Inclusive and Extractive Societies

By coincidence I find myself reading three related pieces at one and the same time

Why Nations Fail (2012) which gripped me from the opening pages of the Preface – as the review in the link says – 

For anyone remotely interested in these issues Why Nations Fail is a must-read. Acemoglu and Robinson are intellectual heavyweights of the first rank, the one a professor of economics at MIT, the other a professor of political science at Harvard.

Mostly, such people write only for other academics. In this book, they have done you the courtesy of writing a book that while at the intellectual cutting edge is not just readable but engrossing.
This alone would be reason to take notice: a vital topic, top scholars, and a well-written book.

You will find an excellent review here which identifies one of the book’s potential weaknesses -  

Explaining the entire history of humankind by dividing the world into “extractive” and “inclusive” institutions is a daunting task. At one level the notion that “extractive” institutions fail and “inclusive” ones succeed can be a tautology - if we mean that “extractive” institutions are ones that successfully block growth and “inclusive” ones are those that do not. 

This not what Acemoglu and Robinson have in mind. But lacking an axiomatic definition of what is “inclusive” and what is “extractive” that is independent from actual outcomes, the classification of historical institutions as belonging to one or the other group can end up being based on ex-post evaluations of the outcomes themselves, thereby making the argument circular and subject to a selection bias.
As a consequence, while many examples fit their theory well, others are more difficult and the discussion of those examples in the book is sometimes strained.

Empirically, when trying to classify a particular set of institutions either as “inclusive” or “extractive”, one has to face the problem of quantifying what a “small” group of individuals, in one case, and “many, in the other, mean. In what sense were the institutional arrangements of the Roman Empire “inclusive” relative, for example, to those of the Communist USSR? Or in what sense did the Spanish Kingdom turn from “inclusive” to “extractive” between the XV and the XVII century?

I should at this point confess that I have reached only page 78 (there are another 400 to go) – but one of the delights of the internet is that it allows you to find and read the most important critical reviews, thus giving you the key questions right from the beginning with which to query the authors….and the review I have quoted from and linked to is, quite simply, the best review I have ever read!!!!!

And it warns me that an issue to which the book devotes little attention is the “role of competition between nations”….

Clearly the book will keep me occupied for the week – but the other two (thankfully shorter) pieces which swam into view (as it were) pose the important question which I suspect the book doesn’t deal with about how to explain the huge discrepancies in life chances WITHIN nations.

A significant percentage of citizens living in “north Britain” (ditto most EU countries and the USA) spend their lives in quasi “third-world” conditions. I myself spent 20 years helping Scotland’s largest public agency develop a strategy to ameliorate this…..and the second piece is (yet another) pamphlet about the deep-rooted poverty within Scotland …..It’s called No More Excuses and has some good lines -

Essentially, the consumption model that dominates our economy exploits workers in poor countries, undermines businesses which are local and based in the community, offers minimum wage part-time and casual employment for the sake of cheap goods and excess profits…..

A society where esteem and self-worth are derived from acquisition, material consumption, and perceived status, rather than from relationships, mutuality or the pursuit of equality, is problematic……. 

But despite the structural causes, it is possible to overcome poverty. It requires that we pull the right levers, focus on the necessary structural change, cherish what is really important and deploy our wealth (money and beyond) for justice and equality rather than compassion. We know this is possible: as already discussed poverty is at much lower levels in the Nordic countries which are at similar stages of development and yet are more competitive, suggesting that equity and economic performance are complements and not substitutes. Ending poverty in Scotland is about allocating our resources in a more effective and sustainable way.

But it is a post from one of the best websites – Real Economics – which rams home the key point that “the current conflict is not between nations but between classes” …..   

German banks managed to capture a large portion of the growing surplus created by German workers and, instead of seeing it invested domestically, lent it abroad (to a broad array of Spanish, Greek and other borrowers)—which was the flip side of Germany’s positive current account balance (since German capitalists, benefiting from lower unit labor costs, could easily outcompete potential exporters in the European south, while German demand for European goods dropped as wages fell).

It is not countries that lend or borrow; different classes within countries create the conditions for and engage in large-scale capital flows between countries. But didn’t Spain (and Greece) have a choice? After all it seems that Spain could have refused to accept the cheap credit, and so would not have suffered from speculative market excesses, poor investment, and the collapse in the savings rate. This might be true, of course, if there were such a decision-maker as “Spain”. There wasn’t. As long as a country has a large number of individuals, households, and business entities, it does not require uniform irresponsibility, or even majority irresponsibility, for the economy to misuse unlimited credit at excessively low interest rates. Every country under those conditions has done the same. . . And this is a point that’s often missed in the popular debate.

Over and over we hear — often, ironically, from those most committed to the idea of a Europe that transcends national boundaries — that Spain (or Greece) must bear responsibility for its actions and must repay what it owes to Germany.

But there is no “Spain” and there is no “Germany” in this story. At the turn of the century Berlin, with the agreement of businesses and labor unions, put into place agreements to restrain wage growth relative to GDP growth. By holding back consumption, those policies forced up German savings rate. Because Germany was unable to invest these savings domestically, and in fact even lowered its investment rate, German banks exported the excess of savings over investment abroad to countries like Spain. . . 

Above all this is not a story about nations. Before the crisis German workers were forced to pay to inflate the Spanish (and Greek) bubble by accepting very low wage growth, even as the European economy boomed. After the crisis Spanish workers were forced to absorb the cost of deflating the bubble in the form of soaring unemployment. But the story doesn’t end there. Before the crisis, German and Spanish lenders eagerly sought out Spanish borrowers and offered them unlimited amounts of extremely cheap loans — somewhere in the fine print I suppose the lenders suggested that it would be better if these loans were used to fund only highly productive investments. But many of them didn’t, and because they didn’t, German and Spanish banks — mainly the German banks who originally exported excess German savings — must take very large losses as these foolish investments, funded by foolish loans, fail to generate the necessary returns.

 It is no great secret that banking systems resolve losses with the cooperation of their governments by passing them on to middle class savers, either directly, in the form of failed deposits or higher taxes, or indirectly, in the form of financial repression.
 Both German and Spanish banks must be recapitalized in order that they can eventually recognize the inevitable losses, and this means either many years of artificially boosted profits on the back of middle class savers, or the direct transfer of losses onto the government balance sheets, with German and Spanish household taxpayers covering the debt repayments.