Social (In)Stability, Distributive Conflicts, and Investment in Poor and Rich Economies

A recently much debated issue is why observed investment and growth rates in poor countries are lower than traditional theory predicts. Empirical evidence suggests that social and political instability is a major reason for the divergence between poor and rich countries. However, there is still the unsolved puzzle that the relationship between development and investment rates is not monotonic but follows a hump-shaped pattern. The empirical evidence shows that although very poor economies have very low investment rates there are ’intermediately’ developed economies that exhibit extremely high investment rates. This paper shows within the framework of a simple game theoretic model that if property rights over produced wealth are not perfectly secure very poor countries are in an instability and inefficiency trap. There exists no redistribution schedule sustaining social stability. However, intermediately productive economies can exhibit investment rates higher than those of high productive economies. Hence, the results of the model predict the empirically observed hump-shaped relationship. Furthermore, the results also support the hypothesis that inequality and investment rates are negatively correlated. JEL Classification Number: D23, D74, O12