ENDOGENOUS ECONOMIC POLICY AND THE STRUCTURE OF PRODUCTION: THEORY AND EVIDENCE

This paper develops and tests a model that predicts a positive relationship between absolute levels of capital stock and how favourable are policies toward capital. The theoretical model we use is a model of campaign contributions and electoral competition, extended to consider the implications for factor mobility and hence the structure of production. There are two main predictions. First, countries with more capital stock tend to implement more pro‐capital policies. Second, in a two‐country model, the country that initially has more capital will be able to attract capital inflows from the other country. Given additional assumptions on the production side, this yields the prediction that the more different are countries' policies, the more different will be the set of goods that they produce. These predictions of the model are confirmed using panel data on cross‐state differences in policies and economic outcomes in India.