Global Inequality and the Institutional Theory

Key Insight

Vast differences in living standards across the world are a relatively recent phenomenon, largely emerging over the last 200 years. For example, while Mexico was richer than polities to its north 500 years ago, the United States only pulled ahead in the nineteenth century. Similarly, South and North Korea were indistinguishable before their division, and the economic gap between the two Nogaleses is even more recent. These disparities are not historically, geographically, culturally, or ethnically predetermined.

The core theory to explain why some nations prosper while others are poor centers on the distinction between inclusive and extractive economic and political institutions. Inclusive economic institutions are defined as those that enforce property rights, create a level playing field, and encourage investments in new technologies and skills, thus being more conducive to sustained economic growth. In contrast, extractive economic institutions are structured to extract resources from the many for the benefit of the few, failing to protect property rights or provide economic incentives.

These economic institutions are synergistically linked with political institutions. Inclusive economic institutions are supported by, and in turn support, inclusive political institutions, which distribute political power widely in a pluralistic manner and establish sufficient political centralization for law, order, and secure property rights. Conversely, extractive economic institutions are connected to extractive political institutions, where power is concentrated in the hands of a few who maintain these institutions for their benefit and use extracted resources to cement their political control.