Inclusiveness vs extractiveness, not democracy vs autocracy

One of the quintessential questions in political economy is which is better for growth: democracy or dictatorship (with the proper preassumptions of course)?

Here's a graph from the Free Exchange blog (click to enlarge):

These are the implications:

"Does economic growth go hand-in-hand with democratic regimes? Not necessarily: correlation does not imply causation. One group of economists found growth induced democracy in East Asia; democracy did not lead to growth. They compared North and South Korea, which were both poor in 1950 and under dictatorial regimes from the end of the Korean War until 1980. From 1980, per capita incomes diverged. The same year South Korea began democratising. But South Korea’s better institutions developed due to dictators’ policy choices, they say.

Others, including Daron Acemoglu and James Robinson, attribute this type of growth to political decision-making. “Extractive institutions” sometimes develop as elites feel more secure and seek their own ends, they say. “Such growth takes place when elites find it in their interest to allow new technologies and institutional changes necessary for economic growth.”

Paul Collier has controversially argued that authoritarianism can be good for growth. He would also say South Korean growth was successful due to its homogenous society. Its foreign immigrant population only reached 1m in 2007, and the majority are Chinese. In ethnically diverse societies only democracy can work for growth, says Mr Collier, because autocratic leaders with a narrow support base are otherwise tempted to siphon off national income. That explains why diverse India, with three major ethnic groups, four key religions, and 15 official languages, had no choice other than democracy-led growth."

But the real issue is not whether a democracy will give us a higher technological breakthrough, but that an inclusive democracy will result in the same. There is a big difference between sustaining the efficiency of institutions in different types of democracies. A democracy in itself does not imply efficient institutions, according to Mancur Olson (2000). Only a fully inclusive democracy will foster institutional efficiency. This implies it has both inclusive political and economic institutions such as the proper functionality of the legal system (rule of law, enforcement of contracts), protection of property from expropriation by a number of elites (financial, corporate or political), and finally an egalitarian system which offers equal opportunity, social mobility and basic human rights (freedom of speech, freedom of assembly, etc.). (A hard number of conditions to fill out, but some countries have managed to do it, right?) 

If we add some "bad" democracies in the the graph above, I'm sure they would turn out as outliers rested in the lower or perhaps lower middle technological quadrant and a high-income quadrant. Even though the graph itself is very perceptive as it tell us exactly of 

As for Paul Collier's South Korean argument, isn't it true that the same homogenous society exists in North Korea as well? Prior to the separation of the Korean peninsula, wasn't this a homogenous society, living on the same geographical position, having the same climate, same historical context, same cultural origin? And yet they diverged into two extremes 60 years later. Isn't the same story applicable to East and West Germany? Or any of the examples mentioned in this post? The reason for such divergence can only be explained by the quality of institutional formation. And one may argue that Korea had a state-led growth that resulted in economic inclusiveness  but it is also a fact that at one point the people in Korea demanded more political freedoms. Just like in 19th century England, where the rising wealth of merchants and manufacturers forced enfranchisement from the aristocratic elites (who had won their power in a similar way from the monarchs 200 years earlier). The South Korean example is more likely to be one of a gradual democratic consolidation. 

The Chinese outlier? 

So how does one explain China? Is it an outlier in the theory of inclusive institutions? Not likely. In previous blog posts I have made certain inferences on why the Chinese growth model was successful, and how a huge level of competition drives China forward (the most notorious example is the Foxconn iPhone factory, where there is a barbed wire around the factory, not to prevent the workers from "escaping" but rather to prevent others from coming in - that's what I call Social Darwinism). However, just like Soviet Russia and a multitude of different examples of states with extractive institutions that were able to achieve initial substantial growth, one cannot grow for an infinite amount of periods based on pure capital accumulation. The basic Solow-Swan growth model teaches us this: at one point more capital will fail to increase productivity and will fail to result in more economic growth. A technological breakthrough will be necessary to break the gridlock and move the economy towards a new steady-state equilibrium. The emphasis is therefore on persistent innovation and new technologies. These are the main long-run factors of economic growth in the West. Of course, they are supported by an inclusive democratic system and institutions that favour free enterprise.

In China, things are a bit different. Instead of being an innovation nation, China is an adapter of technologies. So was Japan back in the 50-ies, but they managed to switch to an innovation nation eventually. Can China do the same? Certain factors point out otherwise. There is a particular example pointing out to the Chinese anti-entreprenuership climate - the example of a business owner thrown in jail for competing against the state-owned companies and taking larger portions of their markets. With such protection of inefficient industries, once the economy runs out of steam it will be obvious that there is nothing to replace the previous growth model and a political crisis will be looming. There is no telling on what the final outcome will be; will China switch to more inclusive political instituions, or will the communist party apply stronger methods of repression? There has already been a hint towards changes in China, with the new PM announcing plans to fight corruption and curb government power, but it is left to be seen whether or not these threats are credible enough.