Are extractive institutions always bad?

A closer look at a Nobel Prize-winning idea.

Written by Lipton Matthews.

Economists Daron Acemoglu, James Robinson and Simon Johnson have practically become household names with their work on the “colonial origins of comparative development”.¹ The central claim is simple. In regions where European settlers found environments suitable for settlement, they constructed “inclusive institutions” that protected property rights, constrained elites and encouraged entrepreneurship. But in regions where settlement was difficult, colonizers instead imposed “extractive institutions” that simply transferred wealth to the metropole.

This argument reshaped the study of economic development and culminated in Nobel Prizes for the aforementioned trio. However, it requires substantial qualification.

Extractive institutions do distort incentives, concentrate political power and curtail entrepreneurship. Hence they often slow growth relative to plausible alternatives. But slowing growth is not the same as preventing it altogether. In fact, evidence shows that economies frequently grow under extractive institutions, sometimes for long periods and sometimes quite substantially.

It is important to recognize that extractive institutions in Africa and the Americas did not originate with European colonialism. Long before Europeans arrived, many societies in these regions were governed by centralized, coercive regimes that relied on forced labor, payment of tribute and elite control over land. Empires and chiefdoms in the Americas extracted surplus through labor drafts and tribute systems, while large parts of Africa had hierarchical polities that exercised authority over almost all production. Colonial rule intensified, reorganized or redirected these extractive institutions; it did not create extraction from nothing.

Colonial Peru illustrates that extractive institutions do not necessarily imply economic stagnation. Spanish rule relied on coercive labor systems such as the mit’a, as well as monopolized trade and political exclusion. These institutions were deeply extractive by any reasonable definition. Yet reconstructions show that Peru experienced rising real wages and per capita output over extended stretches of the colonial era. Mining centers generated large surpluses, supporting complex networks of artisans, traders and service providers. By the eighteenth century, this dynamism was visible in urbanization rates. By the 1700s, urbanization stood at roughly 12 percent in Mexico and about 20 percent in Peru, compared with only 11 percent in Spain itself.

This economic activity was accompanied by meaningful investments in human capital. Colonial authorities and religious orders established schools, seminaries and universities across Spanish America. Literacy and numeracy spread, albeit unevenly. Evidence from numeracy estimates indicates that by the late eighteenth century, the gap in basic human capital among regions such as Argentina, Mexico and Peru narrowed substantially over time, falling from roughly 50 percent to about 30 percent by around 1780. These trends suggest not stagnation but convergence under extractive rule.

While a substantial share of colonial surplus was transferred abroad, enough remained to raise average living standards. Growth occurred not because institutions were inclusive, but because production, specialization and market integration and human capital formation continued under coercive systems.

The same is true in the case of the Dutch cultivation system in Java. The colonial regime was highly extractive. Village authorities were subordinated, peasants were coerced into producing export crops, and the system existed to maximize revenue for the colonial state. Yet extraction on this scale required a major reorganization of economic life: the Dutch build sugar factories and the transport infrastructure to go with them.

Evidence shows that areas near colonial sugar factories remain richer and more educated today than otherwise similar areas farther away. This is despite the fact that sugar production itself has long since disappeared. The explanation is straightforward. Extractive production required infrastructure, technology transfer and human capital. Meeting these requirements forced the colonial state to solve a series of practical problems: expanding irrigation, constructing processing facilities, and strengthening local administrative structures. Once established, these institutions did not vanish with the end of colonial rule. Growth arose not from inclusive institutions, but from the material and organizational demands of extraction itself.

The effects extended even to villages that were subjected to forced cultivation. These villages accumulated more communal land and enjoyed higher levels of education, including for cohorts educated during the colonial period. Extractive rule empowered local authorities in ways that unintentionally facilitated the provision of public goods. So while extractive institutions constrained freedom and entrepreneurship, they actually helped economic development.

The Cold Storage Commission in Southern Rhodesia reveals the same pattern in another sector, namely beef. Established to stabilize settler incomes and secure export markets, it enhanced production by enforcing quality standards, coordinating supply and investing in refrigeration. These measures were explicitly designed to benefit a narrow group of white producers. Yet they boosted the scale and efficiency of the food industry as a whole, and integration into global markets followed.

This case reveals that even racially exclusive institutions can generate economic growth when the colonial state is committed to building real, productive capacity. Growth was not inclusive, and its benefits were narrowly distributed, but it occurred nevertheless. Extractive institutions in Rhodesia created hurdles for some entrepreneurs and ordinary people, but they certainly did not prevent economic development.

The point is not that extractive institutions are optimal but that they are far less deleterious than is often claimed. When extraction is done in order to expand output, states are compelled to invest in both physical and human capital. The resulting institutions — schools, transport networks and administrative systems — then outlast the states that created them.

Furthermore, the popular idea that colonization invariably hurts long-run growth begins to unravel when examined systematically. Once other factors are taken into account, the simple fact of having been colonized carries little independent weight in explaining economic performance. (Hong Kong and Singapore are two of the richest places on the planet.) What stands out instead are disruptions that occurred after colonization.

Warfare, for example, imposes severe and lasting damage — destroying capital, fragmenting markets and diverting resources away from productive use. Trade policy also plays a key role. The turn toward protectionism in many postcolonial states prevented access to global markets and reduced competitive pressures. By shielding domestic industries, governments encouraged rent-seeking rather than innovation. And the costs of such policies accumulate over time.

Latin America offers an interesting case study. The region did not emerge from the colonial period with uniquely high levels of inequality. The decisive break actually occurred much later, during the twentieth century. While much of the world experienced a marked compression of incomes — a broad levelling driven by industrialization, expanded education and integration into global markets — Latin America moved in the opposite direction. From 1913 to the 1970s, inequality rose rather than fell.

This divergence was not some long-delayed consequence of colonial rule. It reflected a specific set of policy choices: protectionism limited exposure to global competition, while state-led development strategies concentrated gains in politically connected groups.

The broader lesson is clear. While extractive institutions are not something for which countries should actively strive, they can and have coexisted with sustained economic growth. There is therefore no simple contrast between inclusive prosperity and extractive stagnation. (The historical record is more complicated than that.) What is more, the “legacy of colonialism” cannot explain all or even most of the differences in income we see today. And its long-term effects aren’t uniformly negative.

Lipton Matthews is a researcher and YouTuber. His work has been featured by the Mises Institute and Chronicles. He is the author of The Corporate Myth. You can reach him at: lo_matthews@yahoo.com

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1. Their paper of that title has over 20,000 academic citations, and spawned several books.