Taking Stock

This chapter provided a brief overview of some of the issues related to the effects of po­litical institutions on economic growth. How societies can choose economic institutions and policies that are not conducive to economic growth was the focus of the previous chapter.

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A natural conjecture based on the analysis there is to relate differences in economic insti­tutions to political institutions. For example, if political power is in the hands of an elite that is opposed to growth, growth-enhancing policies are less likely to emerge. Our analysis in the previous chapter hinted that such considerations could be important. The empirical evidence in Chapter 4 also provided support for such a view, whereby the cluster of economic institutions that provide secure property rights to a broad cross-section of society together with political institutions that place constraints on elites and politicians, and support such economic institutions are conducive to economic growth. Nevertheless, the relationship be­tween political regimes and growth is more complicated for a number of reasons. First, the empirical evidence is less clear-cut than we may have originally presumed—while there are historical examples of the positive effects of democratic institutions on economic growth, the postwar evidence does not provide strong support for the view that democracies and political institutions that constrain rulers and politicians are more conducive to economic growth. Second, political institutions themselves are not given, but are endogenous and change dy­namically. These two factors imply that we need to understand how political institutions affect economic outcomes more carefully and should also consider the modeling of equilib­rium political institutions. Both of these areas are at the forefront of research in political economy and are likely to play a more important role in the research on economic growth in the coming years.

In this light, I presented a number of models to highlight the ideas about political equi­libria and the relationship between political institutions and economic growth that I view to be most important and most promising for future work. I emphasized how preferences over political institutions need to be derived from the implications of these political institutions for economic allocations. I then highlighted how ideal (or perfect) political institutions are unlikely to exist or be feasible in practice, thus different political institutions, by creating different sets of winners and losers, also create tradeoffs. Oligarchies favor the already rich, which brings a range of distortions. Democracies, on the other hand, will typically involve higher taxes on the rich to generate income to redistribute to the less well-off and in the process create distortions on investment and other economic choices. In general, it is impos­sible to unambiguously conclude whether democracies or oligarchies (or yet other political systems favoring other groups) will be more growth-enhancing. However, certain ideas seem both plausible and consistent with the data. One aspect I tried to emphasize is that the dynamic tradeoffs between democracies and other regimes may be different than the static tradeoffs. While democracies may create static distortions because of their greater redis­tributive tendencies, they are likely to outperform oligarchies in the long run because they avoid political sclerosis, whereby the incumbents are able to dominate the political system and erect entry barriers to protect their businesses, even when efficiency dictates that other individuals should enter and form new businesses to replace theirs.

Another important idea I tried to emphasize is that democracies may lead to inefficient outcomes because they may sometimes be dysfunctional. The main functional characteristic of democracies is that they create political equality, providing voice to the masses, free entry of parties, and free and fair elections. However, as already emphasized, political equality often comes with a tendency to choose redistributive policies that are costly for the elites (especially, for elites that have most of their assets in land or in other easily taxable forms). This creates an incentive for the elite to invest to increase their de facto political power in order to capture democratic politics. Captured democracies are particular example of dysfunctional democracies and may lead to a range of inefficiencies not because the regime is democratic, but precisely because its true democratic nature remains unfulfilled. The model in Section 23.5 provides a stark example of this tendency, whereby democracy may lead to a Pareto dominated allocation, even though without the intervention from the elite, democratic politics would lead to higher income per capita and much less distorted allocations. Whether, in practice, the majority of distortions in democracies are related to their redistributive tendencies or to the fact that they are captured by the elites is an empirical question that has not been addressed yet. Future empirical work might shed light on this important set of questions. Another type of dysfunctional democracy, discussed at the beginning of this chapter, is exemplified by the populist regimes such as those of Peron in Argentina and Chavez in Venezuela.

Finally, I also gave a very brief overview of some of the issues that arise when we wish to model the dynamics of political institutions themselves. Section 23.4 provided both an abstract discussion of the types of models that would be useful for such an analysis and examples of how these models can be developed and applied to various situations. Once again, this is an area of active current research and the material presented here is no more

than the tip of the iceberg, and it is meant to entice the reader to think more about these issues and to introduce the bare minimum that is necessary for a more coherent discussion of the relationship between political institutions and economic growth.

23.7. R