Why Nations Fail Illustrated
Lecture 2
Inclusive vs Extractive institutions
October 9, 2018
Masayuki Kudamatsu
Chapter 3 (except the last section)
Weeks 2-4: How institutions affect prosperity
October 9
Chapter 3
October 16
Chapter 7
October 23
Chapter 8
North/South Korea
the Congo
How institutions matter for prosperity
Why did
Industrial Revolution
take place
in England?
History of England
from 13c to 19c
Extractive institutions cause poverty
Inclusive institutions lead to prosperity
Ottoman Empire
Austria-Hungary
Russian Empire
Ming/Qing dynasties
Ethiopia
Somalia
A concept proposed by Douglas North
(Nobel laureate in 1993)
Review 1: Institutions
"humanly devised constraints that structure political, economic and social interactions"
e.g.
When college graduates find a job
Japan
before graduation
Most countries
after graduation
Douglas North (1991) Institutions, p. 3
vs
Review 2: Drivers of Economic Growth
Economic growth
Investment
Innovation
1
Defining Feature of Economics #1
Individuals choose
the best
affordable
option
Optimization
Review 3
Economic Institutions
Political Institutions
Income inequality across countries
Summary of Why Nations Fail's theory
Rich
Poor
Inclusive
Extractive
Inclusive
Extractive
Economic Institutions
Political Institutions
Income inequality across countries
Today's Road Map (1 of 3)
What are inclusive/extractive economic institutions?
How do they affect economic growth?
1
Economic Institutions
Political Institutions
Income inequality across countries
Today's Road Map (2 of 3)
What are inclusive/extractive political institutions?
How do they shape economic institutions?
2
Economic Institutions
Political Institutions
Income inequality across countries
Today's Road Map (3 of 3)
Class discussion (for term paper preparation)
Does this framework helps us understand
Japan's economic growth after WWII ?
3
Economic Institutions
Political Institutions
Income inequality across countries
What are inclusive/extractive economic institutions?
How do they affect economic growth?
Today's Road Map (1 of 3)
1
| economic institutions | ||
|---|---|---|
| Secure for everyone |
Property rights | Insecure for majority of people |
| Free | Occupational choice |
Forced labor |
| Free | Entry of new businesses | Prevented by monopolies |
| Unbiased | System of laws | Biased for the powerful/rich |
| Promoted | Public service provision | Discouraged |
Economic Institutions
Inclusive
Extractive
Property rights
Occupational choice
Entry of
new businesses
System of laws
Public service provision
| economic institutions | ||
|---|---|---|
| Secure for everyone |
Property rights | Insecure for majority of people |
| Free | Occupational choice |
Forced labor |
| Free | Entry of new businesses | Prevented by monopolies |
| Unbiased | System of laws | Biased for the powerful/rich |
| Promoted | Public service provision | Discouraged |
Economic Institutions
Inclusive
Extractive
Property rights
Occupational choice
Entry of
new businesses
System of laws
Public service provision
Property rights
Incentive to invest & innovate
Secure
Own land and what it produces
Grow fruit trees, to eat/sell fruits
e.g.
Property rights
Incentive to invest & innovate
Insecure
e.g.
Thieves will steal what land produces
No incentive to grow fruit trees
Government will confiscate your land
Property rights
Incentive to invest & innovate
Insecure
e.g. North Korea
Private properties outlawed
No one invest/innovate in agriculture
Frequent famines
Property rights
Incentive to invest & innovate
Insecure
e.g. The Congo in 15c-16c
Arbitrary taxation
Farmers reluctant to use
wheels / plows
brought by Europeans
e.g.
Everytime
king's beret
fell off
Property rights
Incentive for anyone to invest & innovate
Secure for everyone
Someone
with talent
Invest/innovate
You never know who has talent at any point in time
Someone
without talent
Invest/innovate
Sustained economic growth
Provide better products
Business fails
Property rights
Incentive for a few to invest & innovate
Insecure for many
Someone
with talent
& secure
In short run
Invest/innovate
Provide better products
Someone
with talent
& insecure
Don't invest/innovate
Short-run
Economic
growth
Property rights
Incentive for a few to invest & innovate
Insecure for many
Someone
with talent
& secure
Unsustained Economic growth
Someone
with talent
& insecure
Don't invest/innovate
Someone
without talent
& secure
Keep selling outdated products
In long run
Barbados in 1680 (as an English colony)
175 sugar planters own most of land
Of population of around 60,000
39,000 are slaves
no property rights
for land or even themselves
Secure property rights only for a few
| economic institutions | ||
|---|---|---|
| Secure for everyone |
Property rights | Insecure for majority of people |
| Free | Occupational choice |
Forced labor |
| Free | Entry of new businesses | Prevented by monopolies |
| Unbiased | System of laws | Biased for the powerful/rich |
| Promoted | Public service provision | Discouraged |
Economic Institutions
Inclusive
Extractive
Property rights
Secure for everyone
Insecure for
majority of people
Occupational choice
Entry of
new businesses
System of laws
Public service provision
| economic institutions | ||
|---|---|---|
| Secure for everyone |
Property rights | Insecure for majority of people |
| Free | Occupational choice |
Forced labor |
| Free | Entry of new businesses | Prevented by monopolies |
| Unbiased | System of laws | Biased for the powerful/rich |
| Promoted | Public service provision | Discouraged |
Economic Institutions
Inclusive
Extractive
Property rights
Secure for everyone
Insecure for
majority of people
Occupational choice
Entry of
new businesses
System of laws
Public service provision
Occupational Choice
Incentive to educate yourself
Free to choose your job
It's a property right on your own labor
Scientific discoveries
+
Make new technologies more usable
Innovation
Occupational Choice
Incentive to educate yourself
Free to choose your job
It's a property right on your own labor
Innovation
e.g. North Korea
10 years of military services after finishing school
Occupational Choice
Incentive to educate yourself
Free to choose your job
It's a property right on your own labor
Innovation
e.g. The Congo in 15c-16c
Slaves work for the elite's plantations
| economic institutions | ||
|---|---|---|
| Secure for everyone |
Property rights | Insecure for majority of people |
| Free | Occupational choice |
Forced labor |
| Free | Entry of new businesses | Prevented by monopolies |
| Unbiased | System of laws | Biased for the powerful/rich |
| Promoted | Public service provision | Discouraged |
Economic Institutions
Inclusive
Extractive
Property rights
Secure for everyone
Insecure for
majority of people
Occupational choice
Free
Forced labor
Entry of
new businesses
System of laws
Public service provision
| economic institutions | ||
|---|---|---|
| Secure for everyone |
Property rights | Insecure for majority of people |
| Free | Occupational choice |
Forced labor |
| Free | Entry of new businesses | Prevented by monopolies |
| Unbiased | System of laws | Biased for the powerful/rich |
| Promoted | Public service provision | Discouraged |
Economic Institutions
Inclusive
Extractive
Property rights
Secure for everyone
Insecure for
majority of people
Occupational choice
Free
Forced labor
Entry of
new businesses
System of laws
Public service provision
Entry of New Businesses
Those with best ideas can produce
Free to enter any industry
It's a property right on your company in the future
Innovation
e.g. Book market
Free to enter
in U.S.
Jeff Bezos set up Amazon
We can now buy books online
Entry of New Businesses
Those with best ideas can produce
Free to enter any industry
It's a property right on your company in the future
Innovation
e.g. North Korea
Markets are banned
Entry of New Businesses
Those with best ideas can produce
Free to enter any industry
It's a property right on your company in the future
Innovation
e.g. The Congo in 15th/16th centuries
King and his associates monopolize
long-distance trade & mercantile activities
| economic institutions | ||
|---|---|---|
| Secure for everyone |
Property rights | Insecure for majority of people |
| Free | Occupational choice |
Forced labor |
| Free | Entry of new businesses | Prevented by monopolies |
| Unbiased | System of laws | Biased for the powerful/rich |
| Promoted | Public service provision | Discouraged |
Economic Institutions
Inclusive
Extractive
Property rights
Secure for everyone
Insecure for
majority of people
Occupational choice
Free
Forced labor
Entry of
new businesses
Free
Prevented by
monopolies
System of laws
Public service provision
| economic institutions | ||
|---|---|---|
| Secure for everyone |
Property rights | Insecure for majority of people |
| Free | Occupational choice |
Forced labor |
| Free | Entry of new businesses | Prevented by monopolies |
| Unbiased | System of laws | Biased for the powerful/rich |
| Promoted | Public service provision | Discouraged |
Economic Institutions
Inclusive
Extractive
Property rights
Secure for everyone
Insecure for
majority of people
Occupational choice
Free
Forced labor
Entry of
new businesses
Free
Prevented by
monopolies
System of laws
Public service provision
System of Laws
Law-breakers will be punished
Unbiased
Discourage unlawful behavior
Victims will be compensated
+
Incentive to invest & innovate
Ensure the enforcement of secure property rights etc.
Barbados in 1680 (as an English colony)
175 sugar planters own most of land
Of population of around 60,000
29 of 40 judges
: large planters
8 most senior military officers
: large planters
| economic institutions | ||
|---|---|---|
| Secure for everyone |
Property rights | Insecure for majority of people |
| Free | Occupational choice |
Forced labor |
| Free | Entry of new businesses | Prevented by monopolies |
| Unbiased | System of laws | Biased for the powerful/rich |
| Promoted | Public service provision | Discouraged |
Economic Institutions
Inclusive
Extractive
Property rights
Secure for everyone
Insecure for
majority of people
Occupational choice
Free
Forced labor
Entry of
new businesses
Free
Prevented by
monopolies
System of laws
Unbiased
Biased for
the powerful / rich
Public service provision
| economic institutions | ||
|---|---|---|
| Secure for everyone |
Property rights | Insecure for majority of people |
| Free | Occupational choice |
Forced labor |
| Free | Entry of new businesses | Prevented by monopolies |
| Unbiased | System of laws | Biased for the powerful/rich |
| Promoted | Public service provision | Discouraged |
Economic Institutions
Inclusive
Extractive
Property rights
Secure for everyone
Insecure for
majority of people
Occupational choice
Free
Forced labor
Entry of
new businesses
Free
Prevented by
monopolies
System of laws
Unbiased
Biased for
the powerful / rich
Public service provision
Public Service Provision
Provided by govt
The smart but poor can run business
Innovation
Transportation (roads, railways)
Telecommunication
Education
Health care
Public Service Provision
Provided by govt
The smart but poor can run business
Innovation
e.g. South Korea
Government has invested in education
Public Service Provision
Provided by govt
The smart but poor can run business
Innovation
e.g. North Korea
Education = Propaganda to legitimize the communist party
| economic institutions | ||
|---|---|---|
| Secure for everyone |
Property rights | Insecure for majority of people |
| Free | Occupational choice |
Forced labor |
| Free | Entry of new businesses | Prevented by monopolies |
| Unbiased | System of laws | Biased for the powerful/rich |
| Promoted | Public service provision | Discouraged |
Economic Institutions
Inclusive
Extractive
Property rights
Secure for everyone
Insecure for
majority of people
Occupational choice
Free
Forced labor
Entry of
new businesses
Free
Prevented by
monopolies
System of laws
Unbiased
Biased for
the powerful / rich
Public service provision
Provided
Limited
| economic institutions | ||
|---|---|---|
| Secure for everyone |
Property rights | Insecure for majority of people |
| Free | Occupational choice |
Forced labor |
| Free | Entry of new businesses | Prevented by monopolies |
| Unbiased | System of laws | Biased for the powerful/rich |
| Promoted | Public service provision | Discouraged |
Economic Institutions
Inclusive
Extractive
Property rights
Secure for everyone
Insecure for
majority of people
Occupational choice
Free
Forced labor
Entry of
new businesses
Free
Prevented by
monopolies
System of laws
Unbiased
Biased for
the powerful / rich
Public service provision
Provided
Limited
Incentive
to invest & innovate
Transfer wealth from
one group to another
Evidence for secure property rights leading to prosperity
Source: Figure 2 of Acemoglu, Johnson, and Robinson (2001)
| economic institutions | ||
|---|---|---|
| Secure for everyone |
Property rights | Insecure for majority of people |
| Free | Occupational choice |
Forced labor |
| Free | Entry of new businesses | Prevented by monopolies |
| Unbiased | System of laws | Biased for the powerful/rich |
| Promoted | Public service provision | Discouraged |
Economic Institutions
Inclusive
Extractive
Property rights
Secure for everyone
Insecure for
majority of people
Occupational choice
Free
Forced labor
Entry of
new businesses
Free
Prevented by
monopolies
System of laws
Unbiased
Biased for
the powerful / rich
Public service provision
Provided
Limited
State
= Monopoly of legitimate violence
Economic Institutions
Political Institutions
Income inequality across countries
What are inclusive/extractive economic institutions?
How do they affect economic growth?
Today's Road Map (1 of 3)
1
Economic Institutions
Political Institutions
Income inequality across countries
What are inclusive/extractive political institutions?
How do they shape economic institutions?
Today's Road Map (2 of 3)
2
A concept proposed by Douglas North
(Nobel laureate in 1993)
"humanly devised constraints that structure political, economic and social interactions"
Douglas North (1991) Institutions, p. 3
Economic Institutions
Society
Economic Institutions
Society
Politics
Political Institutions
Inclusive
Extractive
Both
Plurality
and
Centralized
State
Either
Absolutist
or
Lack of
Centralization
Political institutions are ...
Economic Institutions
Political Institutions
if extractive...
(as in 16c-17c Congo)
Slaves
excluded from politics
Slaves have to work for plantation owners
Economic Institutions
Political Institutions
if extractive...
(as in North Korea)
Communist party dominates politics
Non-members have no freedom in economic activities
Economic Institutions
Political Institutions
if inclusive...
(as in South Korea)
The powerful cannot impose their will upon the rest of society
Extractive institutions won't be set up
Economic Institutions
Political Institutions
Income inequality across countries
Today's Road Map (2 of 3)
2
There's feedback
from economic institutions
Economic Institutions
Political Institutions
if extractive...
The powerful gets richer
The powerful can stay in power by violence
e.g. mid-17c Congo
King is free to take anyone's possessions
Standing army of 5,000 troops
Buy guns from Europeans
Economic Institutions
Political Institutions
if inclusive...
Equal distribution of wealth
The powerful cannot stay in power forever
Inclusive Economic Institutions
Inclusive Political Institutions
Synergy
Extractive Economic Institutions
Extractive Political Institutions
Synergy
Inclusive Economic Institutions
Extractive Political Institutions
Why not?
Economic growth
Elite gets richer
as well
Extractive Political Institutions
Why not?
Economic growth
Elite gets richer
as well
Plurality
&
Centralized State
Economic Growth
Winners
&
Losers
Creative destruction
Losers = Powerful
Why not plurality?
Extractive Econ Instit.
to prevent creative destruction
If
Fear of violent opposition to centralize
Evenly balanced power across groups
+
Why not centralized state?
Fear of being exploited by state
Fear of violent opposition to centralize
Evenly balanced power across groups
+
Why not centralized state?
Fear of being exploited by state
e.g. Congo after 1960
National territory includes
many pre-colonial societies
Fear of violent opposition to centralize
+
Why not centralized state?
Fear of being exploited by state
e.g. Congo after 1960
Katanga and Kasai provinces attempted to secede in 1961
Inclusive political institutions
Plurality
for non-violent political power
No plurality
for violent political power
(Monopoly by the centralized state)
+
=
Note that plurality has two dimensions
Economic Institutions
Political Institutions
Income inequality across countries
Today's Road Map (2 of 3)
2
Economic Institutions
Political Institutions
Income inequality across countries
Today's Road Map (3 of 3)
Class discussion (for term paper preparation)
Does this framework helps us understand
Japan's economic growth after WWII ?
3
Class discussion time
Does Why Nations Fail's theory explains
post-WWII Japan's economic performance?
What do we need to know
to answer this question?
Japan's real GDP per capita over 1960-2017
source: World Bank
Yen
(2010)
Mistakes
do not count
In this course...
I want you to
Fail gracefully
Because...
Pick a country
And discuss whether
Theory of Why Nations Fail can
explain economic performances
of the country of your choice
Term Paper
Pick a country
And discuss whether
Theory of Why Nations Fail can
explain economic performances
of the country of your choice
Term Paper
Pick a country
You cannot choose a country of another student's choice
First come, first served
Post which country you've chosen on Prulu discussion board
The following countries cannot be chosen
as discussed in detail by Why Nations Fail
Argentina
Australia
Botswana
Brazil
China (except since 1979)
Colombia
DR Congo
Ethiopia (except since the 1990s)
France
Guatemala
Japan
North Korea
Mexico
Russia (except since the 1990s)
Sierra Leone
Somalia
South Africa
United Kingdom
United States
Uzbekistan
Zimbabwe
Pick a country (cont.)
Weeks 2-4: How institutions affect prosperity
October 9
Chapter 3
October 16
Chapter 7
October 23
Chapter 8
North/South Korea
the Congo
How institutions matter for prosperity
Why did
Industrial Revolution
take place
in England?
History of England
from 13c to 19c
Extractive institutions cause poverty
Inclusive institutions lead to prosperity
Ottoman Empire
Austria-Hungary
Russian Empire
Ming/Qing dynasties
Ethiopia
Somalia
Next Week
Your to-do list until next class
Pick a country for your term paper
and post it on Prulu
Read Chapter 7 (except from last paragraph on page 208)
and post questions on Prulu
1
2
3
(Also read pp. 102-104, which summarizes Chapter 7)
Keep thinking about whether Why Nations Fail explains Japan's post-WWII economic growth.