Do Rich Countries Choose Better Governments?

Abstract

We analyze public investment in social infrastructure using a two-period model in which a government must intermediate all infrastructure investment. Voters choose a government from two alternative types, high quality and low quality. A high quality government obtains higher returns on infrastructure but also demands a bigger consumption payoff for intermediating investment, implying higher taxes for the voting public. We find that these intermediation costs imply threshold effects in the electoral process--closed economies above a critical level of first period income elect high quality governments, while economies below that level elect low quality ones. Thresholds vanish when voters can borrow abroad; capital mobility reduces the current consumption cost of infrastructure investment and favors better quality governments.We study last the optimal choice of government when government actions are observable with "noise." Small amounts of noise turn out to have no effect on the choice of government type or on infrastructure provision. However, once the level of noise becomes large, the agency problem raises the cost of intermediation, reduces infrastructure provision, and biases elections toward low quality governments. Finally, we test the model with cross-country data and find preliminary empirical support for the messages in it.

JEL Classification: E6, O1