Institutions, Factor Prices, and Taxation: Virtues of Strong States?

While in a few societies economic institutions are designed to provide property rights protection, a level playing field, and basic public goods necessary for economic growth, in many they are structured to maximize the rents captured by the “elite,” the individuals or social groups monopolizing political power (e.g., Douglass C. North 1981; Acemoglu, Simon Johnson, and James A. Robinson 2005. The elite often choose entry barriers, regulations and inefficient contracting institutions that retard economic growth and create resource misallocations in order to protect their economic rents and redistribute resources to themselves (e.g., Mancur Olson 1982; Per Krusell and Jose-Victor RiosRull 1996).1 However, if resources could be redistributed to the elite with fewer distortions, a more efficient allocation of resources, with (part of) the proceeds accruing to the elite, could be chosen. For example, when the necessary fiscal instruments and the associated state capacity are absent, the elite may choose economic institutions and policies so as to redistribute income to themselves by reducing the productivity of competing groups and thus manipulating factor prices (Acemoglu 2007). Direct taxation, if feasible, would be both more efficient and more profitable for the elite. This reasoning suggests that when the state becomes more “developed,” achieves greater “capacity,” and has access to a larger set of fiscal instruments, there will be less need for such