Limits to Growth Under Extractive Institutions: Aiding Imitation, Hampering Innovation

Last time, we introduced Acemoglu and Robinson’s framework for discussing examining institutional development. This week, I want to focus more on a subset of that framework devoted to growth under extractive institutions. We posited that there are two kinds of political and economic institutions: extractive and inclusive, and that inclusive institutions are the variety that best serve long term, sustainable development. I concluded that China has a combination of extractive and inclusive economic institutions, similar to that of South Korea’s growth under military rule by virtue of the export led growth strategy and technology imitation. But progress under said strategy with extractive institutions is not sustainable in the long run due to its inherent imbalances and hampering of necessary technological innovation.

            The story of South Korea’s growth provides an eerily similar, though far from perfectly identical, precursor to that of China’s economic trajectory. General Park Chung-Hee’s government got behind several successful firms by throwing government subsidies and easy credit to fuel their export led growth strategy. Interest rates on loans to export manufacturing firms decreased through out the 1960s from 8% in 1963 to 6% in 1967. These loans were given for various aspects of such firms from factory conversion, raw material imports, and shipping costs.[1] These and further efforts at liberalization encouraged exports to grow by more than 170 times from 1961 to 1972. Through out this period, exports accounted for 20% of the economic growth of South Korea. However it wasn’t long after this initial period of growth that the South Korean economy showed signs of slowing due to the prevailing extractive political institutions and inability of the export led growth strategy to foster technological innovation. After the transition to democratic government in 1987, South Korea’s economy took on more characteristics of imitation led growth rather than just relying on exports through the 1990s. Largely leveraging its close relationship with the US, South Korean companies embarked on ambitions foreign direct investment and technology transfer arrangements in order to speed up its technological catch up.

As shown in “Economic Growth” the cost of copying technology increases as the technological gap between the innovator and imitator countries narrows. South Korean companies had a larger incentive to innovate as the technology level grew closer to the US’. Since both countries were both relatively high capital level countries, capital-biased technological change alone wouldn’t provide an adequate barrier between technology transfer. Thus South Korea’s initial forays into technological imitation were necessary while under extractive institutions, but changes to more inclusive institutions were necessary for more sustainable growth to form.

            One of the barriers to technological innovation in a country with extractive institutions is the necessity to sacrifice present output for future productivity gains. The CCP’s claim to legitimacy largely rests on maintaining the current high levels of growth in the Chinese economy, so sacrificing present output for future productivity would potentially endanger that legitimacy. Therefore, current growth in China is largely based on existing technology that is either imitated or procured through foreign technology exchange agreements. As seen in the case of South Korea, such agreements and imitation have their limits once the technology gap between the imitator country and innovator country narrows enough. China’s favorable export financing policies for its large MNCs, many of which are partially or wholly state owned, provide a telling parallel to South Korea in the 1970s. Acemoglu and Robinson argue that this mix of extractive political institutions with inclusive economic institutions can’t provide a sustained level of growth due to the discouraging of creative destruction as well the lack of technological innovation. This stagnation in technological innovation leads to limits on productivity growth that hampers the sustainability of growth under extractive institutions.

            I chose the photo depicting the building of the Great Wall because of discussions that took place in my Mandarin and China’s Role in the Greater Political Economy this week that I felt related to the growth experienced under extractive institutions. The first emperor of China, Qin Shihuang, decided to expand the original city walls of several cities around Beijing in order to fend off Mongolian invasions from the north. In order to accomplish this massive project, he oversaw the forcible relocation of over 300,000 men to work on the wall through out his reign. Tens of thousands died from exhaustion working on the wall. When they died, the perished workers became part of the wall, as construction would continue on top of their corpses burying them underneath. This practice of forcibly moving workers to add to the wall occurred in each successive dynasty that made such additions. While the earliest constructions involved a wall made from earth, the conversion to brick and mortar wasn’t exactly a technological revolution. The wall itself kept growing, increasingly more areas of China were protected from Northern invasion, but the bodies below kept piling up under all of those stones. Building the Great Wall is a very apt example of growth under extractive institutions. Successive Chinese dynasties would benefit from its construction and the protection it offered, but the extractive institutions that encouraged building the Great Wall also limited the growth in productivity through hampering technological innovation.

[1] http://www.nber.org/chapters/c4065.pdf p. 49-50