On the Dynamic Inefficiency of Governments

Abstract

When the government must decide not only on broad public-policy programs but also on the provision of group-specific public goods, dynamic strategic inefficiencies arise. The struggle between opposing groups - that disagree on the composition of expenditures and compete for office - results in governments being endogenously short-sighted: a systematic under-investment in infrastructure and overspending on public goods arises as resources are more valuable when in power. I find that more ideologically homogeneous societies have higher capital accumulation and more efficient allocations. When there is an average advantage for one group over the other in the political dimension, the group that loses the elections more often tends to spend a higher share of output on public goods while investing even less than the other group. This creates economic cycles - that follow the political cycle - introducing fluctuations in real macroeconomic variables without assuming any exogenous productivity shocks.

Keywords: Public Investment, Commitment, Probabilistic Voting, Markov Equilibrium, Political Cycles