Three Essays on Political Institutions, Inequality, and Economic Growth

Why are some countries much richer than others? Why do some economies grow faster than others? Economists have asked these trite yet crucial questions for more than one century. In recent years, more and more economists shed light on the effect of institutions and income distribution on economic growth. This thesis consists of three essays which investigate the role that inequality or political institutions play for economic growth. The first essay formulates a game-theoretic model between a dictator and the people to find underlying determinants of dictatorial behavior. We emphasize the risk involved for a dictator with choosing a growth-enhancing policy: while such policies can raise additional tax revenues in the short-run, they also increase the likelihood of a revolution which can lead to the eventual overthrow of the dictator. We have three main findings. First, in a country where citizens can earn much through private investment, the dictator has little incentive to implement growth-enhancing policy. Second, we find that a long life-time of a dictator does not always induce her to act benevolently. With a longer life-time, she will be more concerned with the likelihood of a revolution. Finally, we distinguish two different effects of economic performance on democratization. If a good economic performance is achieved by technological progress, then it will lead to a speedy democratization. This result coincides with the empirical research of Barro (1997). However, if a country becomes richer because of more natural resources, then the good economic performance impedes political transition. This result is consistent with Ross (2001), who finds that oil impedes democracy. The thesis’ second main topic is the relationship between economic growth and income or wealth inequality. Chapters 3 and 4 illustrate the demand channel through which inequality affects growth. The main idea is based on the vertical differentiated goods market, which was originally introduced by Shaked and Sutton (1982, 1983). Profit of innovation determines its incentive. The profit of a new differentiated good comes from the willingness to pay and the market share. Both of them will be affected by the distribution of income. Inequality may supply enough rich consumers to buy new luxury or higher quality goods. But on the other side, inequality induced by a relative small market size impedes also the spread of new or better quality goods. We assume an economy with two kinds of individuals, the poor and the rich. Hence, the Gini coefficient is decomposed into two variables, namely, the relative income of the poor and the population share of the poor. The purpose of our research is to show that these two variables might have different effects on economic growth. Thus, the simple regression of the Gini coefficient on the long-run growth rate is able to generate neither an unambiguous empirical result, nor a useful policy recommendation. According to our research, in a country where the separating equilibrium is overwhelming and the goal of government policy is to achieve both an increase in economic growth and a decrease in inequality, one should consider decreasing the population share of the poor but not directly redistributing from the rich to the poor