This theme of extractive versus inclusive institutions of state provides a powerful explanation of the forces and structures that enable sustained economic growth. An inclusive state is one that applies rule of law to ensure democratic accountability, whereas an extractive state is run corruptly for the benefit of elites. There is constant pressure toward extractive politics, since those who have power can use money and guns, while the only things going for inclusive methods are reason and morality. Also, inclusion can be hard to explain. For example protection of inefficient industry looks inclusive but is actually extractive. Protection means that efficient producers pay a tax to keep inefficient producers in business. Free trade is better for everyone, but again its only defence is reason and morality, whereas protection benefits from the squealing of the corrupt.

I just had this letter published in The Australian, which draws on the political debate about human rights, and the argument that inclusive institutions supported by libertarian capitalist politics are actually more supportive of rights, due to their ability to create wealth, than the traditional human rights focus of left wing politics on increasing the power of government to distribute wealth.

Right to flourish
TIM Wilson's excellent analysis ("Narrow focus confuses intent", 23/1)helps to explain how the human rights provided by capitalism enable people to flourish in a dynamic, growing society. Social inclusion is another idea that should be reinterpreted against this broader framework. Inclusion requires the rights to speak your mind and to compete fairly in business under rule of law. It should not focus on use of the tax system to extract ever more wealth from those who earn it to give to those who don't.

But what is your test case for the success of libertarian economic policies, Robert? Maybe you really don't mean all-out libertarianism, but the philosophy that prevails in the West and places like Australia, which I believe has been called state capitalism. The subject of regulating commerce has to come up, for which libertarianism has no or very little tolerance. Yet in 2008 in the U.S. and elsewhere, lax regulation was fingered as the cause of market crashes and catastrophic unemployment. And government action to bail out the auto companies appears to be exactly the right thing to have done, according to the experts.

Can't the private sector itself be extractive in terms of the welfare of the nation? Any sector that is able to concentrate power can operate at the expense of the rest.

DWill wrote: Can't the private sector itself be extractive in terms of the welfare of the nation? Any sector that is able to concentrate power can operate at the expense of the rest.

But the reason the private sector was able to become extractive is because the financial sector is a special interest served by a powerful government, which crafts regulation in the interests of these firms (the sector was far from deregulated). Part of what led to the crisis was the fact that firms were insulated from risk -- creditors ended up being bailed out, and as long as that was a real possibility, they had less incentive to be concerned about risk.

DWill wrote:But what is your test case for the success of libertarian economic policies, Robert? Maybe you really don't mean all-out libertarianism, but the philosophy that prevails in the West and places like Australia, which I believe has been called state capitalism.

If you read the Wikipedia page on Libertarianism you will see it is a diverse concept, with various economists and philosophers asserting views about how to promote individual liberty. In Why Nations Fail, the thread is that individual liberty should be the goal of an inclusive state, with rule of law as the guiding central principle. This idea of rule of law has been controversial in the work of the libertarian Nobel Economics Laureate Friedrich Hayek, who held that a strong state is essential to secure property rights, and thereby to promote individual liberty. The phrase “all out libertarianism” is quite vague, covering everything from anarchism to Hayek’s views on the central role of the state.
“State capitalism” is a concept more associated with former communist states such as Russia and China, where market forces are corrupted by a major role for the state. The USA and Australia by contrast have generally preferred to leave industry to the private sector, without taking government equity in commercial firms. Perhaps the most successful example of state capitalis is Singapore, where the government has a central role in industries such as aviation and banking through its sovereign wealth fund GIC http://en.wikipedia.org/wiki/Government ... orporation .

DWill wrote: The subject of regulating commerce has to come up, for which libertarianism has no or very little tolerance. Yet in 2008 in the U.S. and elsewhere, lax regulation was fingered as the cause of market crashes and catastrophic unemployment. And government action to bail out the auto companies appears to be exactly the right thing to have done, according to the experts.

Later in the book, WNF explains how England established a constitutional alliance between a range of interests who were united by a common interest in rule of law rather than absolutism, and how this happy confluence was the basis for the growth of empire. While some strands of supposed libertarian thought are anarchist in the way you describe, this is more a corruption of the theory of liberty, an attempt by vested interests to co-opt moral philosophy. It is basically a recipe for disaster, and does not fit with the inclusive goals of WNF.

DWill wrote: Can't the private sector itself be extractive in terms of the welfare of the nation? Any sector that is able to concentrate power can operate at the expense of the rest.

Yes of course, and this is a big theme in WNF, with examples from history of the use of the state to create commercial monopolies aimed at extracting wealth from the people. The concentration of power is precisely what the USA sought to undo in the great trust-busting period of the breakup of Standard Oil. Unfortunately, in more recent times it seems that commerce has bought the government so the US is headed on a path towards stagnation and conflict and poverty.

Dexter wrote:

DWill wrote: Can't the private sector itself be extractive in terms of the welfare of the nation? Any sector that is able to concentrate power can operate at the expense of the rest.

But the reason the private sector was able to become extractive is because the financial sector is a special interest served by a powerful government, which crafts regulation in the interests of these firms (the sector was far from deregulated). Part of what led to the crisis was the fact that firms were insulated from risk -- creditors ended up being bailed out, and as long as that was a real possibility, they had less incentive to be concerned about risk.

Not that I'm well schooled in any of this, but it was supposed to have been a piece of deregulation--repeal of Glass-Steagall, allowing commercial and investment banking to join forces--that led to the financial crisis. And it didn't even take a Republican to do it. Did Clinton do that for political reasons or because he thought it would make the economy more robust? It doesn't have to be one or the other. It worked brilliantly and Clinton left office with a budget surplus.

Again, I don't know that much, but I wonder if the finance industry is any more entangled with government than other industries are.

If you read the Wikipedia page on Libertarianism you will see it is a diverse concept, with various economists and philosophers asserting views about how to promote individual liberty.

What is there within Libertarianism that ensures wealth inequality wouldn't grow? It seems the call for increased freedoms would benefit those with leverage more than those without. As in, the market will set the appropriate minimum wage, and so we shouldn't restrict the business owner from hiring people for less.

I would think that in a perfectly "free" market, the stratification of wealth would be even more severe than what we currently see.

Interbane wrote:What is there within Libertarianism that ensures wealth inequality wouldn't grow? It seems the call for increased freedoms would benefit those with leverage more than those without. As in, the market will set the appropriate minimum wage, and so we shouldn't restrict the business owner from hiring people for less. I would think that in a perfectly "free" market, the stratification of wealth would be even more severe than what we currently see.

Thanks Interbane, good comments. Maybe I should not have introduced libertarianism into the discussion, since it is an idea that is corrupted by anti-government zealots in the USA. A bit like trying to talk about Christianity, where everyone has quite different experiences.

I like the approach of Hayek, as he explained in The Constitution of Liberty, emphasising the role of a strong state in providing a level playing field through rule of law. This is the main theme in WNF, with law providing the basis for opportunity and inclusion.

Markets are subject to failure, as in the example of the monopoly exercised by Standard Oil in the USA a century ago, discussed in WNF as a typical example of an extractive state where markets cannot operate properly. To preserve competition and freedom, governments have to intervene to set fair rules. A good analogy here is that governments should steer not row, meaning they should maintain law and order but not own companies.

Inequality is worse under what WNF calls an extractive state, where the powerful use money to corrupt politics. The ideal of freedom is a small strong state with democratic accountability and transparency. Maximising freedom for all requires good regulation to prevent corruption.

The question of minimum wages is complex. My view is that in a rich country such as America the government should augment wages through welfare to provide a social safety net with low effective marginal tax rates, but that anyone should be able to employ people for whatever they can negotiate. Allowing the market to operate in this way would generate economic growth, remove labour market rigidity, and actually create opportunities for people to rise up from the bottom if they have drive and ambition. It would cause the market clearing minimum wage to rise, since you would not be able to find anyone to work for less.

As Maurice Newman recently said, "collusion between big government, big business and big labour allows those in authority to pursue self-serving policies which limit unwanted competition and ideas. Under these policy settings, capitalism's natural tendency to evolve through creative destruction is resisted. When it finally finds expression through economic and financial adjustment, the results can be extremely painful."

WNF emphasises the creative destruction of capitalism as the dynamo of growth, innovation and improvement. It is rather like John F Kennedy's comment that a rising tide lifts all boats. If we can grow the pie, everyone will be better off. As Margeret Thatcher said, you can't make poor people richer by making rich people poorer. While the state should aim to set policy to maximise freedom for all, not just for an elite, that goal is not achieved through extractive collusion.

In Australia, we are now seeing the end of our automobile manufacturing industry, since Australia cannot compete against more efficient countries. I would not be surprised if the same thing happened in America, due to the political process of industry protection. Maurice Newman makes a provocative quote from the head of China's state investment arm. "He described European workers as "slothful" and "indolent" and blamed Europe's outdated labour laws and welfare systems."

My view is that in a rich country such as America the government should augment wages through welfare to provide a social safety net with low effective marginal tax rates, but that anyone should be able to employ people for whatever they can negotiate.

Why should my taxes go towards Walmart's employees because Walmart executives refuse to pay their workers more? To hell with that. That is NOT what my taxes should be used for. Walmart easily nets enough to pay all of their employees over the welfare limit. Having government subsidize the underpayment of workers is ridiculous, especially when the company can afford to pay more. Use those taxes to build infrastructure or invest in research.

It would cause the market clearing minimum wage to rise, since you would not be able to find anyone to work for less.

In order to have more jobs, businesses need to do more business. That won't happen unless we have a middle class with more purchasing power. We won't have that middle class unless there is upward mobility from those in poverty. That won't happen until they make more. This simple formula is at the heart of an insanely complex set of causes and effects, so it's easily confused.

Saying that wages should be whatever is negotiated makes the problem even worse. Now you have a vast swath of the population with even less purchasing power. What would that do to businesses who rely on their business? It would cause them to lay off workers or shut down completely. A small sliver of the economy would do better; real estate in the Hamptons, Yacht manufacturers, private jet manufacturers, Switzerland.

If we can grow the pie, everyone will be better off.

In climbing out of the recent recession, the pie has grown. And only a small percentage of people are better off. The majority of people are worse off than they were before. A rising tide only seems to lift the yachts, and the trickle down smells like urine.

"He described European workers as "slothful" and "indolent" and blamed Europe's outdated labour laws and welfare systems."

There are slothful, useless people where I work that do terrible work because they simply aren't motivated in the right way(a terrible supervisor). Under the same set of laws, two different companies can have entirely different work environments. It's like working for Sears vs Google. It's night and day. If a company's employees aren't motivated, there are ways to change the internal formula regardless of the existing labor laws.

All that the labor laws need to do is offset the unfair leverage of those higher in the chain of command. That doesn't mean immunity from being fired, automatic raises, or benefits beyond what are earned. The workplace should still be incentivized, even if that means finding a way to instill pride(Ford/Google).

Interbane wrote:A rising tide only seems to lift the yachts, and the trickle down smells like urine.

Your phrase "seems to" reflects the perception, often false, that the poor are getting poorer. Research such as the World Bank's influential report Growth is Good for the Poor has proved strong correlation between growth and poverty reduction. People feel resentment about growing inequality, but that does not prove that inequality as such is a bad thing. In fact, inequality is good, reflecting reward for talent and risk.

The problem, in terms of the analytical framework of Why Nations Fail, arises when inequality enables the state to tip from being inclusive - supporting equality of opportunity - to being extractive - actively preventing innovation and entrepreneurial activity that would produce creative destruction. I am not sure where the USA is on that spectrum today.

Walmart is an interesting case study. Providing an abundant range of low cost products promotes social inclusion, while paying low wages seems to lock its employees into poverty. Has Walmart become the Standard Oil of retail, a mega mart that sucks the diversity out of local economies?

We have a similar problem in Australian retail, with the Coles and Woolworths duopoly in supermarkets making it very hard for small farmers to make ends meet, shifting agriculture into a purely commercial business framework of get big or get out. But consumers have never had such a superb range of low cost high quality fresh food to buy.

I don't have a fixed view on minimum wages, but these sort of vexed problems should consider all the evidence, modeling different outcomes, not simply jumping to politically driven conclusions.