The policy-driven misallocation: a political economy perspective

We use a simple model to investigate how policy-makers invest resources in a combination of coercion and buying off between two social groups, i.e. elite and mass, so as to maximize loyalty generation from them to secure the regime survival. The model elite are politically powerful, but the masses are more economically efficient. We show that, regardless of economic efficiency, as long as the regime survival counts more on buying the allegiance of the inefficient elite than that of the efficient mass group, a considerable misallocation will be inevitable. The model also reveals how the government’s strategy toward one will also be affected by changes in the parameters regarding the other group. In contrast to the popular view that efficiency-enhancing policies and institutions are hard to implement due to the resistance from interest groups, our analysis suggests that bad policies can be intentionally adopted by decision-makers, even if they result in misallocations.