In India, institutional drift worked differently and led to the development of a uniquely rigid hereditary caste system that limited the functioning of markets and the allocation of labor across occupations much more severely than the feudal order in medieval Europe. It also underpinned another strong form of absolutism under the Mughal rulers. Most European countries had similar systems in the Middle Ages. Modern Anglo-Saxon surnames such as Baker, Cooper, and Smith are direct descendants of hereditary occupational categories. Bakers baked, coopers made barrels, and smiths forged metals. But these categories were never as rigid as Indian caste distinctions and gradually became meaningless as predictors of a person’s occupation. Though Indian merchants did trade throughout the Indian Ocean, and a major textile industry developed, the caste system and Mughal absolutism were serious impediments to the development of inclusive economic institutions in India. By the nineteenth century, things were even less hospitable for industrialization as India became an extractive colony of the English. China was never formally colonized by a European power, but after the English successfully defeated the Chinese in the Opium Wars between 1839 and 1842, and then again between 1856 and 1860, China had to sign a series of humiliating treaties and allow European exports to enter. As China, India, and others failed to take advantage of commercial and industrial opportunities, Asia, except for Japan, lagged behind as Western Europe was forging ahead.
THE COURSE OF institutional development that Japan charted in the nineteenth century again illustrates the interaction between critical junctures and small differences created by institutional drift. Japan, like China, was under absolutist rule. The Tokugawa family took over in 1600 and ruled over a feudal system that also banned international trade. Japan, too, faced a critical juncture created by Western intervention as four U.S. warships, commanded by Matthew C. Perry, entered Edo Bay in July 1853, demanding trade concessions similar to those England obtained from the Chinese in the Opium Wars. But this critical juncture played out very differently in Japan. Despite their proximity and frequent interactions, by the nineteenth century China and Japan had already drifted apart institutionally.
While Tokugawa rule in Japan was absolutist and extractive, it had only a tenuous hold on the leaders of the other major feudal domains and was susceptible to challenge. Even though there were peasant rebellions and civil strife, absolutism in China was stronger, and the opposition less organized and autonomous. There were no equivalents of the leaders of the other domains in China who could challenge the absolutist rule of the emperor and trace an alternative institutional path. This institutional difference, in many ways small relative to the differences separating China and Japan from Western Europe, had decisive consequences during the critical juncture created by the forceful arrival of the English and Americans. China continued in its absolutist path after the Opium Wars, while the U.S. threat cemented the opposition to Tokugawa rule in Japan and led to a political revolution, the Meiji Restoration, as we will see in chapter 10. This Japanese political revolution enabled more inclusive political institutions and much more inclusive economic institutions to develop, and laid the foundations for subsequent rapid Japanese growth, while China languished under absolutism.
How Japan reacted to the threat posed by U.S. warships, by starting a process of fundamental institutional transformation, helps us understand another aspect of the lay of the land around us: transitions from stagnation to rapid growth. South Korea, Taiwan, and finally China achieved breakneck rates of economic growth since the Second World War through a path similar to the one that Japan took. In each of these cases, growth was preceded by historic changes in the countries’ economic institutions—though not always in their political institutions, as the Chinese case highlights.
The logic of how episodes of rapid growth come to an abrupt end and are reversed is also related. In the same way that decisive steps toward inclusive economic institutions can ignite rapid economic growth, a sharp turn away from inclusive institutions can lead to economic stagnation. But more often, collapses of rapid growth, such as in Argentina or the Soviet Union, are a consequence of growth under extractive institutions coming to an end. As we have seen, this can happen either because of infighting over the spoils of extraction, leading to the collapse of the regime, or because the inherent lack of innovation and creative destruction under extractive institutions puts a limit on sustained growth. How the Soviets ran hard into these limits will be discussed in greater detail in the next chapter.
IF THE POLITICAL and economic institutions of Latin America over the past five hundred years were shaped by Spanish colonialism, those of the Middle East were shaped by Ottoman colonialism. In 1453 the Ottomans under Sultan Mehmet II captured Constantinople, making it their capital. During the rest of the century, the Ottomans conquered large parts of the Balkans and most of the rest of Turkey. In the first half of the sixteenth century, Ottoman rule spread throughout the Middle East and North Africa. By 1566, at the death of Sultan Süleyman I, known as the Magnificent, their empire stretched from Tunisia in the East, through Egypt, all the way to Mecca in the Arabian Peninsula, and on to what is now modern Iraq. The Ottoman state was absolutist, with the sultan accountable to few and sharing power with none. The economic institutions the Ottomans imposed were highly extractive. There was no private property in land, which all formally belonged to the state. Taxation of land and agricultural output, together with loot from war, was the main source of government revenues. However, the Ottoman state did not dominate the Middle East in the same way that it could dominate its heartland in Anatolia or even to the extent that the Spanish state dominated Latin American society. The Ottoman state was continuously challenged by Bedouins and other tribal powers in the Arabian Peninsula. It lacked not only the ability to impose a stable order in much of the Middle East but also the administrative capacity to collect taxes. So it “farmed” them out to individuals, selling off the right to others to collect taxes in whatever way they could. These tax farmers became autonomous and powerful. Rates of taxation in the Middle Eastern territories were very high, varying between one-half or two-thirds of what farmers produced. Much of this revenue was kept by the tax farmers. Because the Ottoman state failed to establish a stable order in these areas, property rights were far from secure, and there was a great deal of lawlessness and banditry as armed groups vied for local control. In Palestine, for example, the situation was so dire that starting in the late sixteenth century, peasants left the most fertile land and moved up to mountainous areas, which gave them greater protection against banditry.
Extractive economic institutions in the urban areas of the Ottoman Empire were no less stifling. Commerce was under state control, and occupations were strictly regulated by guilds and monopolies. The consequence was that at the time of the Industrial Revolution the economic institutions of the Middle East were extractive. The region stagnated economically.
By the 1840s, the Ottomans were trying to reform institutions—for example, by reversing tax farming and getting locally autonomous groups under control. But absolutism persisted until the First World War, and reform efforts were thwarted by the usual fear of creative destruction and the anxiety among elite groups that they would lose economically or politically. While Ottoman reformers talked of introducing private property rights to land in order to increase agricultural productivity, the status quo persisted because of the desire for political control and taxation. Ottoman colonization was followed by European colonization after 1918. When European control ended, the same dynamics we have seen in sub-Saharan Africa took hold, with extractive colonial institutions taken over by independent elites. In some cases, such as the monarchy of Jordan, these elites were direct creations of the colonial powers, but this, too, happened frequently in Africa, as we will see. Middle Eastern countries without oil today have income levels similar to poor Latin American nations. They did not suffer from such immiserizing forces as the slave trade, and they benefited for a longer period from flows of t
echnology from Europe. In the Middle Ages, the Middle East itself was also a relatively advanced part of the world economically. So today it is not as poor as Africa, but the majority of its people still live in poverty.
WE HAVE SEEN that neither geographic- nor cultural- nor ignorance-based theories are helpful for explaining the lay of the land around us. They do not provide a satisfactory account for the prominent patterns of world inequality: the fact that the process of economic divergence started with the Industrial Revolution in England during the eighteenth and nineteenth centuries and then spread to Western Europe and to European settler colonies; the persistent divergence between different parts of the Americas; the poverty of Africa or the Middle East; the divergence between Eastern and Western Europe; and the transitions from stagnation to growth and the sometimes abrupt end to growth spurts. Our institutional theory does.
In the remaining chapters, we will discuss in greater detail how this institutional theory works and illustrate the wide range of phenomena it can account for. These range from the origins of the Neolithic Revolution to the collapse of several civilizations, either because of the intrinsic limits to growth under extractive institutions or because of limited steps toward inclusiveness being reversed.
We will see how and why decisive steps toward inclusive political institutions were taken during the Glorious Revolution in England. We will look more specifically at the following:
• How inclusive institutions emerged from the interplay of the critical juncture created by Atlantic trade and the nature of preexisting English institutions.
• How these institutions persisted and became strengthened to lay the foundations for the Industrial Revolution, thanks in part to the virtuous circle and in part to fortunate turns of contingency.
• How many regimes reigning over absolutist and extractive institutions steadfastly resisted the spread of new technologies unleashed by the Industrial Revolution.
• How Europeans themselves stamped out the possibility of economic growth in many parts of the world that they conquered.
• How the vicious circle and the iron law of oligarchy have created a powerful tendency for extractive institutions to persist, and thus the lands where the Industrial Revolution originally did not spread remain relatively poor.
• Why the Industrial Revolution and other new technologies have not spread and are unlikely to spread to places around the world today where a minimum degree of centralization of the state hasn’t been achieved.
Our discussion will also show that certain areas that managed to transform institutions in a more inclusive direction, such as France or Japan, or that prevented the establishment of extractive institutions, such as the United States or Australia, were more receptive to the spread of the Industrial Revolution and pulled ahead of the rest. As in England, this was not always a smooth process, and along the way, many challenges to inclusive institutions were overcome, sometimes because of the dynamics of the virtuous circle, sometimes thanks to the contingent path of history.
Finally, we will also discuss how the failure of nations today is heavily influenced by their institutional histories, how much policy advice is informed by incorrect hypotheses and is potentially misleading, and how nations are still able to seize critical junctures and break the mold to reform their institutions and embark upon a path to greater prosperity.
5.
“I’VE SEEN THE FUTURE, AND IT WORKS”: GROWTH UNDER EXTRACTIVE INSTITUTIONS
I’VE SEEN THE FUTURE
INSTITUTIONAL DIFFERENCES PLAY the critical role in explaining economic growth throughout the ages. But if most societies in history are based on extractive political and economic institutions, does this imply that growth never takes place? Obviously not. Extractive institutions, by their very logic, must create wealth so that it can be extracted. A ruler monopolizing political power and in control of a centralized state can introduce some degree of law and order and a system of rules, and stimulate economic activity.
But growth under extractive institutions differs in nature from growth brought forth by inclusive institutions. Most important, it will be not sustained growth that requires technological change, but rather growth based on existing technologies. The economic trajectory of the Soviet Union provides a vivid illustration of how the authority and incentives provided by the state can spearhead rapid economic growth under extractive institutions and how this type of growth ultimately comes to an end and collapses.
THE FIRST WORLD WAR had ended and the victorious and the vanquished powers met in the great palace of Versailles, outside Paris, to decide on the parameters of the peace. Prominent among the attendees was Woodrow Wilson, president of the United States. Noticeable by its absence was any representation from Russia. The old tsarist regime had been overthrown by the Bolsheviks in October 1917. A civil war then raged between the Reds (the Bolsheviks) and the Whites. The English, French, and Americans sent an expeditionary force to fight against the Bolsheviks. A mission led by a young diplomat, William Bullitt, and the veteran intellectual and journalist Lincoln Steffens was sent to Moscow to meet with Lenin to try to understand the intentions of the Bolsheviks and how to come to terms with them. Steffens had made his name as an iconoclast, a muckraker journalist who had persistently denounced the evils of capitalism in the United States. He had been in Russia at the time of the revolution. His presence was intended to make the mission look credible and not too hostile. The mission returned with the outlines of an offer from Lenin about what it would take for peace with the newly created Soviet Union. Steffens was bowled over by what he saw as the great potential of the Soviet regime.
“Soviet Russia,” he recalled in his 1931 autobiography, “was a revolutionary government with an evolutionary plan. Their plan was not to end evils such as poverty and riches, graft, privilege, tyranny, and war by direct action, but to seek out and remove their causes. They had set up a dictatorship, supported by a small, trained minority, to make and maintain for a few generations a scientific rearrangement of economic forces which would result in economic democracy first and political democracy last.”
When Steffens returned from his diplomatic mission he went to see his old friend the sculptor Jo Davidson and found him making a portrait bust of the wealthy financier Bernard Baruch. “So you’ve been over in Russia,” Baruch remarked. Steffens answered, “I have been over into the future, and it works.” He would perfect this adage into a form that went down in history: “I’ve seen the future, and it works.”
Right up until the early 1980s, many Westerners were still seeing the future in the Soviet Union, and they kept on believing that it was working. In a sense it was, or at least it did for a time. Lenin had died in 1924, and by 1927 Joseph Stalin had consolidated his grip on the country. He purged his opponents and launched a drive to rapidly industrialize the country. He did it via energizing the State Planning Committee, Gosplan, which had been founded in 1921. Gosplan wrote the first Five-Year Plan, which ran between 1928 and 1933. Economic growth Stalin style was simple: develop industry by government command and obtain the necessary resources for this by taxing agriculture at very high rates. The communist state did not have an effective tax system, so instead Stalin “collectivized” agriculture. This process entailed the abolition of private property rights to land and the herding of all people in the countryside into giant collective farms run by the Communist Party. This made it much easier for Stalin to grab agricultural output and use it to feed all the people who were building and manning the new factories. The consequences of this for the rural folk were calamitous. The collective farms completely lacked incentives for people to work hard, so production fell sharply. So much of what was produced was extracted that there was not enough to eat. People began to starve to death. In the end, probably six million people died of famine, while hundreds of thousands of others were murdered or banished to Siberia during the forcible collectivization.
Neither the newly created industry nor the collectivized farm
s were economically efficient in the sense that they made the best use of what resources the Soviet Union possessed. It sounds like a recipe for economic disaster and stagnation, if not outright collapse. But the Soviet Union grew rapidly. The reason for this is not difficult to understand. Allowing people to make their own decisions via markets is the best way for a society to efficiently use its resources. When the state or a narrow elite controls all these resources instead, neither the right incentives will be created nor will there be an efficient allocation of the skills and talents of people. But in some instances the productivity of labor and capital may be so much higher in one sector or activity, such as heavy industry in the Soviet Union, that even a top-down process under extractive institutions that allocates resources toward that sector can generate growth. As we saw in chapter 3, extractive institutions in Caribbean islands such as Barbados, Cuba, Haiti, and Jamaica could generate relatively high levels of incomes because they allocated resources to the production of sugar, a commodity coveted worldwide. The production of sugar based on gangs of slaves was certainly not “efficient,” and there was no technological change or creative destruction in these societies, but this did not prevent them from achieving some amount of growth under extractive institutions. The situation was similar in the Soviet Union, with industry playing the role of sugar in the Caribbean. Industrial growth in the Soviet Union was further facilitated because its technology was so backward relative to what was available in Europe and the United States, so large gains could be reaped by reallocating resources to the industrial sector, even if all this was done inefficiently and by force.
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