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Why is India so poor? (part 1)

December 14, 2012

Why Nations Fail is a book by Acemoglu and Johnson which argues that extractive institutions cause poverty and inclusive institutions cause prosperity. Extractive institutions are those which are designed to funnel wealth from the lower classes to the politically connected elite. Inclusive institutions are those which promote competition, creative destruction, and equal opportunities for everyone. Extractive institutions are popular with the elites despite their wealth destroying tendencies because they very effectively funnel what little wealth is left to the elites while discouraging social mobility.

In Arvind Subramanian’s review, he provides this simple, yet fascinating graph:
which nations failed india china

The mystery is how can an nearly totally extractive country like China be richer than a pluralistic democracy like India? It might be one thing if the two outliers were tiny, but combined China and India comprise over a third of the world’s population. While I think Subramanian overstates his case, the basic point holds. China’s growth rate needs some explaining (I’m looking forward to Coase’s new book ), it’s still quite poor by global standards, especially when you consider all the malinvestment. There aren’t many democracies poorer than India. Bangladesh is, but they’ve only had democracy since 1991. India has had democracy since 1947, when British colonialism ended.

Acemoglu and Johnson hypothesize that extractive economic institutions cause poverty and extractive political institutions cause extractive economic institutions. So India isn’t exactly a counter-example; it’s an inclusive political order which created extractive economic institutions. India is ranked 132nd on the Ease of Doing Business Index and 123rd on the Heritage Freedom Index, even after decades of reform.

India on gapminder

Indian Average Tariff Rates: Over 100% prior to the early 90’s reforms
india tariff rates

After independence, India’s government was dominated by socialists, complete with five year plans and governmental control of major industries. Socialism seems like it’s designed to convince people that extractive institutions are actually good for the economy. It claims that monopolies and price controls are “just getting rid of market inefficiency”. Centralization and calcification are elevated to goals unto themselves rather than means for specific ends. I would like to do a post eventually analyzing the specific policies post-independence which were the most damaging and why they had such appeal. Today, the tide is turning fairly rapidly. India is reforming its way to much faster growth rates and freer trade. I think it is critically important that India succeeds, not just for the 1.3+ billion people who live there, but to show that democracies can get policy right and that the poor and middle class can overcome deep seated Olsonian special interest problems.

india poverty

Further Reading:
Part 2 here.
Slate on WNF
Ease of Doing Business report
Why Nations Fail blog
Trade liberalization helped the poor
Heritage report on India
Indian economy since independence
Tim Hartford on a new anti-poverty program in India using retina scans to identify recipients.
Predictions about BRICS with Easterly and Moyo

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3 Comments leave one →
  1. June 7, 2013 1:42 pm

    IMHO it is important to understand that the elites do not think this through. No one says lets keep the country corrupt so I can stay at the top even if it holds the country down making me worse off in the long run. They take bribes for the value of the bribe and if they became aware that if everyone gave up their bribes, they will surely think let me go last, just in case.

    • June 7, 2013 1:46 pm

      I was convinced on that issue by Bruce Bueno de Mequita. Politicians in democracies spend a lot of time thinking about how to get votes. Is it really so implausible that dictators spend a lot of time thinking about how to hold on to power, especially when said power can make them incredibly wealthy. Incentives matter.

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  1. Why is India so Poor? (part 2) | azmytheconomics

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