Pathologies of the state

P

TL

a

ARRAA

JDH

KPw

1

hgBwim

fins–Bf

o

iCd

0d

Journal of Economic Behavior & Organization 80 (2011) 339– 350

Contents lists available at SciVerse ScienceDirect

Journal of Economic Behavior & Organization

j ourna l ho me pag e: www.elsev ier .com/ locate / j ebo

athologies of the state

imothy Besley ∗,1

SE, Houghton Street, London WC2A 2AE, UK

r t i c l e i n f o

rticle history:eceived 18 May 2011eceived in revised form 10 August 2011ccepted 15 August 2011vailable online 10 September 2011

EL classification:H211

eywords:ublic choiceeak states

a b s t r a c t

This paper uses a simple dynamic model where a government performs three functions:taxation, public spending and contract enforcement to study pathologies in resource allo-cation by government. A key feature of the approach is that states may invest in their futurecapacities to raise taxes and protect property rights. Three types of state are shown to bepossible in this framework: common-interest states, redistributive states and weak stateswhose emergence depends on the nature of political institutions. We consider both Pigou-vian and Wicksellian benchmarks against which to compare different outcomes that mightarise in political equilibrium. The paper argues for a greater focus on weak government andpoints out that a failure to generate Wicksellian unanimity lies behind them.

© 2011 Elsevier B.V. All rights reserved.

. Introduction

A central theme of the Public Choice literature has been identifying political failure and its consequences. The main focusas been on how and why governments tend to allocate resources to spending that is of questionable social value. Theeneral presumption is therefore that government is, as a consequence, too large. Classic analyses along these lines includeuchanan and Tullock (1962) with its focus on the consequences of legislative log-rolling and Brennan and Buchanan (1980)ho model government as a powerful Leviathan. Thus, many Public Choice economists associate the growth of government

n the twentieth century as discussed, for example, by Holsey and Borcherding (1997), as a symptom of fundamental resourceisallocation by the state.Many such arguments are built on the back of what might be called static models of resource misallocation. Given its

scal capacity, i.e. its power to tax, the government may misuse some of the public resources that it has raised. However, thiseglects the decision to build the tax system in the first place and how it is that fiscal capacity was acquired. Fiscal historians,uch as Brewer (1989), have emphasised the importance of exploring how the power to tax was acquired in the first place

a process of investment in appropriate forms of infrastructure, as well as in systems of monitoring and compliance.2 Both
rewer (1989) and Tilly (1990) put weight on the role of external warfare either to acquire or defend territory as a motive
or building effective tax systems, particularly in late Medieval and early modern Europe.Besley and Persson (2009) have argued that understanding the acquisition of the power to tax requires a dynamic model

f investments in state capacity. This paper uses their framework to revisit some debates in Public Choice about state

∗ Tel.: +44 2079556702.E-mail address: [email protected]

1 This paper was written for a conference in honour of James Buchanan to whom I indebted for his inspirational writings. I am grateful to participantsn the conference for an interesting discussion of the ideas in the paper. Mohammad Vesal offered helpful comments on an earlier draft. My debts to Steveoate and Torsten Persson are immense: my collaborations with them are central to the ideas developed in this paper. The model used here has beeneveloped in joint work with Torsten Persson and published in Besley and Persson (2011b).2 See Levi (1988) for an illuminating discussion of these issues.

167-2681/$ – see front matter © 2011 Elsevier B.V. All rights reserved.oi:10.1016/j.jebo.2011.08.006

dx.doi.org/10.1016/j.jebo.2011.08.006

http://www.sciencedirect.com/science/journal/01672681

http://www.elsevier.com/locate/jebo

mailto:[email protected]

dx.doi.org/10.1016/j.jebo.2011.08.006

340 T. Besley / Journal of Economic Behavior & Organization 80 (2011) 339– 350

pathologies. It will argue that static resource misallocation can result in a state that is overly strong as in the classic PublicChoice account or in a state that is too weak. Which case occurs is influenced by the degree of political stability. The possibilityof a state that is too weak has arguably been a blind spot in Public Choice accounts of political failure. However, a centralfailing in many states throughout the world today, as well as historically, is that governments lack the capacity to dischargebasic functions such as collecting taxes.3

State capacity is about much more than the power to tax. There is an equally important role of government; the roleof the state in creating and enforcing property rights and contracts, thereby supporting markets.4 An effective state in thisdimension has well-functioning and impartial courts where property rights are defined and contracts are enforced. Theinfrastructure to support markets has been developed over time and is something which also needs to be explained ratherthan assumed. Moreover, a joined-up account of state development needs to consider the development of markets and fiscalsystems in tandem (Besley and Persson, 2009).

It is instructive, therefore, to begin with a useful and important background fact. States that are weak in taxing powerare also weak in supporting markets as illustrated in Fig. 1.5 The figure plots the average share of taxes in GDP against acountry’s rank (normalized to the unit interval) of the doing business score for contract enforcement.6 The first illustratesthis for rich and poor countries, the second for countries with high and low constraints on the executive (as measured byPolity IV) and the third by high and low levels of political instability (based on the Polity IV measure of openness of executiverecruitment).7 Observe that the correlation between these two variables is positive. In general countries that have betterconstraints on the executive and greater political instability have both higher tax economies and better support for markets.

In the model developed here, which is from Besley and Persson (2009, 2011b), governments perform three main functions:a productive role (enforcing property rights and/or building infrastructure), financing public goods, and redistribution.8

Political institutions constrain the discretion of policy makers and determine the process for transitions of power. We referto institutions that make public goods spending (as opposed to redistribution) more likely as cohesive. Whether powertransitions are frequent or not determines the degree of political stability.

One of the most striking features of the theoretical approach is its prediction that the productive and extractive roles ofthe state (as conceptualized here) may actually be complements as suggested in Fig. 1. We show why this is the case and useit to reflect on incentives for government to build institutions for the protection of property rights and enforcing contracts.

The model yields three types of states: common interest states, redistributive states and weak states.In a common-interest state, political institutions are cohesive so that all spending is on public goods. Political stability is

then unimportant. State capacity investments reflect the need to fund public goods.In a redistributive state, political institutions are not cohesive but political stability is high. Spending is on a mix of

transfers and public goods. Here, states invest in the power to tax in part to further their redistributive ambitions.A weak state arises when institutions are not cohesive and the prospect of political turnover is high, thereby dampening

the ambition of the incumbent to build an effective state. In this type of state, taxation and protection of property rights arelow which leads to lower Income per capita.

Having considered politically optimal states (depending on the structure of political institutions), the paper discussesnormative criteria and the pathologies that they suggest for each of the three types of state identified by the model. We beginwith a focus on the dominant tradition in economics – a Pigouvian approach which invokes social welfare maximization asits benchmark for good government. We then discuss a Wicksellian perspective where the criterion is what would happenwere citizens allowed to exercise a policy veto – a form of unanimity rule. The common interest state is optimal fromboth perspectives. However, the redistributive and weak states suffer from failings that we discuss from a Pigouvian andWicksellian point of view.

The remainder of this paper is organized as follows. The next section lays out the model that we will use and derivespolitically optimal policies and investments in the state. We show, that under different conditions, the type of state fallswithin one of three categories. In Section 3, we discuss different criteria for evaluating the optimality of the state. In Section4, we look at the differences between a Pigouvian and Wicksellian model of state failure. Section 5 discusses some furtheraspects of weak states and section six concludes.

2. A dynamic model of government

This section lays a simple dynamic model of government from Besley and Persson (2011b). The main policy instrumentsare income taxes, public goods and redistribution. These are standard from any textbook treatment of public finance. The

3 See Acemoglu (2005) for a theoretical discussion of the nature of weak states.4 This is particularly important in the case of financial markets – see La Porta et al. (1998).5 Besley and Persson (2011b) discuss how there are a number of ways of looking at this fact which lead to rather similar conclusions.6 The first series is from the IMF and the second from the World Bank’s Doing Business web site. The GDP variable is based on the average GDP per capita

over the period 1974–2000.7 To minimize reverse causation concerns, these are backward looking measures based on every year for which the country enters the Polity data up

until 1975. Strong executive constraints are measured as one if a country has the highest score in Polity (equal to 7) for every year prior to 1975. A countryis classified as having open recruitment if it has the highest Polity score for XRCOMP and XROPEN for every year prior to 1975.

8 These correspond roughly to the productive, protective, and redistributive roles of the state identified in Buchanan (1975).

T. Besley / Journal of Economic Behavior & Organization 80 (2011) 339– 350 341

010

2030

4050

Tot

al ta

x sh

are

in G

DP

197

5−20

00

0 .2 .4 .6 .8 1Enforcing Contract s

High Income Low IncomeFitted values

Taxes and Contract Enforcement by High and Low Income

010

2030

4050

Tot

al ta

x sh

are

in G

DP

197

5−20

00


Strong constraints Weak constraintsFitted values

Taxes and Contract Enforcement by Executive Constraints

010

2030

4050

Tot

al ta

x sh

are

in G

DP

197

5−20

00


Open recruitment Non−open recruitmentFitted values

Taxes and Contract Enforcement by Recruitment Openness

Fig. 1. Taxes and Contract Enforcement.


government can also invest in fiscal capacity (the choice of tax base and/or level of tax enforcement) and legal capacity (thecourt system which protects private property and enforces contracts). These are investments which affect future levels oftaxation and the productivity of the economy.

2.1. Framework

There are two time periods s = 1, 2 with two groups of individuals, A and B each of which comprises half of the population.There are no savings or government debt. Every individual has income ω

(pJ

s

)where ω ( · ) is an increasing, concave function.

We think of pJs as “legal protection of property rights” or “legal enforcement of contracts”. This can be given microfoundations

as in Besley and Persson (2009) as a credit-market model with partial enforcement of collateralized debt contracts. Legalprotection of transactions is constrained by legal capacity �s with pJ

s ≤ �s for J ∈{

I, O}

. Having installed an amount of legalcapacity, it is costless to make use of it.

At the beginning of s = 1, one group holds power and we will refer to this group as the incumbent denoted by I1 ∈ {A, B}.The other group is the opposition O1 ∈ {A, B} . Between the two time periods, the incumbent is replaced by the oppositionwith probability � . This is exogenously given but could be modeled as an electoral process.9

We assume that utility is linear and depends on the quantities of public and private goods consumed denoted by:

cJs + ˛sgs

where cJs is private consumption of group J members at time s and gs is consumption of public goods with ˛s denoting their

value. One archetypal example of gs is “defense” and in this case, we can interpret ˛s as the “threat of external conflict”.Private consumption in period s depends on net of tax income and transfers and is given by:

cJs = (1 − ts)ω(pJ

s) + rJs

where ts is the tax rate, rJs is a transfer targeted towards group s.10 Let

u(ts, rJs, gs, pJ

s; ˛s) = (1 − ts)ω(pJs) + rJ

s + ˛sgs (1)

be the utility function written as a function of the policy instruments.The value of public goods is stochastic. We assume a two-point distribution ˛s ∈ {˛L, ˛H}, where ˛H > 2 > ˛L > 1, and

Prob[˛s = ˛H] = �. Shocks to ˛s are i.i.d. over time and we assume that the realization of ˛s is known when policy is set. Thelikelihood of high demand for public goods, �, can be thought of as a measure of common interests in this framework. Thisparameter plays a key role in what follows. If � is higher then it is more likely that there is high demand for public goods,such as during a war.11

The ability to raise taxes is constrained by fiscal capacity which we denote by �s, i.e. ts ≤ �s. This can be justified bysupposing that an individual can earn a share (1 − �s) of her income in the informal sector. Thus, �s depends on the efficacyof tax enforcement.

In period one, the incumbent government can invest in increasing both legal and fiscal capacity. We take the initialstocks of such capacities {�1, �1} as given and, for simplicity, we assume that both kinds of investment are irreversible. Thenon-negative investments are denoted by {�2 − �1, �2 − �1}.

Investment in legal capacity might take the form of investing in courts, training judges, and creating credit and propertyregistries. All these are important developments in the creation of effective market economies and have evolved over timein most countries reflecting purposive actions by government. The historical origins of such institutions and their role instate development is long – see, for example, Strayer (1970). Fiscal capacity investment can be thought of as developing atax authority, its compliance structures and infrastructure to enforce an income tax or impose a value added tax. As withlegal capacity, the literature on fiscal history makes clear how these capacities were acquired by the state only by purposiveaction by rulers often in the face of the prospect of war or territorial ambitions.

Both types of state capacity investment are costly. There is a convex cost of investment in legal capacity denoted by:L(�2 − �1), where L�(0) = 0. And, for fiscal capacity, the convex cost is denoted by F(�2 − �1) with F�(0) = 0.

Government policy at date s comprises {ts, gs, {pJs}J=I,O, {rJ

s}J=I,O, ms} where

ms ={

F(�2 − �1) + L(�2 − �1) if s = 10 if s = 2

is the cost of state capacity investments in period s. The government budget constraint in each period is given by:

tsω(pI

s) + ω(pOs )

2= gs + ms + rI

s + rOs

2(2)

9 Besley and Persson (2011b, Chapter 7) discusses possible micro-foundations for this parameter.10 Taxes do not create a deadweight loss but this could be added straightforwardly to the model.11 In this set-up, everyone values public goods in the same way. It is possible to extend the model to have heterogeneous valuations. As shown in Besley

and Persson (2011b, Chapter 2), greater similarity in individual valuations has similar comparative static properties to an increase in �.

Pt�okvoW

tn

12

34

2

s

i

ita

wpoarg

TSp

F


olitical institutions constrain the incumbent to give a fixed share � to the opposition group of any unit of transfers he makeso his own group. We will work with the parameter � = �/(1 + �) ∈ [0, 1/2] which represents more “cohesive” institutions as

gets closer to its maximum of 1/2. Although it is a reduced form way of looking at things, we interpret a higher valuef � as better checks and balances on executive or better representation of the opposition. As we will see below, this is aey parameter that influences the nature of policy. One advantage of this reduced form approach is that it can be given aariety of constitutional foundations in terms of models of political resource allocation. For example, it could be thoughtf as capturing the kind of log-rolling processes emphasized in Buchanan and Tullock (1962), the universalistic norms ofeingast et al. (1981) or the legislative bargaining model of Battaglini and Coate (2008).The parameter � is a key “constitutional” parameter in the model. Besley and Persson (2011b, Chapter 7) considers how

he choice of � can be thought of in this model. However, � could reflect more than just constitutional rules and might includeorms and conventions that foster cooperation in collective action.

The timing of the model is as follows:

There are initial stocks of state capacity: {�1, �1} and an incumbent group I1. Nature then determines ˛1 . I1 chooses a set of first-period policies {t1, g1, pI

1, pO1 , rI

1, rO1 } and investments in period-2 state capacities �2 − �1 and

�2 − �1. I1 remains in power with probability 1 − � , and nature determines ˛2. The new incumbent, I2, chooses period two policy {t2, g2, pI

2, pO2 , rI

2, rO2 }.

The aim now is to solve for a subgame perfect equilibrium in policy and state capacity investments.

.2. Politically optimal policy

A policy vector {ts, gs, pIs, pO

s , rIs, rO

s } is politically optimal if it is chosen by the period s incumbent and maximizes:

˛sgs + (1 − ts)ω(pIs) + rI

s

ubject to rOs ≥ �rI

s and the government budget constraint. We study each component of policy in turn.Our first observation is that fiscal capacity is fully utilized in this model, i.e. ts = �s. This is because with � ≤ 1/2, the

ncumbent gains at (at least) rate 2(

1 − �)

≥ 1 dollars by increasing ts and loses at a rate of one dollar.

Second, observe that pIs = pO

s = �s, i.e., legal capacity is fully utilized with property rights and/or use of contractingnstitutions being fully extended to both groups. This is obvious in the current set up where the incumbent benefits fromhe opposition group having access to property rights through the government budget constraint. This result is essentiallyn application of Diamond and Mirrlees (1971) production efficiency result to this context.12

To derive the politically optimal levels of transfers, we use the government budget constraint to obtain:

rJs = ˇJ[�sω(�s) − gs − ms]

here ˇI = 2(1 − �) and ˇO = 2�. The public revenue available for transfers is part of the tax revenue which is not spent onublic goods, gs, or investments in state capacities, ms. It is divided between the two groups depending on the cohesivenessf institutions as measured by �. Since ˇI ≥ ˇO, the incumbent group will obtain higher transfers. If � = 1/2, then transfersre equally shared whereas if � = 0, the state is operated on a “winner-takes-all” basis where only the incumbent’s groupeceives any transfers. But the resources available for transfers depend on the level of spending on investments and publicoods.

The optimal level of public goods provision is:

G(˛s) ={

�sω(�s) − ms if ˛s ≥ 2(

1 − �)

0 otherwise

his says that either all residual public revenues are spent on transfers or public goods depending on the realization of ˛s.ince, we have assumed that ˛L > 1, then if institutions are sufficiently cohesive (i.e, � is close to a half) all spending is onublic goods and none is on transfers. Since ˛H > 2, there is always spending on public goods if ˛s = ˛H.

To study investment decisions, we plug these optimal policies in to (1) and derive the following “indirect” payoff function:

W(˛s, �s, �s, ms, ˇJ) = ˛sG(˛s) + (1 − �s)ω(�s) + ˇJ[�sω(�s) − G(˛s) − ms]

or future reference, it is also useful to define “value functions”:

UI(�2, �2) = [�W(˛H, �2, �2, 0, ˇI) + (1 − �)W(˛L, �2, �2, 0, ˇI)]

12 Besley and Persson (2011b) show that this result may not hold when there are rents in the production technology.


and

UO(�2, �2) = [�W(˛H, �2, �2, 0, ˇO) + (1 − �)W(˛L, �2, �2, 0, ˇO)]

for being the incumbent or opposition group in period 2 depending on the state variables {�2, �2}. These depend on theexpected realization of the value of public goods as represented by �.

Putting these together, the expected two-period utility of group J in period one is:

W(˛1, �1, �1, m1, 2(1 − �)) + [1 − �]UI(�2, �2) + �UO(�2, �2)

for the incumbent and

W(˛1, �1, �1, m1, 2�) + �UI(�2, �2) + [1 − �]UO(�2, �2)

for the opposition.

2.3. Investments in state capacity

We now explore decisions to invest in state capacity which are determined by the incumbent I1 to maximize:

W(˛1, �1, �1, F(�2 − �1) + L(�2 − �1), 2(1 − �)) + [1 − �]UI(�2, �2) + �UO(�2, �2)

by choice of {�2, �2}. The Euler equations for legal and fiscal capacity are thus

ω�(�2)[1 + (E(2) − 1)�2] � 1L�(�2 − �1)c.s. �2 − �1 � 0

(3)

ω(�2)[(E(2) − 1] � 1F�(�2 − �1)c.s. �2 − �1 � 0

(4)

where 1 = max {2(1 − �), ˛1} and E(2) = �˛H + (1 − �)2 is the expected value of public funds with

2 ={

˛L if ˛L ≥ 2(1 − �)2[(1 − �)(1 − �) + ��] otherwise.

Essentially these conditions set the marginal benefit from investments in state capacity, which depend on the expectedmarginal value of public funds, to their marginal cost. Our next task is to study the implications of (3) and (4).

In the case of legal capacity, there is a direct benefit in terms of future productivity from increasing the quality of thecontracting/property rights environment. However, other effects operate through the effect of legal and fiscal capacity onthe state’s ability to allocate resources in the second period. As shown by Besley and Persson (2009), the key parameter isE(2) – the expected value of period two public funds. If E(2) > 1, then positive investment in both forms of state capacity isguaranteed. Moreover, investments are complements in the sense that an increase in the amount of one kind of state capacityraises the marginal value of the other. This is intuitive. Greater fiscal capacity increases the value of legal capacity becausethere is an additional benefit via public funds. An increase in legal capacity raises wages and hence makes investment infiscal capacity more attractive.

This observation is consistent with Fig. 1 with higher income countries having both higher fiscal and legal capacity. Indetermining the level of state capacities, there are two key conditions:

Cohesiveness condition : ˛L ≥ 2(

1 − �)

This requires that � is close enough to 1/2, i.e. political institutions are sufficiently consensual.

Stability condition : �˛H + (1 − �) 2[(1 − �)

(1 − �

)+ ��

]≥ 1

This condition essentially says that the expected value of future public revenues is sufficiently high even when, withprobability 1 − �, there is transfer spending. Thus, the stability condition is relevant only when the cohesiveness conditionfails. This will be highest when two things are true: constraints are weak (� = 0) and the probability of retaining power ishigh (� = 0). So low political turnover (low �) is generally conducive to the condition holding. The condition can hold evenif � = 0, i.e. there is no prospect of public good spending.

2.4. Three types of state

We now show, following Besley and Persson (2011b), that the model predicts three types of possible state depending onwhether the above two conditions hold.

2

P

12

prtk

sd

2

i

Pw

12

mpoiprs

oAg

2

d

Pie

Tt

tiTm

3

t

i


.4.1. A common-interest stateWe begin with the case where the cohesiveness condition holds. In this case, we have the following result:

roposition 1. Suppose that the Cohesiveness condition holds, then:

There are investments in both kinds of state capacity.An increase in � increases both fiscal and legal capacity investments by making future public funds more valuable.

For this result to hold, we require that � be close enough to one half so that marginal public revenues are allocated toublic goods whether ˛s is high or low. In this case, the incumbent in period one is reassured that the state will use publicesources for common-interests, i.e. public goods, regardless of who is in power in period two. This makes her confidenthat the state can be developed. In this case, we have that E(2) > 1. This implies that there are positive investments in bothinds of state capacity.

This result also highlights the role of strong common interests in the use of state resources in incentives to build thetate. As � increases, then public goods are more valuable. This captures the classic war making incentives for state buildingiscussed in Tilly (1990) who argued that the rise of effective fiscal states in Europe was rooted in war making.

.4.2. A redistributive stateIn a redistributive state, the cohesiveness condition fails while the stability condition is satisfied. The stability condition

mplies that there is a positive incentive to invest in both fiscal and legal capacity. We now have:

roposition 2. Suppose that the cohesiveness condition fails while the stability condition is satisfied then the state is redistributiveith public revenues used to finance transfers when ˛s = ˛L.

There are investments in both kinds of state capacity. An increase in � or a fall in � , increases both fiscal and legal capacity investments by making future public funds more valuable.

In this case, the failure of the cohesiveness condition implies that, when public goods are not valuable, then the govern-ent spends resources on transfers rather than public goods. This implies that the decision to invest in fiscal capacity is

artly motivated by the prospect of securing future transfers. However, for this motive to be strong enough, the prospectf the incumbent holding office in future has to be sufficiently high. The model predicts, therefore, that the incentive tonvest in fiscal and legal capacity is strongest when � → 0 and � → 0. Thus, conditional on institutions being non-cohesive,olitical stability may play a role in fostering investments in the state – the incumbent group acts more and more like aesidual claimant on the state. Investments could even be positive as � → 0, i.e. without any common interest motive fortate building.

This provides an example for growth of government based on selective interests by a politically dominant group intentn using the state as an extractive institution. This is reminiscent of the Leviathan tradition of Brennan and Buchanan (1980).s Brennan and Buchanan argue, state does have some incentives to invest in market supporting institutions as a means ofrowing the tax base.

.4.3. A weak stateThis is the case where both the cohesiveness and stability conditions fail. The following result summarizes the investment

ecisions in a weak state as predicted by the model.

roposition 3. Suppose that the cohesiveness and stability conditions fail, then the state is weak. There is no incentive to investn fiscal capacity and the level of legal capacity investment is lower than with a common interest or redistributive state, all elsequal.

The fact that the stability condition fails now implies that the marginal benefit of investing in fiscal capacity is negative.he weakness of institutions and high political turnover means that any fiscal capacity investments are likely to be used byhe other group once it takes office. This deters investment in the state.

Such weak states suffer from three things – low � so that political institutions do not safeguard common interests; highurnover, � , so that political instability is high; and low � so that common interests are weak. This combination of factorsmplies that incentives to grow the tax base are weak. But this reduces rather than enhances incentives to invest in markets.his is consistent with the evidence in Fig. 1 where states that have low tax takes in GDP are also those which fail to supportarkets effectively.

. The anatomy of state failure

Having characterized the types of states that can arise, the next step is to discuss how to evaluate these outcomes inerms of normative criteria.

Despite the many influential contributions of Buchanan, the mainstream tradition in economic policy analysis is dom-nated by the Pigouvian tradition which defines good government in terms of its achievements relative to a defined social


ordering. This conception of state intervention and its basis was systematically codified in Pigou (1920) although it is fair tosay that he has sometimes been unfairly caricatured for his views as the following quote makes clear:

“It is not sufficient to contrast the imperfect adjustments of unfettered enterprise with the best adjustment thateconomists in their studies can imagine. For we cannot expect that any State authority will attain, or will even whole-heartedly seek, that ideal. Such authorities are liable alike to ignorance, to sectional pressure and to personal corruptionby private interest.” Pigou (1920), p. 296.

However, the Pigouvian tradition that has emerged subsequently steps away from the world of politics and possibleimperfections in policy making. The approach has spawned a large and sophisticated literature on economic policy design– see, for example, Atkinson and Stiglitz (1980). It is the foundation of the modern theory of public goods provision as inSamuelson (1954) and the theory of optimal taxation as in Diamond and Mirrlees (1971) and Mirrlees (1971).

The Pigouvian approach can be used to define notions of political failure in terms of a comparison between the optimalPigouvian policy and politically determined policies. This is the approach taken, for example, in Besley and Coate (1998)which demonstrates that political resource allocation in dynamic models can result in outcomes that are Pareto inefficient.They argue that using Pareto efficiency, as opposed to some kind of more permissive welfare criterion, is more in line witha standard economic approach to market failure. A more permissive approach has been used by Wittman (1989) to arguethat politics is likely to produce efficient results.

An alternative perspective on good government is defined by viewing government as an extension of the process ofexchange where the currency of exchange is policy. Politics is a game which facilitates gains from trade to achieve collectivelysuperior outcomes. This is analogous to a contractarian approach to the state which has its routes in classical liberalism,particularly the political philosophy of Locke (1690). Wicksell (1896) is a classic statement of this view in relation to economicpolicy and has been central to Buchanan’s approach.13 Good government is defined by what would be agreed to by freecitizens negotiating over policies. This has been used (see, for example, Buchanan (1987)) to motivate a constitutionalapproach in which rules are developed to implement such policies.14

A related approach is based on Coase (1960). He looks at policy in terms of what would arise if there were clearlydefined bargaining over policy with well-defined rights. While this is generally applied to the provision of public goods, thisbargaining perspective can be applied to any policy. Acemoglu (2003) couches the debate about government failure in termsof the political Coase theorem and emphasizes the importance of commitment failures in achieving efficient bargains overpolicy.

At the heart of an exchange-based approach is the role of institutions in achieving particular policy outcomes. Governmentis not detached from the economy but is part of a closed behavioral system (Buchanan, 1972).

We will contrast three types of policy outcomes which we will refer to as Pigouvian, Wicksellian, and politically optimalpolicies that we determined above.

3.1. The Pigouvian benchmark

The Pigouvian policy outcome in this setting maximizes:∑s∈{1,2}

Iu(ts, rIs, gs, pI

s; ˛s) + Ou(ts, rOs , gs, pO

s ; ˛s)

subject to the government budget constraint (2) in each period. Essentially, we are supposing that the result is welfarist,maximizing a weighted sum of utilities with weight J for each group. We will normalize so that I + O = 1. Define =max

{I, 1 − I

}≥ 1/2 as the weight on the most favored group. The Utilitarian case is where = I = 1/2. The

weights J could be thought of as classic social welfare weights or else we could think of this criterion being agnosticabout distribution and these just being “Pareto” weights.

The optimal Pigouvian policy{

ts, gs, rIs, rO

s , pIs, pO

s

}in each period has four features in this setting. First, pI

s = pOs = �s

and ts = �s, i.e. legal and fiscal capacities are fully utilized. This is exactly as in the politically optimal policy above and thereasoning is essentially the same. The optimal level of public goods provision is:

G(

˛s; )

={

�sω (�s) − ms if ˛s ≥ 2 0 otherwise

This says that either all residual public revenues are spent on transfers or public goods depending on the realization of ˛s

and the value of I. If is close to one half, then all public spending is on public goods. Since, we have assumed that ˛H > 2,
then the possibility of no spending on public goods arises only when ˛s = ˛L.
Finally, we look at transfers. First, observe that if ˛s ≥ 2 , then there are no transfers in the Pigouvian optimum. This isbecause there is relatively equal social weight of the two groups. However, if this condition fails then the group with the

13 See, in partcular, Buchanan (1967).14 See Brennan and Buchanan (1985) for a classic statement.

hw

ttePibs

F

d

E

Jl

sU

Po

12

3

ohtl

a

p

3

o

t


ighest social weight will optimally receive transfers. With all of the transfers going to the group with the highest socialeight. We use R

(˛s, �s, �s; J

)to denote the optimal transfer function for group J.

It is now clear that politically optimal policies may diverge from the Pigouvian approach on two counts. If is closeo 1/2, but � is close to zero then the political equilibrium will tend to spend too little on public goods and too much onransfers. But if is close to zero or one and � is close to 1/2, then the opposite is true and the Pigouvian critique of politicalquilibrium is too little spending on transfers and too much spending on public goods! The general point here is that theigouvian approach views taking an external perspective on just distribution as legitimate. And if the political equilibriums cohesive (� close to one half), then it will not be socially optimal. Of course, in the current model, given the symmetryetween the groups, there is a natural reason to think that the case where I = O = 1/2, the Utilitarian outcome, makes mostense. But there is nothing in the Pigouvian framework per se that guarantees this.

We can now plug in these optimal policies to derive the following “indirect” payoff function:

s(˛s, �s, �s, ms, , J) = ˛sG(˛s; ) + (1 − �s)ω(�s) + R(˛s, �s; J)

or future reference, it is also useful to define the associated “value function” for group J:

SJ(�2, �2) = [�s(˛H, �2, �2, 0, , J) + (1 − �)s(˛L, �2, �2, 0, , J)].

epending on the state variables {�2, �2}. We now consider investments in state capacities {�2, �2} to maximizeI s(˛1, �1, �1, m1, , I) + ISI(�2, �2) + (1 − I)s(˛1, �1, �1, m1, , O) + (1 − I)SO(�2, �2).

The Euler equations for legal and fiscal capacity are essentially as in (3) and (4) except that 1 = max{

2 , ˛s

}and

(2) = �˛H + (1 − �)2where

2 ={

˛L if ˛L ≥ 2 2 otherwise

ust as in the case of politically optimal policy, it is the future expected value of public funds which drives the results. Asong as E (2) > 1, the investments are complements. This will always be the case since 2 > 1.

We now discuss the performance of government comparing the Pigouvian benchmark with the politically optimal deci-ions. We will focus for simplicity on the case where 2 ≤ ˛L which is the case where the welfare criterion is close totilitarian. The results are summarized in:

roposition 4. Suppose that 2 ≤ ˛L , then the Pigouvian government always invests a positive amount in state capacity. Theutcome compares to the politically optimal government as follows:

With a common interest state, the Pigouvian and politically optimal investments coincide. With a redistributive state, the politically optimal government may be too large or too small compared to the Pigouvianbenchmark. A sufficient condition for the government to be too large is that

2[(1 − �)

(1 − �

)+ ��

]≥ ˛L

which always holds for small enough � and �. A weak state always invests too little in state capacities according to the Pigouvian benchmark.

The first result says that an approximately Utilitarian and common-interest government will invest in the developmentf the state according to the same criterion. It is only when the Pigouvian benchmark favors one group over the other andence engages in pure redistribution that the common-interest state under-invests according to this benchmark. However,hat under-investment will (because of complementarity) also have weaker contract enforcement even if government isarger.

The redistributive state may over-invest in state capacity but this depends on how far the Pigouvian welfare functionpproves of redistribution. The classic case of overbearing government is where � = � = 0 .

The weak state under-invests since the high probability of transition of political power and weak institutions for curbingower implies that the state is too small relative to the Pigouvian benchmark.

.2. The Wicksellian benchmark

The Wicksellian ideal is not defined by an outcome but by what policies would achieve unanimous consent in a processf exchange relative to the no-government status quo.15 There is no standard approach to this so we will suggest one and

15 We are assuming here that everyone knows their type. Another approach, perhaps more in line with some of Buchanan’s discussions, would be tohink in terms of choice behind a veil of ignorance. In principle, this could be a more permissive criterion than that studied here. Moreover, this ex ante


then apply it to the model that we are using here. We will invoke the possibility that citizens have the right to veto a policyvector unilaterally (in any dimension of policy) and unilaterally set an element of the policy to zero, adjusting other policiesto achieve budget balance.

Formally let xs = {ts, gs, rIs, rO

s , pIs, pO

s } and B(�s, �s) be the set of policies which satisfy the government budget constraint.And let vJ(xs, ˛s) be group J’s utility from the policy vector xs. Let x0

s be a policy deviation which sets an element of the policyvector to zero with a balanced budget. We will then say that a policy vector is Wicksellian if there is no x0

s ∈ B(�s, �s) suchthat:

vJ(x0s , ˛s) > vJ(xs, ˛s)

This says that no deviation is possible on every dimension of policy. In effect every citizen is given a veto and only policiespreferred to the status quo will ever be chosen.

This is one particular interpretation of Wicksell. It builds in two important features. First, the form of the veto that beunilaterally exercised is to a status quo where the policy is not used at all. The requirement that the deviations balancethe government budget implies that in a deviation to ts = 0, then gs = 0 and rI

s = rOs so there is interdependence in the way

that policy vetoes can be exercised. Second, we consider vetoes on each dimension. A much more permissive criterion forgovernment, which is consistent with the contractarian or exchange idea is to make the point of comparison the null policyvector. Many more policy interventions are likely to survive this test.16

The following proposition is an implication of Wicksellian policy:

Proposition 5. Let {ts, gs, rIs, rO

s , pIs, pO

s } be a policy vector that satisfies the Wicksellian criterion, then rIs = rO

s = 0.

The argument behind this is straightforward. Suppose that there are positive transfer levels, then a citizen can proposea zero transfer for the other group with the resources freed up either allocated to public goods spending or to a lower levelof taxation. This is bound to make the citizen better off and hence the initial policy could not be Wicksellian.17

The Wicksellian criterion does not rule out the use of taxation or spending on public goods. It also does not rule outprotection of property rights/contract enforcement. But it does rule out transfers. In the way that we have framed theWicksellian criterion, citizens have the ability to veto such transfers and since they are particularistic benefits financed byone group, then this will always happen.

Applying this observation to the politically determined policies, it is clear that the political outcome is Wicksellian onlyif the cohesiveness condition is satisfied, i.e. � is close enough to a half. In this case, politically determined policies alwayspass the unanimity test. However, since both the weak state and the redistributive state have positive transfers, the policiesimplemented fail the Wicksellian unanimity test.

We now apply the unanimity test to state capacity investment. To do so, requires us to augment the policy vector xs toinclude these investments. It is clear that, a common-interest state will produce investments in state capacity which passthe Wicksellian test since both groups share the same policy objective. So it still corresponds to model of government whichis ideal from either a Pigouvian and Wicksellian point of view.

In the case of a redistributive state, things are less clear. However, there are circumstances in which the opposition groupwill now wish to use its veto power over state capacity investments (at least in fiscal capacity). This will be the case where

(�˛H + (1 − �) 2[(1 − �)� + � (1 − �)] − 1 < 0

which is always the case when � is low enough, and � and � go to zero, i.e. weak common interests, very weak institutionsand low turnover. In effect, one group has a monopoly on power and chooses to use this power to further redistributive endssufficiently often.

This case corresponds to the classic Public Choice critique where government is too large. But observe that if citizenswere given the right to veto investments in taxation in this setting, they would damage political incentives to invest in legalcapacity if this were kept in the hands of the government. So it raises the issue of how to maintain incentives to invest inmarkets while curbing incentives to invest in excessive taxation. It is not enough to curb government, there is also a needto promote the right kind of government intervention to build an effective market economy and this cannot be supposed tohappen spontaneously. The answer lies, of course in raising � since this will have the desired effect of achieving a Wicksellian
outcome on both taxation and market supporting dimensions.
In the weak state, there is no investment in fiscal capacity. So, although there is a political failure applied to the useof redistributive instruments, there is no additional critique of the political equilibrium. The weak state is a response toother sources of political failure rather than a failure in itself. The case for maintaining a weak state capacity is based on

point of view begins to look more like a Pigouvian approach with being the probaility of each type. With = 1/2, the Utilitarian and ex ante Wickselliancriteria look rather similar. Examining different ways of formally conceptualizing unanimity rule in different models of the political process and policyenvironments is an interesting issue for future work.

16 For example, if the no government position were without enforcement of property rights, then it is likely that a fair bit of redistribution would beconsistent with unanimity rule couched in this way.

17 It is interesting to observe that the same outcome could be achieved if the citizens were given the right to equal treatment where rIs = rO

s . This iseffectively the same as the outcome with � = 1/2 and all spending is optimally on public goods.

tm

Tcpb

swwipt

tW

4

thcg

wP

wpspstr

lms

sucts

pmp

t

rtet

e


he inability to improve resource allocation. Citizens will be reluctant to create fiscal authority in a weak state because ofisallocation of public resources and political instability.There is a critique of weak states which the Wicksellian criterion as formulated here does not seem to get at well.

he state does not invest in taxing power but it also has weaker incentives to invest in contracting institutions. Thus suchountries will tend to have weaker states and weaker markets. A higher investment in �2 would not however be unanimouslyreferred given that � is low. This contrasts with the Pigouvian perspective which would argue for more state capacity onoth dimensions.18

Another way to approach the normative failure of weak states is via the failure of a political Coase theorem. To see this,uppose that policy is determined via bargaining where each group has the right to make a Wicksellian veto of the kind thate described above. In this case, if there is commitment over the whole policy vector (including the period two policies) thene would expect the citizens to bargain towards the outcome that we characterized for the common-interest state where

nvestments are larger than in the weak state. However, for this to work there must be binding inter-temporal bargains onolicy, effectively committing to a period two Wicksellian veto. Otherwise, we would not get the optimal investments dueo this commitment failure as has been emphasized in Acemoglu (2003).

The constitutional implications of the analysis are unambiguous and focus on institutional and constitutional changeshat serve to increase �. Indeed, this parameter can be thought of as exactly a parameter which characterizes how close to

icksellian is the political constitution.19

. Further aspects of weak states

One key prediction of the model that we have emphasized throughout has been the possibility that non-cohesive insti-utions (formalized as low �) can lead to weak states – those with little fiscal and legal capacity when political turnover isigh. Thus, the problem of weak states can be brought into the anatomy of state failure in a dynamic model where stateapacities are endogenous. This does not seem previously to have been a central issue in the Public Choice critique of theovernment.

However, the analysis only scratches the surface in terms of pathologies of weak states. Here, I sketch a few related issueshich multiply the potential pathologies that can arise in weak states. These are discussed in greater detail in Besley and

ersson (2011b).One unsatisfactory feature of the model is that the rate of political turnover, � , is exogenous. The model suggests that state

eakness is most likely to be an issue when political turnover is high. It is important therefore to study the forces that shapeolitical turnover. Such turnover could be due to regular political competition in elections, customary rules for leadershipuccession or the use of political violence. As emphasized in Besley and Persson (2011a), low � is also likely to encourageolitical violence as a means of acquiring power since the prize from winning office is much greater. Thus weak states mayuffer endogenously from high political turnover due to the prevalence of political violence. Moreover, the evidence suggestshat civil conflict is strongly correlated with political institutions and low income. Violent contests for power will tend toeinforce the weakness of the state in addition to the cost in resources and human misery as a by-product of violence.20

The problem of weak states is further compounded by introducing private capital accumulation. In general, we expectower returns to capital when �2 is low and hence poor incentives to invest in physical and human capital. This comple-

entarity further reinforces poverty in weak states. Indeed, it introduces a multiplier effect from government efforts totrengthen legal protection for investors.

Weak states also tend to suffer from other related pathologies that further compound the forces that we have identifiedo far. When there are rents in production, this can lead to further economic inefficiencies. Incumbent groups will tend tose extra-legal means to extract those rents. This will tend to lead incumbents to try to deprive full access to the law toertain groups to prevent them from fighting back against predation and corruption. This, in turn, undermines the incentiveo invest in legal capacity. Thus states that suffer from corruption and predation will tend to have poorer legal and fiscalystems (the latter due to the complementarity that has been emphasized).21

This brief discussion emphasizes that when � is low (institutions are not cohesive) then multiple economic and political
athologies are likely to result – all forms of misery go to together. The flip side of this is that when � is high, there areultiple virtues. Besley and Persson (2011b) refer to these as development clusters where good policy, high income and
eace go together. Weak states have none of these virtues and non-cohesive institutions (low �) lie at the core.

18 This is a case where taking a more ex ante perspective on unanimity in the spirit of Buchanan would likely have some promise – and would likely bringhe Wicksellian and Pigouvian assessments of weak states closer together.19 This is discussed further in Besley and Persson (2011b, Chapter 7).20 Countries with civil war certainly correspond to a reasonable notion of political instability. However, politically stable states with long-lived corruptulers also appear to be weak in a way that is hard to reconcile with the model laid out here. To understand this requires an extension of the model alonghe lines developed in Besley and Persson (2011b, Chapter 3) where predatory behavior by incumbents is modeled in which the state is run by a thievinglite who keep the state weak in order to allow their plunder to continue. Such states will have poor protection of property rights and low levels of formalaxation. So they will appear weak along the dimensions that we studied in Fig. 1. However, they may also have low � .21 Low � as specified here is not necessarily the most natural parametrization of institutions. However, elicit forms of rent extraction would likely beliminated if citizens who suffered as a consequence of such policies had greater veto power.


Of course, all of this begs the question of where political institutions and political reform come from. Whether it is assimple as redesigning a constitution is moot. A constitution has to be enforceable and immune to political manipulation.Indeed, the idea of enforceable constitution presumes a legal framework is in place which lies above the operation of thepolicy process. This is far too optimistic an assumption for countries that suffer from weak states where rulers regularlyamend the constitution when it suits them to do so. However, as in the evolution of Buchanan’s thinking, the approach thathas been taken here to identify the pathologies of the weak state brings to the fore the question of how to design and enforcerules which are more cohesive.

5. Concluding comments

This paper has used the model of Besley and Persson (2009, 2011b) to explore pathologies of the state – ways of under-standing how the state may fail according to well-specified criteria. The paper contrasts two kinds of welfare approaches –one based on a Pigouvian criterion and the other on a Wicksellian criterion. We have discussed exactly how state failure isdefined in each case.

The common thread of all of the results is the observation that � is low, i.e. institutions are not cohesive. This reinforcesa theme which runs through the Wicksellian project and Buchanan’s seminal contributions which apply this. We havediscussed why low cohesiveness, represented by the parameter �, can result in states that are either too weak or strong.The former has not received sufficient attention in Public Choice. According to the theory, weak states tend in practice to beassociated with cases where there is a high level of political instability and non-cohesive institutions. These are states thatboth raise few taxes and support markets poorly.

This helps to resolve a paradox of public choice, that it was borne as a field predominantly out of a critique of the modernUS state or in Wicksell’s case his observations of Swedish parliamentary democracy in the 19th century. But on a global scale,these are paragons. By now, we have a wider range of experience including the many efforts of countries over the world toestablish and consolidate governments which can foster peace and prosperity. The achievements are, to put it charitably,highly variable. Many people around the world suffer daily from the consequences of weak and/or repressive governments.

The argument in this paper is that Buchanan’s insights about good government lie also at the heart of the problems ofstate weakness. The problem of creating effective states and eliminating weak government around the world today remainsone of finding an institutional recipe to the problem of achieving government by consent.

References

Acemoglu, D., 2003. Why not a political Coase theorem? Social conflict, commitment, and politics. Journal of Comparative Economics 31, 620–652.Acemoglu, D., 2005. Politics and economics in weak and strong states. Journal of Monetary Economics 52, 1199–1226.Atkinson, A.B., Stiglitz, J.E., 1980. Lectures on Public Economics. McGraw Hill, New York.Battaglini, M., Coate, S., 2008. Inefficiency in legislative policy-making: a dynamic analysis. American Economic Review 97, 118–149.Besley, T., Coate, S., 1998. Sources of inefficiency in a representative democracy: a dynamic analysis. American Economic Review 88, 139–156.Besley, T., Persson, T., 2009. The origins of state capacity: property rights, taxation and politics. American Economic Review 99, 1218–1244.Besley, T., Persson, T., 2011a. Fragile states and development policy. Journal of the European Economic Association 9, 371–398.Besley, T., Persson, T., 2011b. Pillars of Prosperity: State Capacity and Economic Development: The 2010 Yrjo Janhsson Lectures. Princeton University Press,

Princeton.Brennan, G., Buchanan, J.M., 1980. The Power to Tax: Analytical Foundations of a Fiscal Constitution. Cambridge University Press, Cambridge.Brennan, G., Buchanan, J.M., 1985. The Reason of Rules: Constitutional Political Economy. Cambridge University Press, Cambridge.Brewer, J., 1989. The Sinews of Power: War, Money and the English State. Knopf, New York, pp. 1688–1783.Buchanan, J.M., 1967. Public Finance in Democratic Process. University of North Carolina Press, Chapel Hill.Buchanan, J.M., 1972. Toward an analysis of closed behavioral systems. In: Buchanan, J.M., Tollison, R. (Eds.), Theory of Public Choice. University of Michigan

Press, Ann Arbor (Chapter 2).Buchanan, J.M., 1975. The limits of liberty: between anarchy and leviathan. University of Chicago Press, Chicago.Buchanan, J.M., 1987. The constitution of economic policy: nobel prize lecture. American Economic Review 77, 243–250.Buchanan, J.M., Tullock, G., 1962. The Calculus of Consent: Logical Foundations of Constitutional Democracy. University of Michigan Press, Ann Arbor.Coase, R., 1960. The problem of social cost. Journal of Law and Economics 3, 1–44.Diamond, P., Mirrlees, J.A., 1971. Optimal taxation and public production. I. Production efficiency. American Economic Review 61, 8–27.Holsey, C., Borcherding, T., 1997. Why does government’s share of national income grow? An assessment of the recent litterature on the U.S. In: Mueller,

D. (Ed.), Perspectives on Public Choice. Cambridge University Press, Cambridge.La Porta, R., Lopez de Silanes, F., Shleifer, A., Vishny, R., 1998. Law and finance. Journal of Political Economy 106, 1113–1155.Levi, M., 1988. Of Rule and Revenue. University of California Press, Berkeley.Locke, J., 1690. Two Treatises of Government. Everyman Edition, London.Mirrlees, J.A., 1971. An exploration in the theory of optimum income taxation. Review of Economic Studies 38, 175–208.Pigou, A.C., 1920. The Economics of Welfare. MacMillan, London.Samuelson, P., 1954. The pure theory of public expenditure. Review of Economics and Statistics 36, 387–389.Strayer, J.R., 1970. On the Medieval Origins of the Modern State. Princeton, Princeton University Press.
Tilly, C., 1990. Coercion, Capital and European States, AD 990-1992. Blackwells, Oxford.Weingast, B., Shepsle, K., Johnsen, C., 1981. The political economy of benefits and costs: a neo-classical approach to distributive politics. Journal of Political
Economy 89, 642–664.Wicksell, K., 1896. A New Principle of Just Taxation. In: Musgrave, R.A., Peacock, A.T. (Eds.), Classics in the Theory of Public Finance. McMillan, London.Wittman, D., 1989. Why democracies produce efficient results. Journal of Political Economy 97, 1395–1426.

Documents

Pathologies of the state