What does political economy tell us about economic development – and vice versa?

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What does political economy tell us about economic development – and vice versa?

Philip Keefer

Development Research Group

The World Bank


November 17, 2003

The opinions expressed here are solely those of the author and not of the World Bank or its directors.

Abstract: This essay reviews three pillars of the political economy literature and asks what they tell us about economic development. Theory and evidence from the literatures on collective action, institutions and political market imperfections are all surveyed. Each makes tremendous advances in our understanding of who wins and who loses in government decision making. Studies of political market imperfections, though, particularly the lack of credibility of pre-electoral political promises and incomplete voter information about candidate characteristics are especially robust in explaining development outcomes. From the institutional literature, the most powerful explanation of development emerges from the research linking political checks and balances to the credibility of government commitments.

What does political economy tell us about economic development – and vice versa?

The problem of underdevelopment is in substantial measure one of government – and therefore political – failure in developing countries. A vast literature has illuminated the role of interest groups, institutions and political market imperfections on the actions of government, but has not been framed as an explanation of these political failures. At the same time, some puzzles in political economy, such as the importance of voter information and the credibility of pre-electoral promises by politicians, take on greatest significance when examined in the context of developing countries. The objective of this essay is therefore to ask what the political economy literature tells us about the causes of underdevelopment, and what the problems of development reveal about the motivations of politicians.

Two government failures are the focus of this essay. One is the adoption of policies that unnecessarily leave many or most people in society worse off.1 The other is the inability to make credible promises to refrain from opportunistic behavior.2 A third significant category of government performance relates to redistribution and inequality. These enter the analysis below at two junctures: as a puzzle, because of the absence of massive redistribution in highly unequal countries where the poor majority can and do vote; and as an explanation, because a significant literature links the failure of some countries to develop institutions favorable to efficient policy and credible government commitments precisely to initial conditions of significant inequality in society.

Scholars have investigated three broad determinants of inefficient policies. The theory of collective action rests on the hypothesis that organized groups of voters apply more pressure on politicians than unorganized groups. The implication of the theory is that where the organized economic interests in a society are particularly antagonistic to broader development objectives, development stalls. The second approach focuses on the institutions that structure how politicians gain and retain power and who can propose or must approve policy change. Here the implication is that countries develop more slowly when their institutions bias political choices towards less efficient outcomes. Finally, policy distortions may be driven by imperfections in political markets, including the lack of voter information; the lack of credibility of pre-electoral political promises; the “all or nothing” nature of many political choices (such as the need to choose a single candidate to represent voter interests on multiple dimensions); and the extent of polarization in the electorate across politically relevant dimensions. Implicit in this literature is the hypothesis that countries in which these imperfections are more severe develop more slowly.

The second government failure – the inability to make credible commitments –handcuffs governments in numerous ways, the most important of which is in their ability to encourage investment. Where institutions, the dynamics of political competition and the distribution of economic rents in a society leave governments unable to make credible promises, or unwilling to adopt the institutions that would allow them to make credible promises, development slows.

The discussion below asks what implications the research in each of these areas holds for government policy choices. The evidence is persuasive that these various strands of political economy analysis all offer a basis for systematically identifying political winners and losers in government decision making. In some cases, in addition, significant insights emerge that help to explain differential levels of economic development. Within the literature on institutions, analyses of checks and balances among political decision makers provide the most robust explanations for development. Analyses of imperfections in political markets, particularly information and pre-electoral credibility, offer another useful perspective to understand development. Other themes, such as the choice of political regime (presidential or parliamentary) or electoral system (plurality or proportional) or the obstacles to interest group formation, are crucial in the analysis of policy outcomes but provide less help in understanding why some countries are developed and others not.

Variations in government performance and economic development

Countries exhibit enormous variation both with respect to their policy choices and their credibility. With respect to policy efficiency, taking into account per capita income, average secondary school enrollment in 154 countries in 1995 varied more than 100 percentage points from the minimum to the maximum.3 Enrollments in the top 25 percent of countries were more than 34 percent higher than the bottom 25 percent. One commonly used measure of credibility is an indicator of the rule of law. On a six point scale, again controlling for per capita income, the lowest scoring 25 percent of countries scored more than one point below the best performing quartile. Similarly, the most corrupt quartile of countries was more than 1.5 points more corrupt than the least corrupt quartile, again on a six point scale.4 Taking policy and credibility failures together, it is not surprising that from 1975 to 2000, income per capita in the fastest growing quartile of countries grew more than two percentage points per year faster than in the slowest growing quartile – a difference that, by the year 2000, meant that the incomes per capita in the slower growing quartile were more than 60 percent less than they otherwise would have been.5

One could argue that these discrepancies, even controlling for income, are outside government control. Many factors enter into school enrollments that are unrelated to government policy; this is even more true with respect to growth. However, again controlling for income per capita, the top quartile of countries spent more than 7 percentage points more on education, as a fraction of total government spending, than the lowest spending quartile.6 It may not be suprising, therefore, that if one simply correlates growth across countries and asks how poor countries are doing relative to rich countries, one finds that divergence between the two groups is increasing (Pritchett 1997). These differences are a core puzzle of the social sciences.

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