old with the new. This become problematic and a setback for those people, often few and are elites. That is also why extractive institutions tend to be left behind in comparison with the progress of its neighbors and other countries in different regions because it does not have the incentives for the people to participate — such as entrepreneurs, scientists, and many gifted minds that have the possibility to yield progress. Why would they at the first place when the institutions that looms over them do not even consider their abilities at the first place, unless their abilities will preserve or may advance the interests of the people who benefitted from the status quo.
Indeed, so long that their greedy tendencies will overwhelm, an institutional reform or a transition to an inclusive institution will remain overlooked and perpetually the cause of why nations fail.
Here I discussed more about the concept of creative destruction.
