Political Economy.

Class 1

Alessandro Riboni

Master in Economics, 2019-20

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Outline

So far we have taken as given:

1 the fact that people could vote

2 government’s ability to collect taxes and enforce public policies

Both should not be taken as granted.

In this and next class we will study democratization and state capacity

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Democratization

How to measure democracy?

Two possible measures: Freedom House (Index ranges from 1 to 7)
and Polity index. They both measure representative or liberal
democracy: free and fair elections, whether those elected rule,
competitive parties, opposition plays an important role and has actual
power, civil and political liberties.
Three waves of democratization (before WWI, after WWII and after
1974).

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Waves of Democratization

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Democratization

Why does democratization happen in some countries but not in

others?
Today many non democracies are in the poor parts of the world, e.g.,
sub-Saharan Africa and Southeast Asia.
Barro (1999): ”Increases in various measures of the standard of living
forecast a gradual rise in democracy. In contrast, democracies that
arise without prior economic development tend not to last”
According to Lipset’ s (1959) modernization hypothesis, the level of
economic development (industrialization, urbanization, education,
etc) drives the creation and consolidation of democracy.
Others (e.g., M. Weber and S. Huntington) focus on the social
environment (religion, culture, ethnic fractionalization)

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Income and Democracy (90s)
Figure 1 of Acemoglu et al. 2008.1

1
Acemoglu et al, 2008, Income and Democracy, AER
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Income and Democracy

Most empirical work are based on cross-country relationships: we

cannot establish that high income ”causes” democracy.
First, we may have reverse causality; possibly democracy causes
income rather than vice versa.
Second, there might be an omitted variable bias. Some other factor
may determine both the political regime and the potential for
economic growth.
Acemoglu et al (2008): ”The major source of potential bias in a
regression of democracy on income per capita is country-specific,
historical factors influencing both political and economic
development.”

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Income and Democracy

Take two countries: US and Colombia. US is richer and more

democratic than Colombia.
Simply looking at cross country correlations would make us conclude
that income causes democracy.
The real challenge is to answer this question: ”will Colombia become
(relatively) more democratic as it becomes (relatively) richer?”
Looking at the “within-country variation” would address Lipset
hypothesis which states that countries should become more
democratic if they are richer, not simply that rich countries should be
democratic

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Income and Democracy

Acemoglu et al. (2008) estimate the following regression

0
dit = αdit−1 + γyit−1 + xit−1 β + δi + µt + εit
dit is democracy in country i at t.
yit−1 is lagged income
xit−1 is a vector of controls.
δi is country specific dummy variable (fixed effect). It is time invariant
Fixed effects remove the influence of long-run (and time invariant)
determinants of both democracy and income.
µt controls for time effects
εit is the error term

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Income and Democracy

Acemoglu et al. (2008) find that the estimate for γ becomes

insignificant once we control for country fixed effect.
Then, why are rich countries democratic today? Acemoglu and
coauthors emphasize the role of early institutions.

”Societies may embark on divergent political-economic development paths,

some leading to relative prosperity and democracy, others to relative poverty
and dictatorship.
”Countries have embarked on divergent development paths at some critical
junctures during the past 500 years ”
” The critical juncture for most societies corresponds to their experience
under European colonization”2

2
Acemoglu et al, 2008, p. 812-13
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Democratization
Effect of transitory income shocks

Several scholars (Huntington, 1991) argue that economic recessions

lead to autocratic regimes losing legitimacy, which ends up increasing
the probability of democratic change
Burke and Leigh (2010) and Bruckner and Ciccone (2011) find that
negative rainfall shocks are followed by significant improvement in
democratic institutions.3
Democratic transitions are triggered by economic crises during which
citizens have nothing to lose in demonstrating for a better
government.

3
Bruckner and Ciccone “Rain and Democratic Window of Opportunity”,
Econometrica 2011
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Rain and Democratization
Bruckner and Ciccone (2011)

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Elite, Revolutionary Threats and Redistribution
Acemoglu and Robinson (2000).4

Consider an economy with population normalized to 1.

Two classes: the rich elite (size δ < 1/2) and the poor citizens (size
1 − δ)
Suppose that elite has formal political power. Citizens have no
formal power but they could start a revolution (de facto power)
Their incomes are y r and y p . Mean income is y

y = (1 − δ)y p + δy r
It is useful to define θ the share of total income that goes to the rich:
θy = δy r (we have θ > δ)

4
Acemoglu and Robinson, 2000, Why did the west extend the franchise? QJE
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Elite, Revolutionary Threats and Redistribution

Taxes τ are linear. Distortion: C (τ )y where C is convex and

increasing
Taxes are used for a transfer

T = τ ((1 − δ)y p + δy r ) − C (τ )y = (τ − C (τ ))y

Elite preferred tax τ r = 0

Preferred tax by the poor (denoted τ p ) maximizes

(1 − τ )y p + (τ − C (τ ))y

The tax τ p is positive and increasing in the elite income:

θ−δ
= C 0 (τ p )
1−δ

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Elite, Revolutionary Threats and Redistribution

Infinite horizon. Individuals have linear utility and discount factor β.

If a revolution (denoted R) is attempted at time s, it succeeds but is
costly in that a fraction µs of the average income is lost.
For all t ≥ s each citizen will receive per year

(1 − µs )y
(1 − δ)
which gives them a discounted payoff of

(1 − µs )y
V p (R, µs ) =
(1 − δ)(1 − β)

The elite gets zero: V r (R, µs ) = 0 meaning that a revolution is very

costly for the elite.

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Elite, Revolutionary Threats and Redistribution

We suppose that µt ∈ {1, µ}. It is 1 with probability 1 − q and it is

µ < 1 with probability q
Shock µt = µ opens a window of opportunity to revolt
Timing at each t: (1) µt is known. (2) The elite sets the tax rate
τt ∈ [0, 1] and then citizens decide whether or not to start a
revolution.
We focus on Markov Perfect Equilibria (strategies do not depend on
past history but only on the state variable, µt ∈ {1, µ})
Remark: It is immediate that a revolution is not started when µt = 1
It is more tricky to find whether there is a revolution in the other
state. The elite might want to make concessions to prevent a
revolution.

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Elite, Revolutionary Threats and Redistribution

Suppose that µt = 1 and hence there is no threat of revolution

(absence of revolution is denoted by N).
When µt = 1 in a MPE equilibrium the elite inevitably chooses τt = 0.
We can define the payoffs for the elite and the citizens

V r (N, 1) = y r + β[qV r (N, µ) + (1 − q)V r (N, 1)]

V p (N, 1) = y p + β[qV p (N, µ) + (1 − q)V r (N, 1)]

The above definitions make the implicit conjecture that also in state
µ the elite can prevent a revolution
We need to verify this conjecture

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Elite, Revolutionary Threats and Redistribution

Does the elite need to make concessions to prevent a revolution?

Suppose that the elite gives no redistribution to the poor. This does
not lead to a revolution when:

yp
V p (R, µ) ≤
1−β
This holds if

y p (1 − δ)
(1 − µ) ≤
y
which is the case if µ ≥ θ.
That is, if µ is too high or inequality is too low. In this case no
redistribution does not trigger a revolution.

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Elite, Revolutionary Threats and Redistribution

Suppose instead the “revolution constraint ” binds:

yp
V p (R, µ) > .
1−β

The elite must make concessions by setting a higher tax rate (and
allow redistribution) in the threat state.
Let τb denote the chosen tax and the associated transfer T
b
Write down the value functions

V r (N, µ; τb) = y r (1 − τb) + T

b + β[qV r (N, µ; τb) + (1 − q)V r (N, 1)]
V p (N, µ; τb) = y p (1 − τb) + T
b + β[qV p (N, µ; τb) + (1 − q)V p (N, 1)]

q is key parameter: the extent to which redistribution recurs in the

future (higher q makes redistribution more credible)

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Elite, Revolutionary Threats and Redistribution

Citizens start a revolution if V p (R, µ) > V p (N, µ; τb) and they will
not start it if V p (R, µ) ≤ V p (N, µ; τb)
Can the elite credibly prevent a revolution?
If we have that
V p (R, µ) ≤ V p (N, µ; τ p ) (1)
it is feasible to avoid a revolution by making the largest possible
concession τ p
We can solve the system of Bellman equations to compute
V p (N, µ; τ p ) and write (1) as

(1 − µ)y y p + (1 − β(1 − q))(τ p (y − y p ) − C (τ p )y )

≤
(1 − δ)(1 − β) (1 − β)

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Elite, Revolutionary Threats and Redistribution

or

µ ≥ θ − (1 − β(1 − q))(τ p (θ − δ) − (1 − δ)C (τ p )) ≡ µ∗

If this condition does not hold, even the maximum credible transfer is
not enough and there will be a revolution whenever possible.

Note that if (1 − q) ' 0 (elite is under constant threat of revolution)

future redistribution is supposed to occur often so that redistribution
prevents revolution ⇒ µ∗ goes down.
Paradoxically, when windows of opportunities are more likely, it is
easier to prevent a revolution
This is because it becomes more credible for the elite to redistribute.

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Elite, Revolutionary Threats and Redistribution

Preposition. There is a unique MPE with these properties:

If µ ≥ θ there is no redistribution and no revolution
If µ < θ we have that the no-revolution constraint binds
If µ ≥ µ∗ the elite will promise some redistribution in the µ state (the
minimum amount of redistribution to avert a revolution). Revolutions
never occur.
If µ < µ∗ there is a revolution in the µ state and no revolution (and no
redistribution) when it is very costly to overthrow the elite

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Elite, Revolutionary Threats and Redistribution

Revolution No Revolution No Revolution

when possible Redistribution No Redistribution

μ* θ μ

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Elite, Revolutionary Threats and Redistribution

µ∗ is a function of θ (inequality) and q (probability that a revolution

is feasible)
µ∗ increasing in θ. Inequality makes revolutions more likely
As discussed above µ∗ decreasing in q since it becomes more credible
to redistribute.
In this model revolutions are averted by current and future
redistribution. The problem is that when µt = 1 it is not credible to
redistribute, making revolutions likely today.
The elite would like to commit to future redistribution but, absent
commitment, this is not possible

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Democratization or Repression?

Now suppose that the elite besides redistribution can also choose
democratization or repression.
Democratization implies that franchise is extended so that taxes are
credibly at τ p since median is poor
Democratization is a commitment device to achieve an outcome
preferable to revolution. Recall that fiscal redistribution within the
existing system is better than R for the elite
Role of institutions as commitment to future policies (as in North and
Weingast, 1989)

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Democratization or Repression?

Repression prevents a revolution but has cost k in that period.

If repression is used revolution cannot occur.
If no repression is used, elite can either democratize or choose some
tax rate. After, the citizens choose wether or not to start a
revolution.

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Democratization, Repression, Redistribution

No Revolution
No Revolution
No Redistribution

μ* θ μ

democratization redistribution

repression repression

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Democratization or Repression?

If inequality is small, revolutions do not materialize.

If inequality is too high, democracy is too redistributive and costly for
the elite ⇒ repression likely better
Democracy occurs for intermediate levels of inequality
To summarize: Democracy is a strategic choice of the elite which is
related to threat of revolution.

Evidence in Aidt and Jensen (2012) and Aidt and Franck (2015) that
revolutionary threats have an effect on suffrage extension.
But Treisman (2017) argues that many autocrats democratize by ”mistake”

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Riboni (Master in Economics) Political Economy. Class 1 Master in Economics, 2019-20 29 / 31
Democracy and Redistribution
from Acemoglu and Robinson, 2005

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Democratization and Policy Outcomes

Mulligan, Gil and Sala-i-Martin (2004) estimate the effect of

democracy on redistribution, education and social spending, open
trade. No clear effect
Aghion, Persson and Rouzet (2012) find that democracies do not
spend more in primary education (external threat is a key driver)
Acemoglu et al. (2014) ”Democracy, Redistribution, and Inequality”
find that democracies raise government size, secondary enrolment and
favor structural transformation. Limited effect on inequality.
Acemoglu et al. (2016) ”Democracy Does Cause Growth” find that
democracy increases future GDP by encouraging investment,
increasing schooling, inducing economic reforms, improving public
good provision, and reducing social unrest.

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