The Economic Role of Political Institutions

Abstract

Thriving markets require not only an appropriately designed economic system, but a secure political foundation that limits the ability of the state to confiscate wealth. This requires a form of limited government, that is, political institutions that credibly commit the state to honor economic and political rights. This paper studies how limited government arose in the developed west, focusing on the critical role of federalism for protecting markets in both England and the United States. Federalism proved fundamental to the impressive economic rise of England in the 18th century and the United States in the 19th and early 20th centuries. The paper also shows that federalism underpins the spectacular economic growth in China over the past fifteen years.

JEL Classification: N4