This chapter will make a first attempt towards answering the following fundamental question that has been in the background of much of what we have done so far:
why do similar societies choose different institutions and policies, leading to very different economic growth outcomes?
Our analysis so far has highlighted the role of capital accumulation, human capital and technology in economic growth.
We have investigated the incentives to accumulate physical capital and human capital, the process via which technology progresses and how different societies transfer and adopt technologies from others (or from the world technology frontier). Throughout we have emphasized that the level of physical capital, the extent of human capital and even the technology of societies should be thought of as endogenous and respond to incentives. This brings us to the fundamental question: why do different societies end up with different levels of physical capital, human capital and technology (or organize their production differently)? While we cannot provide a full and comprehensive answer to this question, the recent literature has made considerable progress in the study of why societies differ in their choices. Chapter 4 has argued against the importance of geographic and cultural factors and has instead suggested that differences in institutions are likely to be the most important fundamental cause of differences in economic performance. The purpose of this and the next chapter is to investigate this claim in greater detail and provide models that can help us understand why institutions might have such an effect and why institutions themselves differ across societies.This chapter starts with a brief informal discussion of political economic analysis of institutions and policies. I will emphasize that different constellations of institutions and policies will typically create different winners and losers, thus social conflict over collective choices (institutions and policies) will be ubiquitous.
Political economy concerns the analysis of how societies resolve—or fail to resolve—these conflicts.The rest of the chapter will present a number of models to shed light on the impact of distributional conflicts. I will start with the simplest environments, highlighting why societies choose distortionary policies. I will then enrich these environments both to investigate the robustness of the channels they highlight and also how these mechanisms interact with each other. Special emphasis will be placed on distortionary policies arising because of two complementary reasons: (1) the desire of individuals or social groups to transfer resources to themselves using limited fiscal instruments, and (2) the potential conflict between different social groups in the marketplace or in the political arena. I will try to highlight why these two sources of distortionary policies are distinct and also argue that the second source of distortions is typically more costly for growth.
I will conclude the chapter by pointing out that in addition to economic policies (such as taxes) and economic institutions such as the security of property rights and the regulation of entry, the provision of public goods by the government is an important topic in the political economy of growth.
22.1.