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Optimal Fiscal Policy in an Economy Facing Socio-Political Instability

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  • Chetan Ghate
  • Quan Vu Le
  • Paul J. Zak

Abstract

We present a model of optimal government policy when policy choices may exacerbate socio-political instability (SPI). We show that optimal policy that takes into account SPI transforms a standard concave growth model into a model with both a poverty trap and endogenous growth. The resulting equilibrium dynamics inherit the properties of government policies and need not be monotone. Indeed, for a broad set of conditions we demonstrate that government policy is unable to eliminate the poverty trap; when these conditions do not hold, "most" countries eventually reach a balanced growth path. The predictions of the model are tested by developing three new measures of SPI for a panel of 58 countries. Estimating optimal policies and the growth equation derived from the model reveals strong support for the theory. In particular, we show via simulations that optimal funding for public investment and the police cause a typical developing economy to expand on a quasi-linear growth path, with the baseline level of SPI determining whether growth is positive or negative.

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Bibliographic Info

Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 308.

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Length: o. p.
Date of creation: 2002
Date of revision:
Handle: RePEc:diw:diwwpp:dp308

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Keywords: Socio-Political Instability; Endogenous Growth; Public Investment; Political Economy of Growth;

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Cited by:
  1. Bang, James T. & Mitra, Aniruddha, 2011. "Brain drain and institutions of governance: Educational attainment of immigrants to the US 1988-1998," Economic Systems, Elsevier, vol. 35(3), pages 335-354, September.
  2. Paul J. ZAK, 2002. "Institutions, Property Rights and Growth," Discussion Papers (REL - Recherches Economiques de Louvain) 2002014, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  3. Jong-A-Pin, Richard, 2009. "On the measurement of political instability and its impact on economic growth," European Journal of Political Economy, Elsevier, vol. 25(1), pages 15-29, March.
  4. Yi Feng & Jacek Kugler & Paul Zak, . "The Path to Prosperity: A Political Model of Demographic Change," Claremont Colleges Working Papers, Claremont Colleges 1999-23, Claremont Colleges.
  5. Patricia Justino, 2007. "Carrot or stick? Redistributive transfers versus policing in contexts of civil unrest," Research Working Papers, MICROCON - A Micro Level Analysis of Violent Conflict 3, MICROCON - A Micro Level Analysis of Violent Conflict.
  6. Moog, Stefan & Raffelhüschen, Bernd, 2009. "Ehrbarer Staat? Die Generationenbilanz - Update 2009: Wirtschaftskrise trifft Tragfähigkeit," FZG Discussion Papers 38, Research Center for Generational Contracts (FZG), University of Freiburg.
  7. Paul J. Zak, 2002. "Institutions, Property Rights, and Growth," Recherches économiques de Louvain, De Boeck Université, De Boeck Université, vol. 68(1), pages 55-73.
  8. Quan V. Le, 2004. "Political and economic determinants of private investment," Journal of International Development, John Wiley & Sons, Ltd., vol. 16(4), pages 589-604.
  9. Ghate Chetan, 2003. "The Politics of Endogenous Growth," The B.E. Journal of Macroeconomics, De Gruyter, De Gruyter, vol. 3(1), pages 1-18, August.
  10. Diana Weinhold & Paul J. Zak, 2005. "The Choice of Institutions: The Role of Risk and Risk-Aversion," Others, EconWPA 0508004, EconWPA.

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