Reading Snippets - Why Nations Fail (2)

The Political & Economic Institution Theory

After denouncing the other theories, they raised their own theory - nations fail because their political and economic institutions are set up for failure.

The crux of the theory is that there are broadly 2 types of institutions - extractive institutions designed by elites to squeeze profits for themselves and no one else, and inclusive institutions that give the general public a chance to succeed and participate in political and economic activities. Extractive states do not allow sustainable economic growth and will eventually fail.

The political and economic institutions are intertwined - political institutions define who become powerful, and the power will be used to steer the economic institutions; in turn, the economic institutions determine how the economy will be run.

There are 2 keywords in this theory - 'pluralistic' and 'centralised'. The institutions should be 'pluralistic' so that multiple players can compete and do not monopolise the power or economic benefits. At the same time, the political institutions should be 'centralised' so that each institution has enough authority to enact policies, instead of hitting impasse every time a decision needs to be made & executed.

The main cause for extractive states to not have sustainable economic growth is down to two reasons. First of all, when political and economic powers are concentrated such that a small elite could reap all the benefits, there would be in-fightings to compete for the podium position. These fights would lead to state failure.

The second reason is the lack of creative destruction. In inclusive states, pluralism allow competing parties to adopt new technologies and embrace knowledge to capture the market. In the process, old technologies and poorly organised parties are pushed out. Productivity improvement is sustained. On contrary, extractive states are inclined to keep the status quo so that the power of the elite and the setup of the institutions will not be challenged. Innovations are discouraged and uncompetitive parties are not phased out. The result is a backward state that could not grow