Extractive institutions and the takeoff to long-run growth: A Schumpeterian perspective

We examine how extractive institutions affect the timing of the takeoff to sustained economic growth, the pace of industrialization, and the long-run balanced growth path of an economy. The politically dominant ruling elite can choose to extract a share of output and/or to interfere with creative destruction by extracting innovation resources. In so doing, the ruling elite needs to balance its desire for grabbing a greater share of resources with the constraint of being able to stay in power. We show that the extraction from output delays the takeoff to sustained economic growth and reduces economic growth in the early industrial period. However, taken by itself, output extraction does not reduce the long-run balanced growth rate. By contrast, if the ruling elite interferes with creative destruction by extracting resources meant for innovation, it suppresses economic growth during industrialization and along the balanced growth path. After deriving the main results analytically, we calibrate the model to the U.S. economy to illustrate the adverse long-run development effects of extractive institutions. According to our results, institutions and policies that reduce the extractive power of the ruling elite can boost economic development to a substantial degree.