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Institutions, Factor Prices, and Taxation: Virtues of Strong States?

  • Daron Acemoglu

Many of the most pernicious economic institutions and policies create entry barriers or manipulate factor prices to transfer resources from entrepreneurs and workers to groups that hold political power. These inefficiencies partly result from the fact that direct and efficient fiscal instruments that can be used for taxation and redistribution of resources are absent. One might then conclude that increasing state capacity and expanding the set of available fiscal instruments should improve the allocation of resources by preventing the use of these inefficient, indirect methods of redistribution. This reasoning ignores the effect of greater state capacity and the change in the set of available fiscal instruments on the political equilibrium, however. Because the availability of more efficient means of taxation increases the potential benefits of controlling state power, it also intensifies costly political conflict aimed at capturing the control of the state. This indirect effect counteracts the benefits from more efficient taxation and may dominate the direct benefits. The paper establishes the possibility that the allocation of resources may deteriorate substantially in response to an autonomous increase in state capacity and the set of fiscal instruments. It also argues that in the British case, which is a key historical example that points to the central role of increased state capacity in economic development, this change was not autonomous; instead, it was an equilibrium response to changes in political institutions that placed better checks on the exercise of power by the executive. This reasoning suggests that the study of the effect of fiscal capacity and the evaluation of policies aimed at increasing state capacity in less-developed economies should be done in the context of dynamic models of political economy, in which fiscal capacity and political constraints are jointly determined.

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.100.2.115
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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 100 (2010)
Issue (Month): 2 (May)
Pages: 115-19

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Handle: RePEc:aea:aecrev:v:100:y:2010:i:2:p:115-19
Note: DOI: 10.1257/aer.100.2.115
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  1. Acemoglu, Daron, 2005. "Politics and economics in weak and strong states," Journal of Monetary Economics, Elsevier, vol. 52(7), pages 1199-1226, October.
  2. Krusell, P. & Rios-Rull, J.V., 1993. "Vested Interests in a Positive Theory of Stagnation and Growth," Papers 547, Stockholm - International Economic Studies.
  3. Edward C. Prescott & Stephen L. Parente, 1999. "Monopoly Rights: A Barrier to Riches," American Economic Review, American Economic Association, vol. 89(5), pages 1216-1233, December.
  4. Dixit, Avinash K, 1987. "Strategic Behavior in Contests," American Economic Review, American Economic Association, vol. 77(5), pages 891-98, December.
  5. Becker, Gary S & Mulligan, Casey B, 2003. "Deadweight Costs and the Size of Government," Journal of Law and Economics, University of Chicago Press, vol. 46(2), pages 293-340, October.
  6. Acemoglu, Daron & Johnson, Simon & Robinson, James A., 2005. "Institutions as a Fundamental Cause of Long-Run Growth," Handbook of Economic Growth, in: Philippe Aghion & Steven Durlauf (ed.), Handbook of Economic Growth, edition 1, volume 1, chapter 6, pages 385-472 Elsevier.
  7. John Douglas Wilson, 1990. "Are Efficiency Improvements In Government Transfer Policies Self-Defeating In Political Equilibrium?," Economics and Politics, Wiley Blackwell, vol. 2(3), pages 241-258, November.
  8. James A. Robinson & Daron Acemoglu, 2000. "Political Losers as a Barrier to Economic Development," American Economic Review, American Economic Association, vol. 90(2), pages 126-130, May.
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