Political capitalism: The interaction between income inequality,economic freedom and democracy

We study the relationship between income inequality and economic freedom for a panel of 100 countries for the 1971–2010 period. Using a panel Granger non-causality approach, we reject the null hypothesis of Granger non-causality running from income inequality to economic freedom, but not vice versa. From a series of dynamic panel estimations we show that the effect of income inequality on economic freedom is negative and robust to the inclusion of additional controls. In particular, inequality is negatively associated with those components of economic freedom related to international trade, domestic market regulation as well as the rule of law and property rights protection. We argue that the negative effect of inequality on economic freedom is due to the economic elite converting its economic power into de facto political power to defend its economic interests; these interests run counter to economic freedom, discouraging innovation and competition as well as protecting the elite's rents. Finally, we show that economic freedom decreases with income inequality even in democratic countries, suggesting that democratic institutions do not prevent economic freedom from eroding. We argue that the latter finding corresponds to a system of political capitalism or captured democracy, where a powerful economic elite can nevertheless exercise de facto political power by cooperating with politicians and other decision-makers for their mutual benefit.     

A Political Economy Application of the “Tragedy of the Anticommons”: The Greek Government Debt Crisis

The tragedy of the anticommons unfolds when separate social agents—be they private owners of a property who intend to use the property for their own economic benefit or political actors who pursue their political objectives—do not hold effective rights to use their economic or political power for their own purposes without consent of the other players of the economic or political game. I shall discuss the Greek government debt crisis and the Eurozone countries’ policies toward Greece within the analytical framework of the tragedy of the anticommons in this paper. I do not intend to dig deep into the structure and long-term trends of public and private finances in Greece. I shall only show that the successive bail-out programs of the Eurozone countries were doomed to fail because of these countries’ competitive and non-cooperative approach to the Greek financial problems. I shall also show that a coordinating agency, say the IMF, can foster the coordinated outcome only under strict informational conditions.     

Terrorist backlash, terrorism mitigation, and policy delegation

This paper presents a three-stage proactive game involving terrorists, elected policymakers, and voters. In each of two targeted countries, a representative voter chooses an elected policymaker, charged with deciding proactive countermeasures to ameliorate a transnational terrorist threat. Two primary considerations drive the voters' strategic choice: free riding on the other countries' countermeasures and limiting a reprisal terrorist attack. The resulting low proactive countermeasures benefit the terrorists, whose attacks successfully exploit voters' strategic actions. This finding stems from a delegation problem where leadership by voters has a detrimental consequence on the well-being of targeted countries. Domestic politics add another layer of concern when addressing a common terrorist threat.     

Borders and Growth

This paper presents a framework to understand and measure the effects of political borders on economic growth and per capita income levels. In our model, political integration between two countries results in a positive country size effect and a negative effect through reduced openness vis-à-vis the rest of the world. Additional effects stem from possible changes in other growth determinants, besides country size and openness, when countries are merged. We estimate the growth effects that would have resulted from the hypothetical removal of national borders between pairs of adjacent countries under various scenarios. We identify country pairs where political integration would have been mutually beneficial. We find that full political integration would have slightly reduced an average country's growth rate, while most countries would benefit from a more limited form of merger, involving higher economic integration with their neighbors.     

The socio-economic determinants of terrorism and political violence in Western Europe (1994–2007)

The main objective of this paper is to empirically investigate the socio-economic causes of terrorism and political violence in a sample of 12 countries in Western Europe. First, we show that in western European countries the classical economic argument of opportunity cost is confirmed. That is, the larger is the set of current economic opportunities for individuals the lower is the likelihood or the willingness for them to be involved in a terrorist activity. Second, expected future economic growth seems to be associated with an increase in current terrorist activities. Eventually, our results also show that terrorist brutality (measured in people killed) is positively associated with real GDP per capita.     

Fiscal policy,rent seeking,and growth under electoral uncertainty: theory and evidence from the OECD

Abstract. We construct a general equilibrium model of economic growth and optimally chosen fiscal policy, in which individuals compete with each other for a share of government spending and two political parties alternate in power according to exogenous electoral uncertainty. The main prediction is that uncertainty about remaining in power results in increased fiscal spending, which in turn distorts incentives by pushing individuals away from productive work to rent‐seeking activities; then, distorted incentives hurt growth. This scenario receives empirical support in a dataset of 25 OECD countries over the period 1982–96. In particular, uncertainty about remaining in power leads to larger government shares in GDP, which in turn exert an adverse effect on the ICRG index measuring incentives and this is bad for growth.     

Clientelism and aid

Using a model of probabilistic voting, we analyze the impact of aid on the political equilibrium in the recipient country or region. We consider politicians with mixed motives: they are interested in promoting social welfare but also value the benefit of holding office. We label as clientelistic the politician who most values the benefit of being in power. We find that the impact of aid on the political equilibrium and therefore on the quality of policy in the recipient country (using utilitarian social welfare as a benchmark) ultimately depends on the value of the elasticity of the marginal utility of consumption. When elasticity is low, the expected policy outcome gets further away from the socially desirable policy set. This substitution of policy quality for aid can help to explain the poor performance of aid in improving policy. Perhaps more surprising is the opposite case, which arises for high values of elasticity of marginal utility: an increase in aid tilts the equilibrium policy towards the welfare-maximizing policy set.     

Military aid,direct intervention and counterterrorism

We analyze the choice often faced by countries of whether to directly intervene to counter an external terrorist threat or to subsidize a foreign government to do it. We present a model which analyzes this policy choice where two countries, home and foreign, face a terrorist threat based in the foreign country. The home country chooses how much to invest in defending itself and in reducing terrorist resources either indirectly by subsidizing the foreign country or by directly by intervening itself and risking destabilizing the foreign country. Using a calibrated model, we are able to show that direct intervention is only an equilibrium if foreign and home efforts are not good substitutes in the technology used to reduce the resources of the terrorist group. A higher relative military efficiency by the home country makes intervention more likely.     

Clientelism and aid

Using a model of probabilistic voting, we analyze the impact of aid on the political equilibrium in the recipient country or region. We consider politicians with mixed motives: they are interested in promoting social welfare but also value the benefit of holding office. We label as clientelistic the politician who most values the benefit of being in power. We find that the impact of aid on the political equilibrium and therefore on the quality of policy in the recipient country (using utilitarian social welfare as a benchmark) ultimately depends on the value of the elasticity of the marginal utility of consumption. When elasticity is low, the expected policy outcome gets further away from the socially desirable policy set. This substitution of policy quality for aid can help to explain the poor performance of aid in improving policy. Perhaps more surprising is the opposite case, which arises for high values of elasticity of marginal utility: an increase in aid tilts the equilibrium policy towards the welfare-maximizing policy set.     

Democracy,Rule of Law,Corruption Incentives,and Growth

We bridge the gap between the standard theory of growth and the mostly static theory of corruption. Some public investment can be diverted from its purpose by corrupt individuals. Voters determine the level of public investment subject to an incentive constraint equalizing the returns from productive and corrupt activities. We concentrate on two exogenous institutional parameters: the “technology of corruption” is the ease with which rent‐seekers can capture a proportion of public spending. The “concentration of political power” is the extent to which rent‐seekers have more political influence than other people. One theoretical prediction is that the effects of the two institutional parameters on income growth and equilibrium corruption are different according to the constraints that are binding at equilibrium. In particular, the effect of judicial quality on growth should be stronger when political power is concentrated. We estimate a system of equations where both corruption and income growth are determined simultaneously and show that income growth is more affected by our proxies for legal and political institutions in countries where political rights and judicial institutions, respectively, are limited.     

The Nonequivalence of Import and Export Quotas in Strategic Equilibrium

The authors use a standard general‐equilibrium trade model to show that export and import policies are not symmetric in the equilibrium of a strategic game with quotas. It is assumed that N (identical) large countries, without cooperation, set their import (or export) quotas to maximize domestic welfare. It is shown that the equilibrium in which all countries use import quotas differs from, and is superior to, the equilibrium in which countries use export quotas. The difference arises because the elasticity of the residual foreign export supply schedule differs between the two equilibria. The authors also study the properties of the sequential equilibrium of the game. In a simultaneous‐move game, each country is indifferent as to whether it uses an import or export quota, given the policy of the other country. However, in a sequential‐move game, the first mover will prefer to use an import quota rather than an export quota.     

Markovian Social Security in Unequal Societies

In this paper, we develop a dynamic political‐economic theory of social security. We analytically characterize a Markov perfect equilibrium and find that the interaction between Markovian tax policy and tax distortion on private investment in human capital shapes an intertemporal policy rule, linking taxes positively over time. By allowing current taxpayers to influence their own future social security benefits, the positive intertemporal tax linkage provides political support for social security. Moreover, this positive tax linkage leads to a negative correlation between wage inequality and the size of a nation's social security system, consistent with the empirical pattern observed across OECD countries.     

Islamist terrorism and the status of women

We investigate the effect of Islamist terrorist activity on women's legal position in society, using data for 171 countries between 1970 and 2016. To identify causal effects, we exploit the prevalence of Islamist terrorism in neighboring countries as an exogenous source of variation, arguing that regional terrorism affects local terrorism through contagion effects. We show that increased activity by Islamist terrorist groups is linked to lower legal status of women. By contrast, we find that neither Islam per se nor other types of terrorism have comparable effects. This reinforces the notion that Islamist terrorism is singularly interested and effective in weakening women's rights. Our results are consistent with a rational-economic model of terrorism, where Islamist terrorists purposefully use violence to maximize political utility, while governments make concessions that constrain the role of women because the costs of compliance are lower than the harm from continued Islamist terrorism.     

Public infrastructure,production organization,and economic development

We develop a political economy model of growth to examine economic development led by the interactions between an economic decision concerning a firm’s production technology (CRS vs. IRS technology) and a political decision concerning public infrastructure. We show that multiple equilibrium growth paths occur due to differences in expectations regarding the quality of public infrastructure. These multiple paths illustrate why economies with poor initial conditions can catch up to and, furthermore, overtake economies with better initial conditions. Our result could explain the experiences of some East Asian countries where the co-evolution of public infrastructure and industrial transformation spurred economic development.     

Coordination and delay in global games

What is the effect of offering agents an option to delay their choices in a global coordination game? We address this question by considering a canonical binary action global game, and allowing players to delay their irreversible decisions. Those that delay have access to accurate private information at the second stage, but receive lower payoffs. We show that, as noise vanishes, as long as the benefit to taking the risky action early is greater than the benefit of taking the risky action late, the introduction of the option to delay reduces the incidence of coordination failure in equilibrium relative to the standard case where all agents must choose their actions at the same time. We outline the welfare implications of this finding, and probe the robustness of our results from a variety of angles.     

BOOMS AND SLUMPS IN A GAME OF SEQUENTIAL INVESTMENT WITH THE CHANGING FUNDAMENTALS

Many less developed countries have experienced prolonged periods of expansions and reversals in foreign investment inflows. This paper presents a simple game-theoretic model that can explain hysteretic patterns of serial correlation in investment behavior. We develop a sequential move game of coordinated investment played by short-run players under the changing economic environment and demonstrate that in a unique equilibrium of the game, the economy fluctuates over multiple static equilibria, generating hysteresis.     

Inefficient predation and political transitions

This paper presents a theory of endogenous economic institutions in non-democracies, where political accountability is enforced through the threat of revolution. We consider a dynamic game between an elite ruling class and a disenfranchised working class, in which workers have imperfect information about the economy's productive possibilities. We characterize the conditions under which (i) the elite implement an inefficient rent-creating economic institution at the risk of provoking a revolution based on institutional grievances, (ii) information shocks can catalyze revolutionary movements that may be contagious among similar countries, and (iii) democratic transitions can be consolidated following revolutionary liberalizations.     

Terrorism and the world economy

It has been argued that terrorism should not have a large effect on economic activity, because terrorist attacks destroy only a small fraction of the stock of capital of a country (see, e.g., Becker, G., Murphy, K., 2001. Prosperity will rise out of the ashes. Wall Street Journal October 29, 2001). In contrast, empirical estimates of the consequences of terrorism typically suggest large effects on economic outcomes (see, e.g., Abadie, A., Gardeazabal, J., 2003. The economic cost of conflict: A case study of the Basque country. American Economic Review 93, 113-132). The main theme of this article is that mobility of productive capital in an open economy may account for much of the difference between the direct and the equilibrium impact of terrorism. We use a simple economic model to show that terrorism may have a large impact on the allocation of productive capital across countries, even if it represents a small fraction of the overall economic risk. The model emphasizes that, in addition to increasing uncertainty, terrorism reduces the expected return to investment. As a result, changes in the intensity of terrorism may cause large movements of capital across countries if the world economy is sufficiently open, so international investors are able to diversify other types of country risks. Using a unique data set on terrorism and other country risks, we find that, in accordance with the predictions of the model, higher levels of terrorist risks are associated with lower levels of net foreign direct investment positions, even after controlling for other types of country risks. On average, a standard deviation increase in the terrorist risk is associated with a fall in the net foreign direct investment position of about 5% of GDP. The magnitude of the estimated effect is large, which suggests that the “open-economy channel” impact of terrorism may be substantial.     

A Simple Model of Inefficient Institutions

This paper develops a simple model of economic and political institutions that lead to poor aggregate economic performance. In the model economy, groups with political power, the elite, choose policies to increase their income and to directly or indirectly transfer resources from the rest of society to themselves. The resulting equilibrium is generally inefficient because of three distinct mechanisms: (1) revenue extraction, (2) factor price manipulation and (3) political consolidation. In particular, the elite may pursue inefficient policies to extract revenue from other groups. They may do so to reduce the demand for factors coming from other groups in the economy, thus indirectly benefiting from changes in factor prices. Finally, they may try to impoverish other groups competing for political power. The elite's preferences over inefficient policies translate into inefficient economic institutions. The notable exception to this general picture emerges when long‐term investments are important, thus creating a commitment (holdup) problem, whereby equilibrium taxes and regulations are worse than the elite would like them to be from an ex ante point of view. In this case, economic institutions that provide additional security of property rights to other groups can be useful.     

Endogenous timing,strategic tariff game and bilateral trade in vertical oligopoly

This paper builds an observable delay game in endogenous timing to study the possible occurrence of trade wars in a vertical, bilateral trade model. It examines the effects of production cost differences and order of moves on optimal tariffs, market equilibria, dumping margin and social welfare in both fixed timing and endogenous timing games. In a fixed timing game, it shows that price dumping in the intermediate good market arises from differences in country-specific final good production costs. Different from Bernhofen (1995; Journal of International Economics), trade costs resulting from reciprocal tariffs in upstream markets can reverse the price dumping under certain conditions. In an endogenous timing game, this paper finds that the magnitude of cost differences significantly influences countries’ decisions on the order of moves in a strategic tariff-making game. Both countries want to be the first movers under a small cost difference and consequently reach a simultaneous equilibrium result. This demonstrates that the second-best equilibrium proceeds under certain conditions. Under a large cost difference, sequential policy-making is the subgame perfect Nash equilibrium. If the cost difference is sufficiently large, both countries have an incentive to launch a trade war as a multiple equilibrium game.