False economy What’s in it for me? Understand what makes the

Variations in living standards between 
countries are best explained by institutional 
differences.
Forget grand theories that try to explain away 
variations in prosperity between countries. The 
truth is far simpler. What really matters are 
economic and political institutions.
A given country’s prosperity is determined by its 
economic institutional landscape – the systems 
and regulations that direct economic behavior 
within its borders. That landscape includes 
property laws, the strength of public services 
and access to finance.
These economic institutions fall into one of two 
categories: extractive or inclusive.
Inclusive 
economic 
institutions 
stimulate 
economic success and are designed to 
encourage participation in economic activities. 
They also nurture economic freedom.
In countries like South Korea and the USA, for 
instance, market rules derive from private 
property laws, as well as from developed 
banking sectors and strong public education 
systems.
These rules enable people to know they can 
work hard and be innovative, certain that their 
efforts will be remunerated and their wealth will 
be preserved.
In contrast, extractive institutions derive incomes 
from groups within society for the benefit of other 
groups. In colonial Latin America, for example, a 
system built on duress and the expropriation of 
indigenous populations was designed to benefit 
the colonizers. In North Korea, the Kim family 
founded a regime that repressed the populace, 
outlawed private property and concentrated all 
power within a select elite.
Much like economic institutions, political 
institutions can also be inclusive or extractive.
The main characteristic of inclusive political 
institutions is pluralism. This means that various 
groups in a given society are politically 
represented, therefore power is shared between 

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them. For institutions to be truly inclusive, it’s 
also essential that they are centralized. 
Centralization of power results in the rule of law 
being upheld; there is no need for these different 
groups to fight each other for superiority.
If political institutions lack pluralism or 
centralization, then they can generally be 
spoken of as being extractive.
The benefit of inclusive political institutions is 
that they result in power-sharing between 
groups. This leads to the erasure of extractive 
economic policies and, consequently, in mutual 
economic benefits for all members of society.