Political Economy Lecture Notes Daron Acemoglu Contents Part 1. Issues and Evidence 3 Chapter 1. General Issues 5 1.1. What Are Institutions? 5 1.2. Developmental Vs. Predatory Institutions 18 1.3. Institutional Origins in the Social Conflict Theories 20 1.4. Towards a Framework 23 1.5. References 30 Chapter 2. Evidence 33 2.1. Aggregate Correlations 33 2.2. “Exogenous” Differences in Institutions 36 2.3. A Sharper Natural Experiment 44 2.4. Reversal of Fortune 46 2.5. Weak and Strong Institutions? 50 2.6. Which Institutions Matter? 52 2.7. Within Country Variation 56 2.8. Micro Evidence 57 2.9. Interpreting the Evidence 59 2.10. References 63 Chapter 3. A Review of Dynamic Games 65 3.1. Basic Definitions 65 3.2. Some Basic Results 69 3.3. Application: Repeated Games With Perfect Observability 73 3.4. Application: Common Pool Games 74 3.5. References 81 Chapter 4. Static Voting Models 83 4.1. Arrow’s Impossibility Theorem 83 4.2. Voting and the Condorcet Paradox 88 4.3. Single-Peaked Preferences and the Median Voter Theorem 89 4.4. Party Competition and the Downsian Policy Convergence Theorem 93 4.5. Beyond Single-Peaked Preferences 95 4.6. Preferences with Single Crossing 97 4.7. Application 98 4.8. Probablilistic Voting 101 4.9. Models with Party/Candidate Ideology 108 4.10. Commitment and Convergence 112 4.11. References 115 iii Political Economy Lecture Notes Chapter 5. Dynamic Voting with Given Constituencies 117 5.1. Myopic Dynamic Voting 117 5.2. Dynamic Voting and Markov Perfect Equilibria 120 5.3. References 127 Chapter 6. Dynamic Voting with Changing Constituencies 129 6.1. Dynamic Voting in Clubs 129 6.2. Voting over Coalitions 140 6.3. References 154 Chapter 7. Voting and Information 155 7.1. Swing Voter’s Curse 155 7.2. Policies and the Evolution of Beliefs 159 7.3. References 162 Chapter 8. Political Agency and Electoral Control 163 8.1. Basic Retrospective Voting Models 163 8.2. Agency with Asymmetric Information 166 8.3. Career Concerns 169 8.4. Political Economy of Mechanisms 171 8.5. References 182 Chapter 9. Failures of Electoral Control 183 9.1. Lobbying 183 9.2. Application of Lobbying to Distributional Conflict 187 9.3. Campaign Contributions 189 Chapter 10. Politics in Weakly-Institutionalized Environments 193 10.1. Introduction 193 10.2. A Model of Divide-and-Rule 195 10.3. A Model of Politics of Fear 208 10.4. Incumbency Veto Power and Persistence of Bad Governments 221 10.5. References 246 Chapter 11. Economic Institutions Under Elite Domination 247 11.1. Motivation 247 11.2. Baseline Model 250 11.3. Inefficient Economic Institutions 266 11.4. Modeling Political Institutions 270 11.5. Further Modeling of Political Consolidation 274 11.6. References 284 Chapter 12. Policy under Democratic Political Institutions 285 12.1. Parliamentary Institutions 292 12.2. Other Important Institutions 293 12.3. References 294 Chapter 13. The Form of Redistribution 297 13.1. Inefficient Redistribution: General Issues 298 13.2. Inefficient Redistribution to Constrain the Amount of Redistribution 300 13.3. Inefficient Redistribution to Fool Voters 301 iv Political Economy Lecture Notes 13.4. Inefficient Redistribution to Maintain Power 303 13.5. References 310 Chapter 14. Political Economy of States 313 14.1. The Role of the State in Economic Development and in Economics 313 14.2. Weak Versus Strong States 314 14.3. The Formation of the State 328 14.4. References 340 Chapter 15. Oligarchy Versus Democracy 343 15.1. Basic Model 343 15.2. Political Equilibrium: Democracy 353 15.3. Political Equilibrium: Oligarchy 355 15.4. Comparison Between Democracy and Oligarchy 357 15.5. New Technologies 360 15.6. Regime Dynamics: Smooth Transitions 362 15.7. Regime Dynamics: Conflict Over Regimes 364 15.8. References 367 Chapter 16. Power 369 16.1. The Power Function 370 16.2. Economic Power 373 16.3. Electoral Corruption and Resource Allocation 376 16.4. Employment and Power 377 16.5. References 381 Chapter 17. Modeling Non-Democratic Politics 383 17.1. Basic Issues 383 17.2. A Simple Model of Non-Democratic Politics 384 17.3. Incentive Compatible Promises 392 17.4. References 402 Chapter 18. Democratization 403 18.1. The Emergence of Democratic Institutions 403 18.2. A Model of Democratization 404 18.3. Subgame Perfect Equilibria 411 18.4. Alternative Approaches 414 18.5. References 416 Chapter 19. Political Instability and Coups 419 19.1. Basic Model 419 19.2. Discussion 430 19.3. References 433 Chapter 20. Economic Structure and Democracy 435 20.1. A Simple Model of Economic Structure 435 20.2. Political Conflict 438 20.3. Capital, Land and the Transition to Democracy 438 20.4. Costs of Coup on Capital and Land 441 20.5. Capital, Land and the Burden of Democracy 444 20.6. References 451 v Political Economy Lecture Notes Chapter 21. Change and Persistence in Institutions 453 21.1. Baseline Model 455 21.2. Analysis of Baseline Model 460 21.3. Generalizations: Markov Regime-Switching Models and State Dependence 480 21.4. Durable Political Institutions and Captured Democracy 484 21.5. Effective Reform 489 21.6. References 490 Chapter 22. Modeling Constitutions 493 22.1. Model and Definitions 495 22.2. Preferences over Voting Rules 496 22.3. Self-Stability 501 22.4. Stability and Reform of Political Institutions 507 22.5. Dynamics and Stability of Constitutions, Coalitions and Clubs 510 22.6. Conclusions 530 22.7. References 530 Chapter 23. Dynamics of Political Compromise 533 23.1. Modeling Political Compromise 533 23.2. Political Stability and Political Compromises 543 23.3. References 563 vi Political Economy Lecture Notes These are preliminary notes. They include typos and mistakes. 1 Part 1 Issues and Evidence CHAPTER 1 General Issues The first lecture is a broad overview of the main issues and the evidence. The rest of the course will be about formal models. However, it is useful to begin with a relatively broad discussion, without formalizing every claim. Some of the statements here will be formalized in the models discussed later, and for those that are not formalized, you will have the tools to formalize them depending on your own interests. 1.1. What Are Institutions? 1.1.1. Different views of institutions. One of the first things you learn in economics as an undergraduate is that the way that societies are organized, or briefly their “institutions”, are an important determinant of their economic performance–though perhaps without being clear what “institutions” are. For instance, you learn that competitive markets, in conjunc- ture with well-defined and enforced property rights, allocate resources efficiently. An economy with such a set of institutions is then contrasted to other ways of organizing the economy. For example, the most common argument is that the Soviet Union did less well economically because it tried to allocate resources via central planning (though see Allen, 2003). This debate about the pros and cons of socialist versus capitalist institutions dates back at least to the 1920s. One argument (now obviously discredited) was that socialism would not face incentive problems because people’s preferences would change when society was changed (just another example that one has to be careful about claims regarding “manipulation of preferences”). In response, von Mises raised the ‘calculation problem.’ He argued that it would be simply impossible for a socialist central planner to compute efficiently the allocation of resources. In the 1930s Lange (1936, 1937) famously argued that since the central planner knew the Walrasian system of supply and demand equations, he would be able to mimic the mar- ket and solve the equations for the allocation of resources. The famous response to Lange came from Hayek (1945), who argued that the price system was able to communicate and aggregate information much more efficiently than an individual or a computer could do. Of 5 Political Economy Lecture Notes course, in hindsight, the incentive problems of socialism seem even more first-order than those calculation problems. Another example of a traditional discussion of the importance of institutions comes from economic history. Modern capitalistic economies are often contrasted with the feudal economies of the middle ages where labor and land were not allocated via the market. Many economic histories indeed emphasize how economic development is linked to the emergence of markets, trade, exchange etc. (see Hicks, 1969, or Wrightson, 2000). This is therefore an example of the evolution of a specific set of institutions playing an important role in economic development. A final obvious example of institutions is the tragedy of the commons and problems with common ownership of property, which feature prominently in both discussions of pre-capitalist land systems and in todays environmental debates. These problems refer to excessive use of a common resource, such as land or a stock of game or an environmental resource. The tragedy of commons is often viewed as a failure of “institutions”. A set of institutions establishing clear property rights would (or might) avoid the tragedy of the commons. There is a counter-tradition in economics emanating from Coase (1960). The so-called “Coase Theorem” claims that in a world without ‘transactions costs’ rational individuals can always negotiate to an allocation of resources that is efficient. To be exact, this theorem actually requires an initial allocation of property rights that are secure, so it does presume some type of institutional background (though it argues that the specifics of who has property rights is not that important). Moreover, the Coase Theorem is in fact not exactly a theorem. It holds only under a very restrictive set of assumptions, even though most of the discussion in applied work that appeals to it makes it sound as if it holds under a very general set of assumptions.