Governance as Production: Embedding Transaction Costs and Incentive Structures in the Optimal Growth Model

This paper develops a governance-augmented version of the Ramsey-Cass-Koopmans growth model that integrates the insights of Coase, Williamson, Alchian-Demsetz, Barzel, Grossman-Hart-Moore, and North. The model shows that institutions are not merely background conditions but an intrinsic part of the production process. Governance structures shape accumulation through three channels: safeguarding and maladaptation costs that lower effective returns, fixed bureaucratic overhead that reduces feasible consumption, and the balance between investment incentives and bureaucratic drag that alters scale properties. These institutional parameters determine not only the level of steady-state capital and consumption but also the speed of convergence, the possibility of multiple equilibria, and the emergence of poverty traps. The framework provides a unifed explanation of global divergence, interprets reform as shifts in institutional coefficients, and incorporates political economy by treating institutions as outcomes of elite choices. The conclusion is that governance is production.