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Growth in the Shadow of Expropriation

  • Mark Aguiar

    (University of Rochester)

  • Manuel Amador

    ()

    (Department of Economics, Stanford Univeristy)

We propose a tractable variant of the open economy neoclassical growth model that emphasizes political economy and contracting frictions. The political economy frictions involve disagreement and political turnover, while the contracting friction is a lack of commitment regarding foreign debt. We show that the political economy frictions induce growth dynamics in a limited-commitment environment that would otherwise move immediately to the steady state. In particular, greater political disagreement corresponds to a high tax rate on investment, generating slow convergence to the steady state. While in the standard neoclassical growth model capital’s share in production plays an important role in determining the speed of convergence, this parameter is replaced by political disagreement in our open economy reformulation. Moreover, while political frictions shorten the horizon of the government, the government may still pursue a path of tax rates in which the first best investment is achieved in the long run. The model rationalizes why openness has different implications for growth depending on the political environment, why institutions such as respect for property rights evolve over time, why governments in open countries that grow rapidly tend to accumulate net foreign assets rather than liabilities, and why foreign aid may not affect growth.

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Paper provided by Stanford Institute for Economic Policy Research in its series Discussion Papers with number 08-051.

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Date of creation: Jul 2009
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Handle: RePEc:sip:dpaper:08-051
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