On the dynamic inefficiency of governments

When the government must decide not only on road public-policy programs (like investment in infrastructure) but also on the provision of group-specific public goods (like regional transfers or subsidies), dynamic strategic inefficiencies arise. I present a model where the struggle between opposing groups -they disagree on the composition of expenditures and compete for government office- results in governments being endogenously short-sighted. As a result, there is a systematic under-investment in infrastructure and overspending on public goods. This results from resources being more valuable when in power than when out of power. Which group wins government office depends on explicitly modeled election outcomes that are functions of economic as well as (exogenous) political preferences of the citizens. I show how different characteristics of the groups involved in the political conflict affect the economy. In particular, I find that more ideologically homogeneous societies have higher capital accumulation and more efficient allocations since there is a greater incumbency advantage. I also find that when there is an average advantage for one group over the other in the political dimension, this group has incentives to act differently in office, even though both groups have the same basic preferences regarding the size of public spending (though not regarding its composition) and the level of investment. The group that loses the elections more often tends to spend a higher share of output on public goods while investing even less than the other group (when in office). This creates economic cycles -that follow the political cycle- introducing fluctuations in real macroeconomic variables without assuming any exogenous productivity shocks