Political Economy of Development

Stockholm Doctoral Course Program in Economics

Development Economics II

Lecture 5

Political Economy of

Development

Masayuki Kudamatsu IIES, Stockholm University

Big question today

How does politics

More specific questions today

1. Why do welfare-enhancing reforms

often get stalled?

2. Is democracy good for

development?

3. What makes democracy work?

1. Why do welfare-enhancing

reforms often get stalled?

• Structural adjustment reforms in

1980s

• Streamlining procedures of setting

up a firm (cf. Djankov et al. 2003)

• Formalizing property rights

• Anti-corruption measures

1.1 Quick literature survey

Basic idea for why welfare-enhancing reform gets stalled

• Winners may propose

compensation for losers

• As welfare (total surplus) increases, winners still better off

• Once reform enacted, winners lose

incentive for compensation

⇒ Winners’ promise not credible

Reform gets stalled because...

• Losers constitute a majority

• Even if losers are a minority:

(1) Small group size solves collective action problem to lobby govt (Olson 1965)

(2) Individuals uncertain whether to win or lose (Fernandez & Rodrik 1991)

• Uncertainty over whether losers will

have political power (Jain & Mukand 2003)

• The ruler’s “career concern” (Majumdar

• These papers look at only one policy reform

• In reality, there are many policies to

reform, whose feasibility may depend on each other

• Caselli and Gennaioli (2008) tackle

1.2 Caselli and Gennaioli

(2008)

Research questions:

• Deregulation of entry

• Improving contract enforcement in

credit market (financial reform)

• Both increase entry and thus

welfare

• But politically feasible?

Why original & important?

• Entry deregulation & financial reform:

• Perhaps two of the most important reforms for development

• Aghion et al. (2008) and Burgess & Pande (2005) for impact evaluations • Only analyzed separately before

• Provide a 1st example of

Model: Demography &

Endowment

• A continuum (of measure 1) of

agents

• Each agent: endowed w/ 1 unit of

labor & managerial talent θ

• Fraction λ: θ = 1 (talented)

• Fraction 1 − λ: θ = θ(≤ 1)

(untalented)

Model: Demography &

Endowment (cont.)

• Fraction η: also endowed w/ a firm

(incumbent)

e.g. Family-owned firm

• Fraction 1 − η: (outsiders)

• None own wealth

Model: Technology

• If agent w/ talent θ owns a firm and

hires l labor (incl. his own):

y = θl1−α

• α: degree of decreasing return to

scale

• See sec. V.B. for constant return to scale

Model: Market for control

• Outsiders can buy a firm from an

incumbent by paying price p

• Each agent can run at most 1 firm

⇒ Talented incumbents cannot buy a

firm from untalented incumbents • Main results would still hold if

otherwise (p. 1227)

• No market for managers

⇒ Incumbent cannot hire talented agent as manager of their firm

Model: Policy variable 1

ε(≥ k): cost of setting up a firm for outsiders

• k(> 0): technologically determined

fixed cost

• If k = 0, no role of market for control (pp. 1206-7)

• ε −k: degree of entry regulation

• Bureaucratic setup costs (incl. bribes) cf. Djankov et al. 2003

Model: Policy variable 2

φ: fraction of borrower’s profit that lenders can recover in case of default

• Quality of financial legislation / contract enforcement

• As no agents has assets, they need to borrow for setting up / buying a firm ⇒ φ ↑: financial reform

• Credit supply: perfectly elastic w/

Model: payoffs

• Workers: w

• Incumbents who don’t sell: π + w

(profit plus his own wage)

• Incumbents who sell: p + w

• Outsiders who set up a firm:

π + w −ε

Model: Timing of events

1. Outsiders: decide whether to

become a firm owner (either by

paying setup cost ε or paying p to

an incumbent) by borrowing money

2. Firm owners: hire workers by

paying wage w

3. Production takes place

4. Borrowers: decide whether or not to

Assumptions

1. η < λ < 1

• To focus on whether talented outsiders can set up a firm 2. k = αλα−1

⇒ At first best, no untalented agent runs a firm

• Main results would still hold if

αλα₋1

Analysis: How to proceed

• Characterize equilibrium choice of

outsiders by:

f _{: total # of firms (entrepreneurship)} s _{: share of firms run by talented agents}

(meritocracy)

• Initially we have f = η and s = λ

• First best: f = λ and s = 1 (Lemma

Analysis: How to proceed (cont.)

1. Derive payoffs as functions of (f,s)

2. Analyze how (f,s) change with ε

and φ

3. Identify winners and losers from

reforms (ε ↓ and φ ↑)

⇒ Assess political feasibility of

Analysis 1: equilibrium payoffs

a. Derive each firm’s labor demand

given w

b. Solve for eq. w from labor market

clearing

c. Obtain π as a function of exog.

Analysis 1a: labor market

• Firm owner solves:

max

l θl

1−α _{− wl}

• By FOC, the optimal labor demand

by firm owner of talent θ is:

l∗(θ) = �(1 − α)θ w

Analysis 1b: labor market (cont.)

• Labor market clearing:

1 = fsl∗(1) +f(1 −s)l∗(θ)

= f�1 − α w

�_α1

(s + (1 − s)θα1)

⇒ Equilibrium wage:

w(f,s) = (1 − α)fα[s + (1 − s)θα1]α

Analysis 1c: profit function

To obtain profit function

π(θ) = θl∗(θ)1−α − w(f,s)l∗(θ)

Analysis 1c: profit function (cont.)

For talented firm owners

πH(f,s) ≡ αfα−1[s + (1 − s)g]α−1

For untalented firm owners

πL(f,s) ≡ gπH(f,s)

where

Analysis 1c: profit function (cont.)

πH(f,s) ≡ αfα−1[s + (1 −s)g]α−1

πL(f,s) ≡ gπH(f,s)

• ∂πH_∂(f_f ,s) < 0, ∂πL_∂(f_f,s) < 0:

⇐ More firms push up wage

• ∂πH_∂(f_s,s) < 0, ∂πL_∂(f_s,s) < 0:

Talented incumbent’s payoff

(See Proof of Proposition 3)

As f or s goes up:

⇒ Talented incumbents prefer lower f,

Untalented incumbent’s payoff

(See Proof of Proposition 3)

As f or s goes up:

• πL(f,s) + w(f,s) is...

• Minimized at w(f,s) = (1−α)gα

• Maxw(f,s) = (1−α)λα _{could be}

larger than this

• Which happens if λ is large

• We’ll see in such a case no one will set up a firm and thus wage does not reach its maximum

⇒ Untalented incumbents prefer lower

Analysis 2: Derive

f

and

s

• An outsider’s decision to

a. Set up a firm by payingε

b. Buy a firm from an incumbent by payingp

• Either way, an outsider needs to

borrow

How much to borrow

Let L be amount of loan, π profit

Analysis 2a: entry

• Outsiders:

• want to set up a firm ifπ(f,s) ≥ ε

• can set up a firm if φπ(f,s) ≥ ε

⇒ Ifφ <1, credit constraint (want to own a firm, but cannot borrow for it)

Analysis 2a: entry (cont.)

Lemma 2: No untalented outsiders set up a firm under assumption 2 (ie.

k = αλα−1)

• This simplifies analysis below

Proof of Lemma 2

• πH > πL

⇒ If some untalented enter, all

talented should have already entered

• πL: largest when 1st untalented

enter after all talented entered (w/ no firm sale)

⇒ If such πL is smaller than ε/φ,

Proposition 1

Assume no market for control. The unique equilibrium is:

• Entry iff φπH(η, λ) ≥ ε

• At least some talented outsiders set up new firms

• No Entry iff φπH(η, λ) < ε

Proposition 1 (cont.)

φπH(η, λ): Amount of money talented agents can borrow if no one sets up a firm in the equilibrium

• If larger than the set-up cost ε,

Corollary 1

Without market for control,

• ε ↓ or φ ↑ ⇒ Both f & s: ↑

• Untalented outsiders won’t set up a firm (lemma 2)

⇒ # of talented outsiders setting up a firm ↑ ⇒ f ↑ & s ↑

• 1st best cannot be achieved

• 1st best: no untalented owns a firm • _πL: lowest at ε = k, φ = 1

• But πL > 0,∀f,s (by α > 0)

Analysis 2b: market for control

• Untalented incumbents:

• want to sell if p ≥ πL(f,s)

• Talented outsiders:

• want to buy if πH(f,s) ≥ p

• can buy ifp ≤ φπH(f,s)

⇒ Transaction takes place if

πL(f,s) ≤ p ≤ φπH(f,s) ⇐⇒ φ ≥ g

Analysis 2b: market for control

(cont.)

• Financial reform encourages the

sale of a firm from untalented to talented

• Consistent w/ evidence by Rossi & Volpin (2004)

• p: determined by bargaining power

btw. seller & buyer

• For much of analysis, the exact p

does not matter (fn. 17) • Later, it will be assumed that

Proposition 2

If market for control exists, the unique equilibrium is

• No Sales if φ < g

• NO untalented incumbents sell • No Entry if φπH(η, λ) < ε

• Entry otherwise (by Proposition 1)

• All Sell if φ ≥ g

• ALL untalented incumbents sell • No Entry if φπH(η,1) < ε

Proposition 2 (cont.)

Why all sell, not some sell?

• One more untalented incumbent

sells

⇒ Labor demand ↑ (talented demand

more)

⇒ Wage ↑, πH ↓

• But this does not affect the

condition for sale as long as φ ≥ g:

Corollary 2

If φ does not cross the φ = g line,

• ε ↓ or φ ↑ ⇒ Both f & s: ↑ Transition from φ < g to φ ≥ g:

• s jumps up to 1

• This change would be smooth if continuousθ (p.1233)

⇒ πH(f,s) goes down

⇒ Fewer talented agents set up a firm

Consistent w/ empirical findings

(& new empirical implications)

• φ ↑ or ε ↓ ⇒ s ↑

• Djankov & Murrell 2002

• ε ↑⇒ f ↓

• Klapper, Laeven, & Rajan 2004 • Fisman & Sarria-Allende 2004

• φ ↑ may reduce f

Analysis 3: Political feasibility

• Who are the winners and losers

from the two reforms?

• Assumption 3:

• In the status quo (ε0, φ0), the

Winners & Losers from

ε

↓

/

φ

↑

• Outsiders: always win (Prop 4(i))

• Their payoff: at least w(f,s)

• Talented incumbents: always lose

(Prop 4(ii))

• Both φ ↑ & ε ↓ erode πH more than they increase wage

• Maximum wage (w(λ,1))at 1st-best is not large enough to compensate profit loss

Proposition 4 (iii)

Untalented incumbents’ payoff:

• Always ↓ by deregulation

• Forφ < g, wage cannot be large enough to compensate profit loss • Forφ ≥g, price of firm ↓

Why untalented incumbents’

payoff goes up with

φ

↑

?

Once All Sell equilibrium achieved, their payoff: w(f,1) +φπH(f,1)

• No Entry equilibrium: wage

constant at w(η,1) while the firm price increases

• Entry equilibrium: wage goes up

with φ via f ↑ while the firm price is

But this is conditional on large ε0

• For small ε0: financial reform induces entry before All Sell equilibrium achieved

• In this case, untalented incumbents’

payoff goes down with φ ↑ due to

Intuition

• Untalented incumbents:

endogenously compensated by

market for control

• Welfare gain by financial reform: firms run by more talented

• By selling firms to talented,

Implications

• Untalented incumbents: more likely

to support financial reform w/ higher

ε0

⇐ Because higher entry barrier kills

the profit-reducing effect of financial reform

⇒ To enact financial reform, raising ε

Optimal sequence of reform can then be (section IV.C)

• First, financial reform without entry

deregulation

• so untalented incumbents support the reform

• Then entry deregulation

• Now untalented incumbents have

• A very nice policy implication that incorporates political-economy

• But perhaps naive to assume that

political feasibility goes up with # of supports

• What’s the role of political

2. Is democracy good for

development?

• Democracy: perhaps most

important political institutions

• Development assistance

practitioners: often advocate democracy as a means to good governance

What is democracy, BTW?

Definition in this lecture:

• A political system in which

Digression: Democracy datasets

• Polity IV or Freedom House

treats different aspects of democracy as

substitutes

• Przeworski et al. (2000)

(recently updated by Cheibub et al. 2010)

treats different aspects of democracy as

complements

cf. Munck and Verkuilen (2002) for

2-1. Evidence

• Large social science literature on

which political regime can achieve higher growth

cf. Przeworski & Limongi (1993) for an early literature survey

• Acemoglu et al. (2008) provide

2-1 Evidence (cont.)

1. Rich countries today: more

2-1 Evidence (cont.)

1. Rich countries today: more

democratic (Fig.2)

• This could be either due to

1. Democracy⇒ Development

2. Development⇒ Democracy

3. 3rd Factor ⇒

2-1 Evidence (cont.)

2. No correlation between changes in

income and changes in democracy in 20th century

2-1 Evidence (cont.)

3. Positive correlation between

2-1 Evidence (cont.)

3. Positive correlation in the very long

run: 1500-2000 (Fig.5)

• This could be either due to

1. Very long-run effect of democracy on development

2. Very long-run effect of development on democracy

2-1 Evidence (cont.)

• Correlation with health

• Positive cross-sectionally

• Zero for changes after WWII (Besley & Kudamatsu 2006, Ross 2006)

• Correlation with education

• Positive cross-sectionally

• Zero for changes after WWII, if years of schooling used (Acemoglu et al. 2005)

2-1 Evidence (cont.)

Very difficult to identify causal effect of democracy

• Democracy: endogenous

• education, emergence of middle class, etc. (Lipset 1959)

• transitory negative income shock (Brucker & Ciccone 2011)

• Kudamatsu (2012): use

cross-counry micro panel data on

2-2 Beyond simple comparison

4 reasons for why simple comparison is fruitless

a. Representation theory of politics ⇒ Heterogenous treatment effect

b. Accountability theory of politics

⇒ Complementary institutions to make democracy work

c. One more stylized fact

⇒ Autocracy: highly heterogenous

Digression: 2 views on politics

• Representation

• Conflict of interest among citizens

cf. Persson & Tabellini (2000, ch. 3 & 5)

• Accountability

• Conflict of interest

between govt & citizens

2-2a Representation perspective

Acemoglu (2008)’s model nicely summarizes this perspective for the impact on growth

• Firm managers and Workers

• Firm managers prefer

• Low tax rate

• Entry barrier to keep wages low

• Workers prefer

Standard growth theory suggests:

• Tax ↑ ⇒ Investment ↓

⇒ Short-run growth↓

• Entry barrier ↑ ⇒ Innovation ↓

• Tax ↑ ⇒ Investment ↓ ⇒ Short-run growth↓

• Entry barrier ↑ ⇒ Innovation ↓

⇒ Long-run growth ↓

• Autocracy: Firm managers decide policies

1. Tax: low

⇒Short-run growth: high

2. Entry barrier: high

• Tax ↑ ⇒ Investment ↓ ⇒ Short-run growth↓

• Entry barrier ↑ ⇒ Innovation ↓

⇒ Long-run growth ↓

• Democracy: Workers decide policies

1. Tax: high

⇒Short-run growth: low

2. Entry barrier: low

• Impact of democracy on growth has two channels

• Investment • Innovation

• Democracy: good for growth in

sectors where innovation is more important than capital accumulation

⇒ Aghion et al. (2008) provide

evidence consistent with this

• Theory uncovers heterogenous

2-2b Accountability perspective

• Democracy: regularized leadership

contest

• Citizens can replace incompetent

leaders w/ (potentially) better ones

⇒ Incentives for leaders to behave

well

• This argument makes (at least) 3

implicit assumptions

1. Voters know what leaders did ⇒w/o free media, this is unlikely

2. Voters behave as one agent ⇒w/ conflict of interest among voters, this is unlikely

3. Challenger is better than bad-behaving incumbent

⇒ w/o complementary institutions,

2-2c One more stylized fact

More volatile economic growth in autocracy than in democracy

• Performance varies a lot more for

2-2c One more stylized fact

More volatile economic growth in autocracy than in democracy

• Performance varies a lot more for

autocracy (Fig.7)

• Jones & Olken (2005): Natural

death of a leader ⇒ Changes in

⇒ Autocracy appears to be VERY heterogeneous

⇒ Not an ideal control group to

2-2d de facto political power

• Acemoglu & Robinson (2008): Rich

may intensify de facto political power to nullify de jure political power of poor

⇒ Regime change may not be

More fruitful questions to ask:

• What makes democracy work?

3. What makes democracy

work?

• Competitive election per se may not

bring benefits to citizens

• What institutions are

complementary to elections?

• Literature has so far identified:

• Free media (or information provision) • Reservation of political office

• Enfranchisement

3-1 Free Media

• Political agency model: citizens

punish incumbents who chose wrong policies

• Unless citizens observe what policy

is chosen, however, they won’t be able to punish

• Role of media crucial to make

3-1 Free Media (cont.)

• Quite a few papers by now

empirically show this

complementary role of media (or information provision in general)

• Besley & Burgess (2002) for newspaper circulation in India

• Ferraz & Finan (2008) for corruption audit in Brazil

• Enikolopov, Petrova, & Zhuravskaya (2011) for independent media in Russia

3-2 Political Reservation

• Citizen-candidate model:

policy-makers cannot commit to electoral platforms

• Disadvantaged groups (women,

minority ethnic groups, etc.) tend to be underrepresented in democratic politics

⇒ Their preferred policies won’t be

3-2 Political Reservation (cont.)

• India has attempted to correct this

by reserving political office to disadvantaged groups

• In 1992, 1/3 of rural municipalities

randomly chosen in a state: only women can become municipality prime minister (Pradhan)

3-2 Political Reservation (cont.)

• Chattopadhyay & Duflo (2004)

empirically show that reservation for women increases adoption of

policies cared by women

• Pande (2003) empirically shows

3-3 Franchise extension

• Median voter theorem: suffrage

extension leads to policy change

• Before WWII, suffrage often first

given to men, then to women

• Women more concerned on child

health than men

• Miller (2008) shows enfranchising

3-3 Franchise extension (cont.)

• Today, all democratic countries

have universal suffrage

• In reality, poor people are effectively

barred from voting

• Illiterate people cannot write a candidate’s name on the ballot • Poll taxes, literacy test in US South

• In this context, electronic voting can be “de facto” enfranchisement

• Fujiwara (2010) estimates its

impact in Brazil

The following pictures are taken from Figures 1 and 2 of

• Using RD design, Fujiwara (2010) finds that due to electronic voting:

• # of invalid votes↓

• public health care spending↑

3-4 Term limit

• Some democracies impose term

limit

• Often due to the nasty dictatorship in the past (e.g. Latin America)

• Ferraz & Finan (2011) show those

Brazilian mayors who cannot run for re-election due to term limit are

3-5 Secret Ballot

• In agrarian society, landlords supply

the votes of their workers in exchange for money, favors, or policies from politicians

• Britain, Germany, France in 19th century

• Chile until 1958

• No secret ballot in these cases

• Ballots have to be obtained from candidates

• Secret ballot makes tenants’ voting choice unobservable to landlords

• Landlords then cannot fire tenants

who voted against their will

• Baland & Robinson (2008) provide

such evidence in Chile: landlord

party’s vote share ↓ after secret

4. What makes autocracy work

• Some developing countries: still

autocracy

• China, Cuba, North Korea, many Gulf states, etc.

• Military coups: still relevant

• Thailand, Fiji, Guinea, Honduras, Mali, Guinea-Bissau, Egypt

• See Besley & Kudamatsu (2007,

section 2) for a literature review

• Best paper in this literature so far:

Stylized facts on autocrats

• Extracting enormous rents from

power

• Personal wealth equivalent of country’s foreign debt

• Extensive & very inefficient redistribution

• Buy crops from farmers for way below world price

• Bloated bureaucracy

• Active support from sizable share of

Research question

• What characteristics of autocracy &

Model: demographics

• A continuum of infinitely-lived

citizens of mass 1

• Proportion πA: group A; the rest

group B

• Group identity: observable &

impossible to change (e.g. skin color)

• Leader of group St ∈ {A,B} in

Model: technology & citizens’

Model: leader

S

_t

’s actions

(policies)

• Tax on each activity: τ_tSta, τ_tStb ⇐ No state capacity to tax income

• Patronage to each group: ηStA

t , η S_tB t

Model: preference

• Group A citizens

(1 −z_tA)(ωa − τSta

t > 0, satisfying

R�(ηStA

Model: preference (cont.)

• Group B citizens

(1 − z_tB)(ωb − τStb

t )

+ z_tB(ωb − θB − τSta

t )

+ R(ηStB

Model: preference (cont.)

• If ousted, leader’s payoff is 0 fromt on

• δ: discount factor for both groups of

Model: political institutions

• Uncertainty of leadership succession in autocracy

• Group j �= St cannot replace leader

Model: Timing of events at

t

1 Leader of St chooses policy vector

Pt ≡ {τ_tSta,τ_tStb,η_tStA,η_tStB}

2 Group St decides whether to

support leader, sSt

t ∈ {0,1}

3 Both groups decide whether to

Model: Timing of events (cont.)

4(a) If sSt

t = 1, Pt implemented, payoffs

realize, St+1 = St w/ prob. γSt

4(b) If sSt

t = 0, leader ousted,

Pr ≡ {0,0,0,0} implemented,

Model: discussion on

assumptions

(1) No collective action problem

(2) No repression

(3) Group j �= St never supports leader

of St

• (1) & (2): fine as leader would otherwise steal more

• (3): Why not leader seeks support

Definition of equilibrium

Focus on Markov Perfect Equilibrium (MPE)

• Strategies: contingent only on the

payoff-relevant state variable St &

prior actions within the same period • Exclude history-dependent strategies such as trigger strategy (see sec 3.1)

⇒ Below time subscript t dropped

• State transitions: as described in

Digression: Equilibrium concepts

for repeated games

A repeated game has many SPEs ⇒

Economists focus on a subset of them that are most plausible

1. Stationary SPEs

2. SPEs on the Pareto frontier (& take

a stance on relative bargaining power of players) ⇐Baland & Robinson (2008)

Definition of equilibrium (cont.)

Pure-strategy MPE: set of the following 4 strategies that are best responses to each other

• Leader of A: PA = P

• Leader of B: PB = P

• Group A citizens:

σA(S,PS) = {sA,zA}

• Group B citizens:

Analysis: value functions

• Assume S = A w.l.o.g.

• Case of S = B can all be analyzed symmetrically

• Vj(S): value function for group j citizens in state S

• Wj(S): value function for leader of j

in state S

Analysis: switching

• Choice of zB: no impact on

continuation value

⇒ z_tB = 1 iff ωb − τAb < ωb −θB − τAa

• Likewise, choice of zA:

Analysis: switching (cont.)

Tax revenue from a citizen of group B

• τAb if zB = 0 ⇐⇒ τAb ≤ θB + τAa

• τAa if zB = 1 ⇐⇒ τAb > θB +τAa

τAb

Tax Revenue

from a citizen

of group B

θB + τAa 45o

Analysis: switching (cont.)

• Same is true for tax revenue from

group A

⇒ Leader sets (τAa,τAb) so that zA = zB = 0

⇒ Upper limit on tax rates:

Analysis: support for incumbent

• If s = 1 (support)

ωa − τAa + R(ηAA)

+ δγAVA(A) + δ(1 − γA)VA(B)

• If s = 0 (oust)

Analysis: support for incumbent

(cont.)

⇒ s = 1 iff

τAa − R(ηAA)

≤ δ(γA − γA)(VA(A) −VA(B))

≡ ΦA

LHS: Net tax payment

Analysis: leader’s problem

max τAa,τAb,ηAA,ηAB

πA(τAa − ηAA)

+(1 − πA)(τAb −ηAB) +δγAWA(A)

subject to

• τAa ≤ θA + τAb, τAb ≤ θB + τAa

• τAa − R(ηAA) ≤ ΦA

Lemma 1

1. ηAB = 0: no transfer to excluded

group

⇐ Excluded group cannot affect leader’s survival

2. τAb = θB + τAa: tax revenue from excluded group maximized

• Excluded group cannot affect leader’s survival

⇒ Leader can tax them until they are indifferent btw. activities a & b

Lemma 1 (cont.)

3. τAa = ΦA + R(ηAA): tax on leader’s group constrained

⇐ Leader’s group would kick leader out if higherτAa than this

• In equilibrium, leader is always supported

⇒ Leader’s objective function:

max ηAA

πA(ΦA + R(ηAA) − ηAA)

Lemma 1 (cont.)

• Excluded group won’t switch as long as τAb _≤θB_+τAa

⇒ For each unit of ηAA spent to πA

citizens, tax revenue goes up by

Lemma 1 (cont.)

Over-redistribution to leader’s group: consistent w/ evidence

• Bates (1981, chap. 2-3): African

govts’ food policy

• Food price: set by govt below market price (taxation)

Proposition 1

• τAa depends on θB, γB, γB.

• How to prove

• Lemma 1: τ’s as a function of ΦA_,ΦB • Leader’s strategy: best response to

citizen’s support strategy

• τ’s determine citizens’ future payoff and thusΦA,ΦB

• Citizens’ support strategy: best

response to leader’s tax policy strategy • Find the fix point.

• It turns out there’s unique fix point⇒

Proposition 1: intuition

• Suppose ηAA = ηBB = θA = 0

• θB ↑ implies τAb ↑

• by Lemma 1: τAb = θB +τAa ⇐ Group B cannot oust leader A

⇒ Group B fears leader A’s rule

• Uncertain succession process in autocracy ⇒Ousting leader B increases prob. of leader A’s rule (γB −γB > 0)

VB(A) = ωB − τAb +... ↓

Proposition 1: intuition (cont.)

⇒ Leader B can raise τBb

• by Lemma 1: τBb = ΦB +R(ηBB)

⇒ Leader B can raise τBa, too

• by Lemma 1: τBa = θA +τBb

• Even if θA = 0!

⇒ Group A fears leader B’s rule

VA(B) = ωA − τBa + ... ↓

Proposition 1: intuition (cont.)

⇒ Leader A can raise τAa

• by Lemma 1: τAa = ΦA +R(ηAA)

⇒ Leader A can raise τAb, too

• by Lemma 1: τAb = θB +τAa

⇒ Group B fears leader A’s rule

• ... and so on and so forth

(amplification of fear)

• But eventually converges

• δ(γA −γA) < 1,δ(γB −γB) < 1

Proposition 1: intuition (cont.)

• Just one of the groups has

comparative advantage in one economic activity (θB > 0,θA = 0)

• Enough for leader to expropriate

Discussions 1/4

• If γj = γj,∃j ∈ {A,B}, no amplification of fear

⇒ Allows group j = S to discipline

autocrat

Discussion 2/4

• If group j �= S can have a say in

leadership succession (ie. democracy)

⇒ Allows citizens with power to

discipline autocrat

Discussion 3/4

• The model predicts higher tax to

excluded group

• Kasara (2007) finds the president’s

Discussion 4/4

• Leader stays in power w/ high prob.

(γS)

• Why not invest in income taxation

capacity and promote development so tax revenue increases?

• Stationary bandit theory (by McGuire and Olson 1996)

• Taxation capacity & long time horizon

⇒ Autocrat has incentive to promote development to increase tax revenue

Conclusion / Future research

• No more simple comparison btw.

democracy & autocracy

• Identify institutions complementary

to competitive popular elections

• Explain heterogenous

performances of autocracy

Future research (cont.)

• Understand gray zone cases

(“competitive authoritarianism” or “electoral autocracy”)

e.g. Afghanistan, Venezuela,

Kenya, Zimbabwe, Iran, Russia, etc.

• When govt represses opposition?

Future research (cont.)

• Political selection: if opposition candidates are bad, incumbents have no incentive to behave well

• But we know little about what can

improve the pool of candidates • Ferraz & Finan (2011): higher wage

attracts wealthy & educated

candidates for municipal legislature in Brazil

Future research (cont.)

• What political institutions can

sustain long-run economic growth

• Growth boom and bust

• Bust often as a result of conflict over redistribution

• In the 1980s, East Asians managed to avoid such conflict while Latin

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