The Origins of State Capacity: Property Rights, Taxation, and Politics

Economists generally assume the existence of sufficient institutions to sustain a market economy and tax the citizens. However, this starting point cannot easily be taken for granted in many states, neither in history nor in the world of today. This paper develops a framework where "policy choices", regulation of markets and tax rates, are constrained by "economic institutions", which in turn reflect past investments in legal and fiscal state capacity. We study the economic and political derminants of these investments. The analysis illustrates that common interest public goods, such as fighting wars, as well as political stability and inclusive political institutions are conducive to building state capacity. Premilinary empirical evidence show that the correlations found in cross-country data are consistent with the theory. The authors are grateful to Steve Coate for useful discussions, to Mick Keen for providing us with data, and to Dario Caldara for excellent research assistance.