A Political Economy Model of Resource Pricing with Evidence from the Fuel Market

The paper suggests that institutional developments may not have monotone effects on economic policy. The paper develops a model and offers evidence from fuel pricing across countries to show that improvements in the rule of law and democracy may initially enable the public to increase its share of the economy's rents mainly through distortionary policies that transfer the rents in-kind and limit the funds that the politicians can divert toward their private interests. In later stages, when politics become competitive and checks and balances grow strong, the public is more assured of receiving the benefits of marginal government funds and demands more efficient policies. The magnitudes of such effects seem substantial and the gains from institutional and policy designs that can mitigate the commitment problems between the public and the politicians can be large. The empirical work generates other insights into the determinants of fuel prices as well. In addition, the perspective developed here offers explanations for other phenomena such as the association between the spread of democracy and the proliferation of distortionary policies in the developing countries over the past several decades.