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Why is India so Poor? (part 2)

June 5, 2013

In my previous post, I wrote that India was poor because of its extractive institutions were implemented despite inclusive political institutions. But what are the particular institutions which were so damaging? How should people analyze laws to determine if they are beneficial to the rich and powerful or to the average person? Often laws which do not look extractive actually are.

All politicians want to control policy. Democracy serves as a way to check a politician’s personal goals and replace them with the goals of the voters. Elites use the counter-intuitive situations where extractive institutions look inclusive to get non-elites to support the very policies which are keeping them poor. Tricking the voters allows politicians to personally control policy even when the policy is contrary to the interests of the masses.

How to Be Extractive, Step 1: Keep the Poor Poor
Maintain the caste system. Don’t let the poor think that they can improve their lot in life, since that just creates instability. Instead, idolize subsistence agriculture, despite the fact that it is a brutal way to live. Keep the peasants poor, uneducated, disconnected, and disempowered. To make sure none of the lower classes are able to improve their lot, require an expensive licence in order to do any well-paying job. Prevent anyone except for your political supporters from getting a licence so that people must support you politically to feed their families. If anyone criticizes you, distract them by talking about how capitalism is evil.

Step 2: Concentrate Economic Power
Channel resources away from farmer and toward easily controlled heavy industry monopolies.

monopoly pricing

Monopolies allow the government to profit by controlling price and reducing quantity. Whatever you do, don’t allow competition. Competitors will lower prices and innovate, which cuts into your profit margins. To prevent this, set up barriers to entry such as quotas, heavy regulation and an anti-trust agency which prosecutes competitors out of existence. If that doesn’t work, simply nationalize any upstarts.

Step 3: Prevent Creative Destruction
Maintain high taxes, so that firms not sponsored by the government fail quickly and to extract as much money as possible to give to your supporters. Prevent international trade at all costs, so that there are no economic opportunities for the masses, and no competitors to politically controlled monopolies. Do not allow foreign direct investment. That will create new firms which will compete with the government’s monopolies and allow the poor to better themselves. Ease the peasant’s concerns by appealing to their hatred of foreigners.

How to Recognize Extractive Institutions
A law might be extractive if…:
1. It decreases production instead of increasing it.
2. It adds regulation which is too complex for the average person to understand.
3. It increases market power by limiting competition and entry.
4. It denies economic opportunities to the common man, but not the elites.

Consumption requires production. Food must be grown before it is eaten, goods must be manufactured before they can be used. Laws which lower the amount which is produced will unavoidably reduce what people have to consume, although they can change the distribution of consumption so that the law is worthwhile to the group which lobbied for it. The special interest group won’t mind if the economic pie gets smaller so long as they get a bigger slice.

When it comes to regulation, the devil is in the details. Laws which sound good on the surface often benefit those they are trying to regulate. Those who are regulated care far more about the regulation than the average person. Hence, they pay more to lobby, and put more effort into creating a law which helps them.

Market power is the friend of the rich and powerful and the enemy of the poor. Just because it is run by the government doesn’t make it good.

You don’t do anyone any favors by denying them an opportunity to improve their life. If a law takes away options for the poor, it is probably extractive.

Conclusion
I think India was poor for such a long time because the rhetoric of the political classes was effective at framing extractive policies as beneficial to the poor. Basically, they convinced Indian voters to vote against their own interests and maintain a system where only the elites benefited. The reforms of the 90’s and 2000’s have demonstrated the effectiveness of a freer market at reducing poverty, and hopefully those trends will continue.

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2 Comments leave one →
  1. Darla L. Koch permalink
    June 18, 2013 12:36 am

    The antidote to extractive institutions are inclusive institutions, which are designed to create incentives that reward everyone for hard work and innovation. Inclusive economic institutions include the protection of private property rights, predictable enforcement of contracts, regulation to prevent monopolies, access to credit and opportunities to invest. If, for example, a young couple is unsure about the legality of their land title, it’s unlikely that they will invest the time and money to improve their house. If an entrepreneur assumes that the government will not challenge monopolies that unfairly squeeze out competition, then she won’t invest her life savings to develop a disruptive technology.

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

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