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The Political Economy of Underdevelopment Bernardo Mueller Department of Economics University of Brasilia - Brazil In a Coasean world there would be no underdevelopment. Motivation • Is growth an exogenous inexorable process? … Are poor economies incipiently catching up in regular ways with those already richer? (Danny Qua, 1996, European Economic Review) • Will relatively poor economies remain poor for many generations? Will the rich countries of the year 2100 be the same countries that are relatively rich today? (Sala-i-Martin, 1996, Economic Journal) Convergence hypothesis • Forces pushing for convergence: ▫ Diminishing returns to capital. ▫ Poorer countries have higher rates of return leading capital to flow from richer countries. ▫ Second mover advantages. Real Gross Domestic Product per Capita $45,000 $40,000 USA $35,000 Australia Great Britain Netherlands France Sweden Germany Japan $30,000 $25,000 $20,000 Argentina South Africa Mexico Brazil Botswana Egypt Indonesia Zimbabwe Bangladesh $15,000 $10,000 $5,000 Source: Penn World Tables. 04 20 01 98 20 19 95 19 92 19 89 19 86 19 83 80 19 19 77 19 74 71 19 19 68 19 65 19 62 19 59 19 56 53 19 19 19 50 $0 - convergence X.X. Sala-i-Martin 1996. The Economic Journal. - convergence Robert J. Barro. 2000. “Rule of Law, Democracy and Economic Performance”in Heritage Foundation, 2000 Index of Economic Freedom. Conditional - convergence Barro. 2001. AEA Papers and Proceedings. • “...the speed of convergence has been estimated to be within a narrow range centering on 2 % per year (p=0.02). Although this is a very robust and strongly significant finding, I would like to emphasize that a speed of 2 % per year is very small. For example, it suggests that it will take 35 years for half of the distance between the initial level of income and the steady state level to vanish. This is quite slow.” Sala-i-Martin. 1996.The Economic Journal, Vol. 106, No. 437. (Jul.), pp.1034. Corruption, Bureaucratic Efficiency, Political Instability Paolo Mauro. 2005. “Corruption and Growth” The Quarterly Journal of Economics, Vol. 110, No. 3. (Aug., 1995), pp. 681-712. Economic Freedom Haan and Strum. 2007. “Handling Economic Freedom in Growth Regressions” Economic Journal Watch, Vol. 4 No. 1, January:79-82. Religion Barro and McCleary, 2003. Religion and Economic Growth Across Countries. American Sociological Review, Volume 68, Number 5, 1 October 2003, pp. 760 -781(22) . Democracy Feng, Y. 1997. Democracy, Political Stability and Economic Growth British Journal of Political Science, Vol. 27, No. 3. (Jul., 1997), pp. 391-418 Democracy Helliwell, J.F. 1994. Empirical Linkages between Democracy and Economic Growth British Journal of Political Science, Vol. 24, No. 2. (Apr., 1994), pp. 225-248 Social Trust Study Published in Controls Growth effect Studies using social trust Helliwell (1996a) NBER working paper - 0% Knack and Keefer (1997) American Economic Review Education, investment goods prices, initial GDP 56 % La Porta et al. (1997) American Economic Review Initial GDP 20 % Whiteley (2000) Political Studies Investment, education, initial GDP 40 % Schneider et al. (2000) Eu. J. of Urban and Regional Stud. Investment, openness, initial GRP Neg. Zak and Knack (2001) Economic Journal Investment price, education, initial GDP 60 % Beugelsdijk et al. (2004) Oxford Economic Papers Robustness analysis 58 % Beugelsdijk and van Schaik (2005) Eu. J. of Political Economy Investment, schooling, agglomeration, initial GRP 0% Bengtsson et al. (2005) Working paper Robustness analysis 36 % Boulila et al. (2006) Conference paper - 16 % Bjørnskov (2006b) Working paper - 54 % Roth (2006) Working paper Education, investments, pop. growth, initial GDP Bjørnskov, C. 2007. “Social Capital and Economic Growth: A Survey” - The Troika of Social Capital (eds. Gunnar L.H. Svendsen and Gert T. Svendsen) Social Capital Stephen Knack; Philip Keefer. 1997. Does Social Capital Have an Economic Payoff? A Cross-Country Investigation The Quarterly Journal of Economics, Vol. 112, No. 4. (Nov., 1997), pp. 1251-1288 Ethnic Diversity Alesina, Alberto F. and La Ferrara, Eliana, "Ethnic Diversity and Economic Performance" (December 2003). Harvard Institute of Economic Research Discussion Paper No. 2028. Legal Origin Levine, R. 1998. The Legal Environment, Banks, and Long-Run Economic Growth Journal of Money, Credit and Banking, Vol. 30, No. 3, Part 2: Comparative Financial Systems. (Aug., 1998), pp. 596-613. Foreign Aid Rajan, R.G. and A.Subramanian. 2005 Aid and Growth: What Does the Cross-Country Evidence Really Show? IMF Working Paper, June. Governance Olson JR. Sarna & Swamy, 2000. Governance and growth: A simple hypothesis explaining cross-country differences in productivity growth. Public Choice 102: 341–364. Governance Stephen KnacK, 2006. Governance and Growth, October 2006 What has been learnt and what remains to be explored? “… the results leave unexplained a good deal of the relatively weak growth performance of countries in sub-Saharan Africa and Latin America. That is, the analysis does not fully capture the characteristics of the typical country on these continents that lead to below-average growth.” Barro, Robert J, 1991. "Economic Growth in a Cross Section of Countries,” The Quarterly Journal of Economics, MIT Press, vol. 106(2), pages 407-43, May Robert J. Barro. 1997. Determinants of Economic Growth: A Cross-Country Empirical Study, MIT Press, Cambridge . Approaches to Understand the Political Economy of Underdevelopment • Stein, Tommasi, Echebarría, Lora and Payne. 2006. The Politics of Policies: Economic and Social Progress in Latin America, Inter-American Development Bank. • Bueno de Mesquita, Smith, Siverson and Morrow. 2003. The Logic of Political Survival MIT Press. • Rajan, 2006. The Persistence of Underdevelopment: Constituencies and Competitive Rent Preservation, ECGI Working Paper. Oliver Williamson. 2000. “The New Institutional Economics: Taking Stock, Looking Ahead” Journal of Economic Literature. Transaction Cost Politics • Extension of Transaction Cost Economics to Politics and Policymaking. • Transaction costs are characteristically more pervasive in political processes than in economic interactions. • North. 1990. “A Transaction Cost Theory of Politics” Journal of Theoretical Politics, Oct 1990; 2: 355 - 367. • Dixit, A.K., 1996, The Making of Economic Policy: A Transaction-Cost Politics Perspective, Cambridge, Mass.: MIT Press The Politics of Policies (2006). IADB. Characteristics of policy outcomes (game of) Policymaking process Characteristics of the issue area Working of political institutions Basic Institutions and History The Politics of Policies (2006). IADB. Characteristics of policy outcomes Stability vs. volatility Adaptability vs. rigidity Public-regardedness vs. private regardedness Investment-like qualities Quality of implementation and enforcement (game of) Policymaking process Characteristics of the issue area Working of political institutions Basic Institutions and History The Politics of Policies (2006). IADB. Characteristics of policy outcomes Stability vs. volatility Adaptability vs. rigidity Public-regardedness vs. private regardedness Investment-like qualities Quality of implementation and enforcement (game of) Policymaking process Characteristics of the issue area Working of political institutions actors preferences powers sequence arenas forums frequency of interaction Basic Institutions and History The Politics of Policies (2006). IADB. Characteristics of policy outcomes Stability vs. volatility Adaptability vs. rigidity Public-regardedness vs. private regardedness Investment-like qualities Quality of implementation and enforcement (game of) Policymaking process Characteristics of the issue area All policy areas simultaneously (same country) Working of political institutions actors preferences powers sequence arenas forums frequency of interaction Basic Institutions and History The Politics of Policies (2006). IADB. Characteristics of policy outcomes Stability vs. volatility Adaptability vs. rigidity Public-regardedness vs. private regardedness Investment-like qualities Quality of implementation and enforcement (game of) Policymaking process Characteristics of the issue area Budgetary process Working of political institutions actors preferences powers sequence arenas forums frequency of interaction Basic Institutions and History The Politics of Policies (2006). IADB. Characteristics of policy outcomes Stability vs. volatility Adaptability vs. rigidity Public-regardedness vs. private regardedness Investment-like qualities Quality of implementation and enforcement (game of) Policymaking process Characteristics of the issue area Telecommunication sector (Levy and Spiller, 1996) Working of political institutions actors preferences powers sequence arenas forums frequency of interaction Basic Institutions and History The Politics of Policies (2006). IADB. Characteristics of policy outcomes Stability vs. volatility Adaptability vs. rigidity Public-regardedness vs. private regardedness Investment-like qualities Quality of implementation and enforcement (game of) Policymaking process Characteristics of the issue area Environmental policy Working of political institutions actors preferences powers sequence arenas forums frequency of interaction Basic Institutions and History Political Institutions in Brazil • Executive Preponderance • What are the President’s powers? ▫ ▫ ▫ ▫ ▫ Sets the agenda in Congress. Line item veto. Decree power. Cabinet and 40,000 federal jobs. Discretion over appropriation of budget amendments. ▫ Upshot: high governability at low cost. Political Institutions in Brazil • Executive Preponderance • What are the President’s preferences? ▫ Monetary stability. ▫ Economic growth. ▫ National macroeconomic variables. Political Institutions in Brazil • Executive Preponderance • Why these preferences? ▫ Electorate and inflationary memory. ▫ Globalized financial markets. Political Institutions in Brazil • Congress ▫ Weak parties in the electoral arena, strong parties in the legislative arena. ▫ Preferences for geographic redistribution. ▫ Result: exchange of pork for policies leading to high levels of governability while still providing checks. Political Institutions in Brazil • Other political actors and veto points ▫ Judiciary (independent but slow). ▫ Public prosecutors (independent, powerful and active) ▫ Governors (no longer powerful at federal level) ▫ Constitution (highly amended) ▫ Bureaucracy (stable, high quality for Latin America) Four categories of policies 1. Stable and adaptable macroeconomic policies. Primary Surplus - Brazil 7 6 5 % of GDP 4 3 Actual Target 2 1 -2 Year Source: Banco Central do Brasil, Boletim de Finanças Públicas. 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 -1 1990 0 Four categories of policies 1. Stable and adaptable macroeconomic policies. 2. Exchange of pork for policies. (Alston and Mueller. 2006. JLEO). Four categories of policies 1. Stable and adaptable macroeconomic policies. 2. Exchange of pork for policies. (Alston and Mueller. 2006. JLEO). 3. Hard-wired policies (Earmarked revenue and expenditures). Evolution of Budgetary Earmarking, 1979-2003. 100 60 Earmarked transfers to states and muni. Earmarked revenues 40 De-earmarked via DRU % 80 Not earmarked 20 83 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 19 19 19 79 81 0 Year Source: Brasil. Secretaria de Orçamento Federal. (2003) "Vinculações de Receita dos Orçamentos Fiscal e da Seguridade social e o Poder Discricionário de Alocação de Recursos do Governo Federal“ - Volume 1, N.1, Brasília, SOF, pg. 6. This graph does not include revenues from government bonds or privatization. Four categories of policies 1. Stable and adaptable macroeconomic policies. 2. Exchange of pork for policies. (Alston and Mueller. 2006. JLEO). 3. Hard-wired policies (Earmarked revenue and expenditures). 4. Residual policies – contingent on the fiscal imperative and subject to political shocks. “Impoundments” in Regulatory Agency Budget 2.5 R$ billion 2.0 1.5 1.0 0.5 0.0 2001 2002 2003 2004 ANATEL's Budget ANATEL's Liquidated Expenditures "Contingenciamentos" Source: Pereira Filho (2006). 2005 2006 Upshot • • • • High levels of governability. Stability, fiscal discipline, gradual reform. Persistent institutional strengthening. Gradually translating into higher levels of sustained growth. Other Latin American Countries • • • • • • Argentina Venezuela Bolivia Chile Ecuador Mexico Robert J. Barro. 2000. “Rule of Law, Democracy and Economic Performance”in Heritage Foundation 2000 Index of Economic Freedom. Bueno de Mesquita, Smith, Siverson and Morrow. 2003. The Logic of Political Survival, MIT Press. • The Selectorate Theory. • Why do some political systems seem more prone to policy failures than others? • Dependent Variable: Leader’s choice between providing public goods, private goods or her own pocket. The Selectorate Theory • Claim: It makes no sense to classify regimes as democracies or dictatorships, as presidential or parliamentary. • A better classification is according to the size of the selectorate and the size of the winning coalition. The Selectorate Theory • Selectorate: all those people in a country who have an institutionally granted right or norm that gives them a say in choosing the government. • Winning coaltion: those members of the selectorate whose support is essential to keep the incumbent leadership in office. The Selectorate Theory winning coalition selectorate disenfranchised The Selectorate Theory • The government taxes the citizens and uses these resources: ▫ to provide private goods to members of the winning coalition; ▫ to provide public goods that benefit all society; ▫ For herself (Swiss Bank accounts, lavish lifestyles or pet projects). The Selectorate Theory • To hold on to power the leader must provide sufficient benefits to the winning coalition so that the least satisfied member still prefers to support the leader than to defect to a rival. The Selectorate Theory • A defector from the winning coalition that supports a rival for leadership faces the risk that he will not be essential to the new leader and will be left out of the new winning coalition. • The probability of being essential in the successor winning coalition is W/S. The Selectorate Theory Case 1: Large W/S WC Selectorate Implication: Public goods and economic growth, low rate of survival in office. The Selectorate Theory Case 2: Small W/S WC Selectorate Implication: Private goods, low growth, high rate of survival in office. The Selectorate Theory Case 2: Large W/S selectorate WC Ideal situation for a dictator: very cheap and loyal winning coalition Bueno de Mesquita, Smith, Siverson and Morrow. 2003. The Logic of Political Survival, MIT Press. The Persistence of Underdevelopment: Constituencies and Competitive Rent Preservation, Raghuram Rajan, ECGI Working Paper N0150/2007 The Persistence of Underdevelopment • Most explanations of the persistence of underdevelopment rely on a privileged elite forcing sub-optimal policies on the rest of the population through oppressive political institutions (example Acemoglu, Johnson and Robinson, 2004). The Persistence of Underdevelopment • However, underdevelopment has survived emancipation, independence and even democratization. • “Why choose poverty?” • This paper tries to explain the persistence without appealing to oppressive political institutions that give all the power to the elite. Model • Three constituencies: ▫ Oligopolists (or oligarchs); ▫ Educated (middle class); ▫ Uneducated (poor). Model • Oligopolists – owns a firm that needs managers and laborers. • Managers and laborers are complementary. • There are diminishing returns in firm size. • Only educated can be managers. Model • There are two types of policies: ▫ Pro-market reforms; ▫ Reforms that increase access to endowments, e.g. education. Model • Each group has one vote on policy reform, that is, an imperfect democracy. Result • Interesting result: there is no non-trivial equilibrium where both reforms get enacted. Result (intuition) • The uneducated always vote for education reform. • The educated vote against because it reduces their rents. • The oligopolist likes education reform because it reduces rents received by educated. • But if education reform goes through the oligopolist will face a united workforce of educated that will push for promarket reforms. • So the oligopolist votes with the educated against education reform. • The poor oppose having only market reform because as managers leave the firm the workers become less productive and salaries fall. Result (intuition) • With only an elite and one constrained group, it is puzzling when reforms do not take place under different types of democracy. • The only solution then is to destroy the power of the elite. • With multiple constrained groups, reforms affect the rents of each constituency differently. • Crabs in a bucket.