Saturday, 30 November 2013

Extractive Economics

""The best books," said George Orwell, " are those that tell you what you know already." (He might have said, know, but don't quite recognise.) Such a book is, Why Nations Fail by  Daron Acemoglu and James Robinson. 

The thesis is that societies fall between two extremes, 'extractive' or 'inclusive'. An 'extractive' society is one where all property and power is concentrated to an elite who run society for their own convenience. Feudalism being a classic example of an extractive economic model. 

An 'inclusive' society is where individuals, other than the aristocracy, have property rights and human rights - the right to be governed by the rule of law rather than the arbitrary will of a king or the landowner.  A society with rights for all and the possibilities of social mobility.

The 'inclusive' structure tends to engender growing, innovative societies where the standard of living keeps improving as 'creative destruction' replaces the old methods with new, better ways. 'Extractive' societies stifle innovation, the elite are afraid of change, lest they lose some of their wealth. In Ancient Rome, for example, slave owners made money by using their slaves to carry water, in buckets, for others. This wealthy elite resisted the innovation of piped town water as soon as they realised that it would lead to a loss of income.    

It is rather comforting to tell ourselves that, in general, societies are heading in the direction of democracy, or inclusiveness. What Acemoglu and Robinson show is that such a trajectory is not inevitable, in fact 'inclusive' societies can lose inclusiveness and become extractive.

Britain, home of the Industrial Revolution, may be one such society.  The authors make the case that Industrial Revolution was seeded  by the Glorious Revolution of 1688 This, and the subsequent Bill of Rights act of 1689 which, with the Magna Carta, ensured that no man, not even the King, was above the law. 

The British Bill of Rights limitrd the power of the Monarchy making it subservient to Parliament. While countries such as Spain were far more wealthy, due to the riches that they were extracting from their colonies in South America, the social structures in Spain enforced monopolies controlled for the benefit of the King and his supporters. This left Spain frozen, technically and socially. 

The new manufacturing technologies that were developed in Britain happened because Britain's newly 'inclusive' society encouraged innovation. Patent laws and property rights made investment in new ideas worthwhile.

Spain's society, geared to extracting the wealth of it's subjects, made innovation hard to introduce, the people with the money were, 'doing quite nicely, thank you'. The ones with the skills and interest who might have benefited couldn't easily mobilise the money to develop new technologies. And, if they should manage to stumble upon the means, the overwhelming power of the monarch might stifle it, should it threaten his income stream.

Such powerful elites engage with other structures which stifle change. In England the Roman Catholic church, which famously limited scientific thinking, was constrained by the Glorious Revolution. The Age of Enlightenment, which fed so much new science into the new technologies of the Industrial Revolution, commenced with the challenges to the Catholic church made by Protestantism. Its English embodiment was the Glorious Revolution.

The changes to the law following the Glorious Revolution led to the conditions that seeded the technological changes of the Industrial Revolution. Subsequently, of course, Britain's technical innovations were emulated through Europe while Britain focused on it's commercial empire. The 'extractive' techniques which had held feudalistic Europe technically frozen were applied in varying degrees throughout the colonies of the British Empire.

It became easier for Britain to sit back and wait for the dividends to roll in than bankroll innovation. These days, with British manufacturing all but invisible to the naked eye, the City of London is said to be the Jewel in the Crown of the British economy. Now all British economic policy is written to support the City. 

What passes for investment in Britain is almost invariably property investment.  Policies, engineered to encourage the growth of personal debt, see the middles classes rushing to throw as much of their income into property. Lending is permitted to expand which supports ever increasing property prices. An endless, Uroboros like cycle, soaking up money that might have been available for investment in manufacturing and useful jobs. See my earlier post: dual-income-no-savings

The British economy is increasingly structured towards the benefit of the banks the British taxpayer had to bail out in 2009, the same taxpayers who had their pension funds hit by the reckless lending of those same banks. 

Britain is well on the way to becoming an extractive economy again with the majority of the population working to service debt to keep an aristocracy of bankers in the money.


  1. Thought provoking blog. And you make some valid points on the self-perpetuating property bubble. Whilst this might ultimately lead to a more extractive economy, I don't think a service industry is necessarily going to. I would imagine that a manufacturing-driven economy would be more extractive as there would be a higher ratio of unskilled and semi-skilled workers to higher-paid skilled workers.

    Also, I'm not sure about the lack of innovation in the UK. I think a lot is made of Britain's diminishing manufacturing industry, some of which is exaggerated. We still made a lot of stuff here. We no longer make a lot of cheaper bulk goods, which is more suited to developing economies, but we still make a lot of high-end goods, such as, luxury cars, hi-fi equipment, high-end vacuum cleaners, semiconductor equipment, graphics cards, musical instruments, film and tv production, and so on. There was a piece on a recent TopGear that lined up all the vehicles still "Made in Britain" on The Mall and there was a healthy array.

    I understand the argument given the recent financial crises, to warn against over-reliance on the banking industry, but I think we should be proud of the strong service industries we have built in this country, as well as the manufacturing niches and heritage. Britons are very good at adapting and innovating, and that is at the heart of any good economy, and ultimately, an inclusive society.

  2. Thanks for your comments Craig. But, I don't think there's an inherent connection between manufacturing versus service and extractive economy or not.

    I think extractive economies are those where a large amount of capital is essential to start/maintain the business. This keeps the economy under the control of governments and/or multinationals and it can then be extractive because its hard to set up competing suppliers because the entry cost is too high.

    In recent times a number of areas that were once the the essential province of multinationals and/or governments have met competition from small outsiders. Areas such as power generation and even money supply. That's why the forces of conservatism, which tend to favour extractive economies, support high cost nuclear power and hate things like Bitcoins. But this could be the subject of another blog.