© SOAS | 3737

Centre for Development, Environment and Policy

P110

Political Economy of Public Policy

Prepared by Colin Poulton with Dr Elodie Douarin

Units 1–9 prepared by Colin Poulton.

Parts of Units 3–4 draw on C12 Political Economy of Public Policy (2001) prepared by

George Rapsomanikis, Mike Stockbridge, Berkeley Hill and Sophia Davidova, revised

in 2002 by Derek Ray, and in 2009 by Elodie Douarin.

Unit 10 prepared by Elodie Douarin and Colin Poulton.

Political Economy of Public Policy Module Introduction

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ABOUT THIS MODULE

Technical specialists (researchers, development workers, even policy advisors) often

get frustrated that policies that are actually adopted and/or implemented deviate far

from their technical recommendations. In economics, this is often referred to as

‘state failure’: the state does not do what economists would like it to do to promote

market development and efficiency, what those concerned with poverty would like it

to do to reduce poverty, or what those concerned with the environment would like it

to do to protect environmental resources. Glaring inequality may be reproduced for

generations. Whilst there are technical dimensions to ‘state failure’, including

imperfect information, there are clearly also other factors at play. It is rarely

straightforward to talk about an undisputed ‘public interest’ that the state should be

pursuing and indeed it can be quite misleading to talk about ‘the state’ as if it were a

single, monolithic entity. Instead, multiple actors with competing or conflicting

interests seek to influence the actions of a variety of state agencies to protect or

further their own ends. The relative power of these groups is then important in

determining outcomes.

This module explores the interactions between politics and policy, seeking to

understand actual policies as the outcome of interaction between rational politicians

and the people and groups who help them acquire and retain power. Moreover,

policy-making both faces economic constraints and generates economic outcomes

that affect future distributions of power within society. Thus, political economy

explores the two-way interaction between economics and politics.

This module is aimed at policy-makers, policy analysts, advocates and practitioners –

from academia, government departments, international development agencies,

NGOs, private business or other civil society groups – who are involved in the design

of policy to promote development, to combat poverty or to protect the environment.

The module draws on theory from both developed and developing countries, but the

application is more to the latter. In common with some other CeDEP modules, there

is also an emphasis on policies affecting rural space. However, more general lessons

can be drawn from the module.

As a result of studying this course, students will be equipped to understand how

political processes and forces influence policy-making and to assess what needs to

change if policy is more effectively to promote rural development, poverty reduction

or environmental protection in the area where they work.

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STRUCTURE OF THE MODULE

The first four units of the module introduce foundational political economy theories

explaining how political and economic forces interact, describing how both leaders

and policies are selected, examining the influence of voters and interest groups, and

also exploring the role of the bureaucracy in policy implementation. These theories

seek both to explain the dynamics of, and to contrast, oligarchic political systems

and more open democratic systems. A critical question for development is what

determines the transition from one system to the other.

The next five units apply these theories to a range of development debates, spanning

sub-Saharan Africa, Latin America and Asia. Unit 5 explores the political, as well as

the technical, determinants of state capacity. Unit 6 explores global trends in

inequality and the drivers of these. Unit 7 considers the political as well as economic

lessons to be learned from the Asian experience of broad-based growth in the latter

half of the 20th century. In the light of the widespread transition to competitive

electoral politics in most countries of Latin America and Sub-Saharan Africa, Unit 8

explores the conditions under which competitive politics may lead to more pro-poor

policy-making in contexts where the majority of the electorate are poor. Unit 9

examines the political as well as economic impacts of mineral wealth and overseas

development assistance (aid) on ‘beneficiary’ countries.

The final unit explores how domestic economic interests are projected into

international negotiations, using negotiations on agricultural trade and climate

change as examples.

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WHAT YOU WILL LEARN

Module Aims

To show both how politics influences policy-making and how the structure of

the economy influences the nature of politics.

To consider how political and economic power interact to create and perpetuate

inequality – a major proximate ‘reason’ for poverty – and, conversely, the

political conditions that are likely to be conducive to pro-poor growth.

To consider how the spread of competitive electoral politics is likely to influence

policy-making in countries where the majority of the electorate is poor (and

often rural).

To examine the policy-making process and the roles of bureaucracies and

interest groups in shaping outcomes.

To explore the impacts of mineral resources and aid flows on governance and

policy-making.

To examine international negotiations and institutions through the lens of

rational actors and power.

Module Learning Outcomes

By the end of the module, students should be able to:

apply the concept of rents to the analysis of state organisations, policy and

performance

explain how political and economic power interact to create and perpetuate

inequality, and what might be done to challenge it

assess the potential for competitive electoral politics to encourage more pro-

poor policy-making in countries where the majority of the electorate is poor,

and to identify interventions that could reinforce this

examine the influence of bureaucracies and interest groups over policy in

practice, in the light of alternative theoretical models and experience in

different parts of the world

describe the impacts of mineral resources and aid flows on governance and

policy-making

explain and critically interpret how domestic political and economic

considerations and power shape the outcomes of international negotiations.

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ASSESSMENT

This module is assessed by:

an examined assignment (EA) worth 40%

a written examination worth 60%.

Since the EA is an element of the formal examination process, please note the

following:

(a) The EA questions and submission date will be available from the Virtual

Learning Environment (VLE).

(b) The EA is submitted by uploading it to the VLE.

(c) The EA is marked by the module tutor and students will receive a percentage

mark and feedback.

(d) Answers submitted must be entirely the student’s own work and not a product

of collaboration.

(e) Plagiarism is a breach of regulations. To ensure compliance with the specific

University of London regulations, all students are advised to read the

guidelines on referencing the work of other people. For more detailed

information, see the FAQ the VLE.

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STUDY MATERIALS

Textbooks

Two textbooks accompany this module.

Acemoglu, D. & Robinson, A. (2013) Why Nations Fail: The Origins of Power,

Prosperity and Poverty. London, Profile Books.

This is a highly influential book that looks at development dynamics from a

historical perspective. It is written in a popular style, which makes it quite fast to

read, but is also rather long and, in the view of the module author, becomes

repetitive after a while! Students are encouraged to read at least the first eleven

chapters (two thirds of the book). Much of this will be flagged up as Key or

Further Readings to accompany particular units. If you can continue to the end,

please do so!

Khan, M. & Jomo, K. (2000) Rents, Rent-Seeking and Economic Development:

Theory and Evidence in Asia. Cambridge, UK, Cambridge University Press.

The first two chapters of this book present a theory of rents and explain their

importance to development processes, from both political and economic

perspectives. Chapter 1 and part of Chapter 2 are included as Key Readings

within the module. In addition, students are encouraged to read the remainder of

Chapter 2 and at least one further chapter as Further Readings as the module

proceeds.

For each of the module units, the following are provided.

Key Readings

These are drawn mainly from the textbooks, relevant academic journals and

internationally respected reports. They are provided to add breadth and depth to the

unit materials and are required reading as they contain material on which you may

be examined. Readings are supplied as digital copies and ebooks via the SOAS Online

Library. For information on how to access the Library, please see the VLE.

Further Readings

These texts are not always provided, but weblinks have been included where

possible. Further Study Materials are NOT examinable; they are included to enable

you to pursue your own areas of interest.

Multimedia

Students are encouraged to look at these and use the VLE to discuss their

implications with other students and the tutor.

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References

Each unit contains a full list of all material cited in the text. All references cited in the

unit text are listed in the relevant units. However, this is primarily a matter of good

academic practice: to show where points made in the text can be substantiated.

Students are not expected to consult these references as part of their study of this

module.

Self-Assessment Questions

Often, you will find a set of Self-Assessment Questions at the end of each section

within a unit. It is important that you work through all of these. Their purpose is

threefold:

to check your understanding of basic concepts and ideas

to verify your ability to execute technical procedures in practice

to develop your skills in interpreting the results of empirical analysis.

Also, you will find additional Unit Self-Assessment Questions at the end of each

unit, which aim to help you assess your broader understanding of the unit material.

Answers to the Self-Assessment Questions are provided in the Answer Booklet.

In-text Questions

This icon invites you to answer a question for which an answer is

provided. Try not to look at the answer yet, and write down what you

think is a reasonable answer to the question before reading on. This is

equivalent to lecturers asking a question of their class and using the

answers as a springboard for further explanation.

In-text Activities

This symbol invites you to halt and consider an issue or engage in a

practical activity.

Key Terms and Concepts

At the end of each unit you are provided with a list of Key Terms and Concepts which

have been introduced in the unit. The first time these appear in the text guide they

are Bold Italicised. Some key words are very likely to be used in examination

questions, and an explanation of the meaning of relevant key words will nearly

always attract credit in your answers.

Acronyms and Abbreviations

As you progress through the module you may need to check unfamiliar acronyms

that are used. A full list of these is provided for you at the end of the introduction.

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TUTORIAL SUPPORT

There are two opportunities for receiving support from tutors during your study.

These opportunities involve:

(a) participating in the Virtual Learning Environment (VLE)

(b) completing the examined assignment (EA).

Virtual Learning Environment (VLE)

The Virtual Learning Environment provides an opportunity for you to interact with

both other students and tutors. A discussion forum is provided through which you

can post questions regarding any study topic that you have difficulty with, or for

which you require further clarification. You can also discuss more general issues on

the News forum within the CeDEP Programme Area.

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INDICATIVE STUDY CALENDAR

Part/unit Unit title Study time

(hours)

PART I THEORETICAL FOUNDATIONS

Unit 1 The State, Policy-Making and Political Economy 10

Unit 2 Exclusive versus Inclusive Institutions 10

Unit 3 Democratic Political Systems and their Rules 15

Unit 4 Policy Processes 15

PART II POLITICAL ECONOMY OF DEVELOPMENT

Unit 5 State Capacity 15

Unit 6 Inequality Dynamics 15

Unit 7 Developmental States? 15

Unit 8 Democratisation 10

Unit 9 Minerals and Aid 10

PART III INTERNATIONAL POLITICAL ECONOMY

Unit 10 Policy-Making at the International Level 10

Examined Assignment

Check the VLE for submission deadline

15

Examination entry July

Revision and examination preparation Jul–Sep

End-of-module examination Late Sep—

early Oct

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ACRONYMS AND ABBREVIATIONS

AoA Agreement on Agriculture

ASUMPAL Association of Small-Sized Irrigation Users of Palencia (Guatemala)

BSE bovine spongiform encephalopathy

bST bovine somatotropine hormone

CAP Common Agricultural Policy

CBD Convention on Biological Diversity

CCP Chinese Communist Party

CCS carbon capture and storage

CIA Central Intelligence Agency

CS consumer surplus

CSD Commission on Sustainable Development

CVMP Committee for Veterinary and Medicine Products

CW consumer welfare

DDA Doha Development Agenda

DFID Department for International Development, UK

EC European Community

EMBRAPA Brazilian Agricultural Research Corporation

EU European Union

EU-ETS European Union Emissions Trading Scheme

G&H Grossman and Helpman

GATT General Agreement on Tariffs and Trade

GDP gross domestic product

GHG greenhouse gas

GMO genetically modified organism

GNP gross national product

GPE global political economy

HIV/AIDS human immunodeficiency virus/acquired immunodeficiency syndrome

IPCC Intergovernmental Panel on Climate Change

IPE international political economy

IR international relations

LDC least developed countries

LRTAP long range transboundary air pollution

MAS Movement for Socialism (in Brazil)

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MDG millennium development goal

MST Movement of Landless Workers (in Brazil)

MTID Markets, Trade, and Institutions Division

NAS National Academy of Sciences

NCPB National Cereals and Produce Board, Kenya

NEPAD New Partnership for African Development

NGO non-governmental organisation

NPM new public management

ODI Overseas Development Institute, London

OECD Organisation for Economic Co-operation and Development

PhD Doctor of Philosophy (in Latin: philosophiæ doctor)

PPF policy preference function

PPP purchasing power parity

PRI Institutional Revolutionary Party (in Mexico)

PS producer surplus

PW producer welfare

RAPID Research and Policy in Development (a programme of ODI)

STC surplus transformation curve

UK United Kingdom

UN United Nations

UNCED United Nations Conference on Environment and Development

UNCHE United Nations Conference on the Human Environment

UNCTAD United Nations Conference on Trade and Development

UNEP United Nations Environment Programme

UNESCO United Nations Educational, Scientific and Cultural Organization

UNFCCC United Nations Framework on Climate Change Convention

UNFPA United Nations Population Fund

US(A) United States (of America)

USAID United States Agency for International Development

VAT value added tax

WSSD World Summit on Sustainable Development

WTO World Trade Organization

Unit One: The State, Policy-Making and Political

Economy

Unit Information 2

Unit Overview 2 Unit Aims 2 Unit Learning Outcomes 2

Key Readings 3

Further Readings 4

References 6

1.0 State roles and state ‘failure’ 8

Section Overview 8 Section Learning Outcome 8 1.1 State failures and market failures 8 1.2 Sources of state failure 10 1.3 North (1990) on state failure 12 1.4 State activities 14 Section 1 Self Assessment Questions 17

2.0 Introducing political economy 18

Section Overview 18 Section Learning Outcomes 18 2.1 Defining characteristics of political economy analysis 18 2.2 A generic political economy model 22 Section 2 Self Assessment Questions 26

3.0 Rents 27

Section Overview 27 Section Learning Outcome 27 3.1 Different types of rents and their allocation 27 Section 3 Self Assessment Question 30

Unit Summary 31

Unit Self Assessment Questions 32

Key Terms and Concepts 33

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UNIT INFORMATION

Unit Overview

Many policy analysts, researchers, entrepreneurs, development practitioners and

citizens get frustrated by what they see as the failure of the state or its agencies to

do what they think it should do. The two main areas in which states are seen to fail

are policy design and service delivery. In this unit we review how influential schools

of economic thought see the role of the state and explore reasons for so-called state

failure. We then introduce basic elements of political economy analysis, which

examines the interaction of political and economic processes within a society and can

shed some light on why states actually act as they do (and why they formulate the

policies that they do). The unit concludes with an introduction to the concept of

rents, which is central to political economy analysis. Rents are the benefit flows that

those in power can confer on themselves and their supporters through policy

intervention. How they do this is a major determinant of whether an economy grows

fast and reduces poverty rapidly or not.

Unit Aims

To review how influential schools of economic thought see the role of the state

and explore reasons for so-called state failure.

To introduce a generic political economy model for analysing the selection of

leaders and the formation of policy.

To present the concept of rents.

Unit Learning Outcomes

By the end of this unit, students should be able to:

compare alternative explanations as to why states often do not perform the

roles that economists and other policy analysts would like them to

explain the basic objectives of political economy analysis and the distinction

between macro-, sector- and problem-level analysis

describe the main building blocks of a basic political economy model and

explain the importance of each

distinguish different types of rents and explain their potential contributions to

economic growth and development.

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KEY READINGS

Section 1

Bates, R. (1989) Beyond the Miracle of the Market: The Political Economy of

Agrarian Development in Kenya. Cambridge, Cambridge University Press. pp. 6–9.

This short section from the introduction of a 1989 book by Robert Bates on Kenya simply and

powerfully illustrates the importance of the allocation of property rights to the direction of

economic growth, with major consequences for inequality and poverty. It also underlines the

point that the allocation of property rights within an economy is fundamentally a question of

politics. The argument is made with reference to the work of Coase (1960), often held up as one

of the foundational works of new institutional economics.

Section 2

Drazen, A. (2008) Is there a different political economy for developing countries?

Issues, perspectives and methodology. Journal of African Economies, 17 (AERC

Supplement 1), i23–i31.

The overall purpose of Drazen’s paper is to argue that the same general approach can be

applied to the analysis of political economy issues in developed and developing countries. In the

selected pages, Drazen outlines the key building blocks of a generic political economy model,

which (he argues) can be applied to any context. The main elements of his model are political

actors, their objectives and the mechanisms by which political decisions are made (ie

institutions). As you read this excerpt, think how the ‘building blocks’ might apply within a

country with which you are familiar.

Section 3

Khan, M. (2000a) Rents, efficiency and growth. In: Khan, M. & Jomo, K. (Eds.)

Rents, Rent-Seeking and Economic Development: Theory and Evidence in Asia.

Cambridge, Cambridge University Press. pp. 21–69.

In this chapter, Khan sets out six types of rents that governments can bestow on firms,

individuals and groups within an economy. These rents flow from the allocation of property

rights. Khan’s theory is heterodox, drawing on neoclassical economics, new institutional

economics and the works of Karl Marx. His central argument is that the wise distribution of

some of these types of rents can spur economic growth — thus facilitating development even in

apparently highly corrupt environments — whilst others act as a deadweight burden on the

economy. The explanation of each type of rent should be readily accessible to all students of

this module.

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FURTHER READINGS

Acemoglu, D. & Robinson, J. (2013) Why Nations Fail: The Origins of Power,

Prosperity and Poverty. London, Profile Books. pp. 7–69.

The opening chapter of the module textbook makes the case that institutions are critical to

development, with ‘inclusive’ institutions enabling poverty-reducing growth whilst ‘extractive’

institutions perpetuate inequality and poverty. However, the institutions that the authors have

in mind are fundamentally political, so a study of institutions and development has to examine

politics. In the second chapter the authors consider other ‘big picture’ narratives of

development success and failure, and conclude that you cannot ignore politics if you want to

understand development outcomes.

Chinsinga, B. & Poulton, C. (2014) Beyond technocratic debates: the significance and

transience of political incentives in the Malawi Farm Input Subsidy Programme (FISP).

Development Policy Review, 32 (s2), s123–s150.

Available from: http://onlinelibrary.wiley.com/doi/10.1111/dpr.2014.32.issue-

s2/issuetoc

This paper spans policy problem, sectoral and macro levels of political economy analysis. Its

focus is the widely known Malawi farm input subsidy programme, but it draws on Mushtaq

Khan’s theory of rents and a wider understanding of how power was maintained in the country

during the period in question (2005—2012) to try and explain key features of the programme and

also significant changes in the implementation of the programme over this period.

DFID. (2009) Political Economy Analysis: How to Note. London, Department for

International Development (DFID). DFID Practice Paper July 2009.

Available from: http://www.odi.org.uk/events/2009/07/23/1929-dfid-note-political-

economy-analysis.pdf

This paper illustrates the fact that aid donors are increasingly looking to political economy

analysis to inform their country-level strategies and activities. Section 2 of the paper describes

a number of practical approaches to political economy analysis at macro, sectoral and policy

problem levels.

Leftwich, A. (2014) Beyond political economy: the politics of social sector reform in

the Philippines - the analytical framework. In: Fabella, R., Faustino, J., Leftwich, A. &

Parker, A. (Eds.) Room For Maneuver: Social Sector Policy Reform in the Philippines.

Makati City, Philippines, The Asia Foundation. pp. 17–27.

Available from: http://asiafoundation.org/resources/pdfs/RoomforManeuverBook.pdf

In this chapter of a book that we will return to in a later unit, Adrian Leftwich provides a

critique of political economy analysis. In relation to this module, the critique can be taken in

one of two ways: (1) the limits of political economy analysis should be clarified and the

complementary insights of related disciplines (eg institutional analysis, political analysis) should

be explicitly recognised; (2) political economy analysis should not be too narrowly tied to

neoclassical economic logic (although this is undeniably important), as there are numerous

important questions that a narrow political economy approach cannot answer. The position

taken in this module is mainly (2), with a little bit of (1)! As you work through the module, see

how satisfactory you think this position is.

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World Bank (2008) The Political Economy of Policy Reform: Issues and Implications

for Policy Dialogue and Development Operations. Social Development Department,

Washington DC, The World Bank. Report No 44288-GLB.

Available from:

http://siteresources.worldbank.org/EXTSOCIALDEV/Resources/The_Political_Economy

_of_Policy_Reform_Issues_and_Implications_for_Policy_Dialogue_and_Development_

Operations.pdf

Examines World Bank experience in promoting policy reform in agriculture and the water and

sanitation sectors of developing countries from a political economy perspective. Reform is fairly

narrowly conceived as pro-market action, but the insights as to who might support or propose

reform and why, and how the reform process can be structured so as to gain support and reduce

opposition, are useful.

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REFERENCES

Acemoglu, D. & Robinson, J. (2013) Why Nations Fail: The Origins of Power,

Prosperity and Poverty. London, Profile Books.

Anderson, K. (2010) Political economy of distortions to agricultural incentives:

introduction and summary. In: Anderson, K. (Ed.) Political Economy of Distortions to

Agricultural Incentives. Washington DC, The World Bank.

Bardhan, P. (1996) Decentralised development. Indian Economic Review, XXXI (2),

139–156.

Bates, R. (1989) Beyond the Miracle of the Market: The Political Economy of Agrarian

Development in Kenya. Cambridge, Cambridge University Press.

Bates, R. (1995) Social dilemmas and rational individuals. In: Harriss, J., Hunter, J.,

& Lewis, C. (Eds.) The New Institutional Economics and Third World Development .

London, Routledge. pp. 27–48.

Binswanger, H. & McIntire, J. (1987) Behavioural and material determinants of

production relations in land-abundant tropical agriculture. Economic Development and

Cultural Change, 36 (1), 75–99.

Coase, R. (1960) The problem of social cost. Journal of Law and Economics, 3

(October), 1–44.

Collinson, S. (Ed.) (2003) Power, Livelihoods and Conflict: Case Studies in Political

Economy Analysis for Humanitarian Action. London, Overseas Development Institute

(ODI). Humanitarian Policy Group Report No 13.

Available from: http://www.odi.org.uk/resources/download/241.pdf

[Accessed 22 January 2015]

DFID. (2009) Political Economy Analysis: How to Note. London, Department for

International Development (DFID), DFID Practice Paper July 2009.

Drazen, A. (2008) Is there a different political economy for developing countries?

Issues, perspectives and methodology. Journal of African Economies, 17 (AERC

Supplement 1), 18–71.

Grossman, G. & Helpman, E. (1995) Trade wars and trade talks. Journal of Political

Economy, 103 (4), 675–708.

Khan, M. (1995) State failure in weak states: a critique of new institutionalist

explanations. In: Harriss, J., Hunter, J. & Lewis, C. (Eds.) The New Institutional

Economics and Third World Development. London, Routledge. pp. 71–86.

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Khan, M. (2000a) Rents, efficiency and growth. In: Khan, M. & Jomo, K. (Eds.) Rents,

Rent-Seeking and Economic Development: Theory and Evidence in Asia. Cambridge,

Cambridge University Press. pp. 21–69.

Khan, M. (2000b) Rent-seeking as process. In: Khan, M. & Jomo, K. (Eds.) Rents,

Rent-Seeking and Economic Development: Theory and Evidence in Asia. Cambridge,

Cambridge University Press. pp. 70–144.

Khan, M. (2005) Markets, states and democracy: patron-client networks and the case

for democracy in developing countries. Democratization, 15 (5), 704–724.

Krueger, A., Schiff, M. & Valdes, A. (1988) Agricultural incentives in developing

countries – measuring the effect of sectoral and economy-wide policies. World Bank

Economic Review, 2 (3), 255–272.

Kydd, J. (2009) A new institutional economic analysis of the state and agriculture in

Sub-Saharan Africa. In: Kirsten, J., Dorward, A., Poulton, C. & Vink, N. (Eds.)

Institutional Economics Perspectives on African Agricultural Development. Washington

DC, International Food Policy Research Institute (IFPRI). pp. 429–460.

North, D. (1990) Institutions, Institutional Change and Economic Performance.

Cambridge, Cambridge University Press.

Rausser, G. & Roland, G. (2009) Special Interests versus the Public Interest in Policy

Determination. Washington DC, The World Bank. Agricultural Distortions Working

Paper No 78.

Available from: http://go.worldbank.org/3QR2ZQFN20 [Accessed 22 January 2015]

Simon, H. (1957) A behavioral model of rational choice. In: Models of Man, Social and

Rational: Mathematical Essays on Rational Human Behavior in a Social Setting. New

York, Wiley.

van de Walle N (2001) African Economies and the Politics of Permanent Crisis, 1979–

1999. Cambridge University Press, New York.

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1.0 STATE ROLES AND STATE ‘FAILURE’

Section Overview

Most students of development or environmental management would agree that, in

some way or other, the performance of the state is critical to observed outcomes.

Whilst economic theory often portrays the role of the state as being to correct for

market failure, technocrats are frequently frustrated by what they see as state

failure, ie the failure of governments to design or implement policies that would

promote growth, welfare, poverty reduction or the sustainable management of

natural resources. In this section we review what neoclassical and new institutional

economics tend to see as the role of the state, then explore a number of

explanations of state failure. We finish by categorising state activities in a way that

will facilitate later political economy analysis.

Section Learning Outcome

By the end of this section, students should be able to:

compare alternative explanations as to why states often do not perform the

roles that economists and other policy analysts would like them to.

1.1 State failures and market failures

Whether you work in the private sector, for a non-governmental organisation (NGO)

or within a state (or other public) agency, it would be surprising if you do not have

stories about the poor performance of some state agency or other. Your stories may

not emanate exclusively from your experience as a professional; you may have

stories to tell in your ‘private’ capacity as a citizen and taxpayer. All this is likely to

be true whether you live in a so-called developed or in a developing country.

Reflect briefly on your most poignant stories of state ‘failure’. What did

the state or its agency fail to do? What were your expectations as to what it should do?

Perhaps the failure in question relates to choice or design of policy that was

inappropriate or downright damaging. Were key stakeholders excluded from

deliberations over, or decision-making on, policy design? Perhaps it relates to failure

to implement a policy in the way that was intended – or indeed at all! You may have

been frustrated or angered by unfair, unresponsive or inefficient delivery of a

particular public service. Worse, you may believe that the root cause of the poor

service delivery was some kind of corruption within the delivery agency.

These possibilities highlight the fact that states, which are complex ‘organisations’

composed of multiple agencies that are rarely perfectly co-ordinated, both design

policies that affect other actors and directly deliver (or fail to deliver) many services.

However, basic economic theory tends to abstract from these realities, treating the

state as something of a ‘black box’, albeit one with a critical role: to correct for

failures in the functioning of markets.

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Neoclassical economics

The main focus of basic neoclassical economics is the functioning of the market

economy. When information and capital are readily available, markets are contested

by multiple players and factors of production move readily from one area to another

as opportunities appear and disappear. The well-being of all players in the economy

is apparently well served by the free operation of markets.

However, basic neoclassical economics recognises a number of (pervasive) conditions

under which markets fail to deliver optimal outcomes. These include:

markets are monopolistic, rather than competitive, due to economies of scale

in production or other barriers to entry (or exit)

goods or services have public, common pool or toll good characteristics, rather

than being the type of rivalrous and excludable private goods that commercial

firms are attracted to produce

the activities of one firm affect those of other firms in a positive or negative

way, such that some goods or services are over-produced and others under-

produced by firms that respond purely to private profit motives. This is the

case in the hypothetical example of the train line and farmers discussed by

Bates (1989).

Where markets ‘fail’, it is hoped that the state can devise policies to correct for the

failure – for example, removing barriers to market entry, regulating the activities of

monopolies so that they perform more like competitive markets or establishing clear

property rights.

New institutional economics

For new institutional economics, the basic point of departure from neoclassical

economics is recognition that information is costly to acquire and, therefore, in

practice, nearly always imperfect. Economic actors may struggle to acquire adequate

information about markets that they wish to participate in, for example, regarding

the prices prevailing in those markets. However, even more fundamentally, they

often lack reliable information regarding the motives of other actors within those

markets, making them vulnerable to various forms of opportunistic behaviour. Sellers

may lie about the true quality of a good that they are selling. Workers may shirk

their responsibilities if the employer is not monitoring their performance closely.

Recognition of the costliness of information leads new institutional economics to

focus heavily on contractual arrangements between economic actors: the processes

of search, screening and negotiation that they go through before doing business with

each other, and the monitoring and enforcement processes that accompany business

transactions.

Costly (imperfect) information may be sufficient to prevent a particular market from

developing. Binswanger and McIntire (1987) showed clearly how, in rural areas

characterised by low population density and reliance on seasonal rainfall for

agricultural production, the costliness of information prevents markets for crop

insurance from developing. In turn, the lack of crop insurance contributes to the

failure of seasonal credit markets (ie credit is not available to most farmers, unless

the state somehow subsidises this), as servicing large numbers of small loans under

conditions of high risk and uncertainty can be prohibitively costly.

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Additional sources of market failure suggest additional reasons for states to intervene

in support of market development and functioning. However, recognition of the

costliness of information also suggests an important caveat. If markets fail due to

imperfect information, the state may only be able to assist in overcoming the failure

if it is better informed than the various private market participants, ie if it can access

the necessary information at a lower cost than they can.

Negotiating and enforcing contracts becomes particularly costly if the rights of

contracting parties to own, use or benefit from certain assets are not clearly

established and protected by law. Without recourse to efficient (ie fair and low cost)

legal mechanisms, only the powerful can enforce contracts – through recourse to

economic or social sanctions or perhaps the hiring of private thugs or militias. New

institutional economics writings thus also tend to promote the view that two of the

primary tasks of government are to protect property rights and to guarantee the rule

of law. However, as will be argued below, the allocation of property rights is

fundamentally a political issue.

1.2 Sources of state failure

Basic neoclassical and new institutional economics may differ in their emphases

regarding the priorities for state intervention to support market development and

functioning. However, at least as explained so far, they share one basic premise:

that the desirable role for the state is defined by what the market cannot do well.

Analysis of market failures thus leads to ‘normative’ prescriptions as to what the

state should do to correct for these. It is at this point that technocrats can start to

become disillusioned – when the state does not follow their recommendations!

There can be various reasons for why states do not follow the best recommendations

of independent policy analysts or researchers. (Let’s assume for now that, if perfectly

implemented, these recommendations would maximise economic growth, poverty

reduction, welfare or some other public/national objective.) These reasons include

the following.

Limited information

We have already noted that states need high-quality information if they are to

pursue policies that effectively correct for market failures. Sometimes states pass

legislation requiring that private actors supply regulators with information. However,

in general, private market participants are better informed about their own

intentions, activities, costs and profits than state agencies are and, moreover, often

have reasons for wishing to withhold much of this information from the state. This

inclination is likely to be compounded in contexts where there is an historic lack of

trust between state and private sector. Sometimes, independent policy analysts and

researchers can be better informed about the circumstances of the private sector

than the government is.

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Weak policy-making capacity

Whilst independent policy analysts, researchers or aid donors might generate policy

recommendations that they would like a government to follow, actual policy might be

devised by civil servants within the relevant ministries. For various reasons, including

the fact that salaries are too low to attract the best brains, in-house policy analysts

may be less skilled or less well equipped with software or data than independent

analysts and may, therefore, design ‘sub-optimal’ policies. At the same time, the

policy process might not allow external agents to make an effective contribution to

policy formulation. For now, to keep it simple and focused on the technical capacity

issue, let’s assume that the in-house analysts are reluctant to engage with external

agents, so as to refine their policy proposals, as this risks opening themselves up to

criticism.

It should be clear that this is a deliberately stylised and somewhat naïve explanation

of poor policy. However, there may at times be an element of truth in it. Whilst

international financial institutions soon abandoned most efforts to reform African

state agencies during the structural adjustment era, preferring instead to ‘get the

state out’ and let the market take over, they did continue to invest in the technical

(policy analysis) capacity of the ministries of finance or other central agencies

responsible for delivering macroeconomic stability within several low-income

countries. This was recognition that the technical capacity of these agencies was an

important constraint to better policy. Meanwhile, radical economic reforms in some

Latin American countries, including Chile (to take a controversial example), were led

by US-trained economists who returned to take up positions within their national

governments or civil services.

Poor public sector management

State agencies may be hampered by lack of information or skilled personnel.

However, they may also fail to get the most out of what they have. One of the

reasons why market enthusiasts like competitive markets so much is that the profit

motive – and, conversely, the risk of bankruptcy – provides strong incentives for

individual participants to work hard and to innovate in response to opportunities and

threats. By contrast, performance incentives within state agencies can be very weak.

The agencies themselves are often monopolies in their area – insulated both from

competition and from the voices of stakeholders whom they are meant to serve – as

well as enjoying an information asymmetry advantage over their political masters

who are meant to oversee their performance. Meanwhile, the pay and promotion

prospects of individual staff may be related more to whom they know than to how

they have performed. Van de Walle (2001) argues that the capacity of most African

civil services was undermined in the two–three decades after independence by the

politicisation of both hiring and staff rewards, even as the number of trained civil

servants increased dramatically.

Poor public sector management can affect policy design, but it is even more likely to

affect policy implementation. It can also be associated with corruption. Staff who do

not perceive that their career depends fundamentally on high performance of their

duties (as viewed by clients or other stakeholders), but rather who believe that they

will retain their post as long as they retain the support of a particular political patron,

are more likely to engage in corruption than those who see that their conduct is

closely monitored and assessed by their superiors.

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The private interest state

Basic neoclassical and new institutional economics both assume that there is a ‘public

interest’ that can be reasonably clearly defined and that policy should seek to

promote. As noted above, this public interest is often linked to the correction of

market failures in pursuit of economic growth or general welfare. In recent years,

international goals and many national policy statements have specified poverty

reduction as the overarching objective of official state policy.

There are at least three major critiques of this naïve, public interest view of the

state:

It is hard, if not impossible, to define a single ‘public interest ’ in a complex

world of multiple actors, interests and imperfect markets. What is good for one

group may be less good or even disadvantageous for another. Decisions have

to be taken about competing interests and claims on scarce resources. Note

that equity considerations do not appear explicitly in basic neoclassical

economic models: as long as no one can be made better off without

simultaneously making someone else worse off, an equilibrium is considered

‘Pareto optimal’, ie efficient. Distribution of starting assets is taken as given

and actors stoically accept whatever final distribution of incomes the interplay

of market forces generates. In reality, equity and distributional considerations

are fundamental to politics and to what states do.

Whilst economic theory assumes that private market actors are self-seeking

individuals, it assumes that public servants exist to work for the public interest.

As Elinor Ostrom has joked, ‘Are civil servants supposed to be selected from a

different gene pool to the rest of society?’

The state is not a single entity, but is comprised of multiple agencies that are

at best imperfectly coordinated (in part due to imperfect information). These

agencies may pursue objectives that are, in detail if not in overarching

objectives, at odds with each other.

These criticisms give rise to the notion of the private interest state. Particular

individuals and groups seek to capture power or to influence the decisions of those in

power so as to generate benefit streams for themselves and fellow group members –

not necessarily for the whole of society. Some of the decisions taken by those in

power, influencing the allocation of resources in this way, are perfectly legal; others

are not and may be considered under the general heading - ‘Corruption’.

The four sources of state failure just outlined are not an exhaustive list. You may be

able to think of others. However, they point towards different solutions –

(technocratic) capacity building, managerial and political reforms. The notion of the

private interest state points us most clearly towards the political economy literature

that will be the main focus of this module.

1.3 North (1990) on state failure

We noted above that new institutional economics writings, in a similar way to the

work of neoclassical economists, often lead to prescript ions as to what the state

should do to overcome market failures. In his 1990 book, Institutions, Institutional

Change and Economic Performance, Nobel Prize winning new institutional economic

historian Douglass North argued that the key to economic development is to reduce

the transaction costs associated with increasingly complex and long-distance trade,

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so as to gain the wealth-creation benefits that flow from specialisation and

economies of scale in production. Establishing clear property rights is part of this

story, but so too is the design of institutions that facilitate the acquisition of

information and the efficient enforcement of contracts. Some of these institutions are

privately established, but many – especially those for the enforcement of contracts –

rely at least in part on state legislation and/or action.

North observed that some societies have been remarkably successful in pursuing this

transaction cost reduction agenda and, as a result, have secured high average

incomes. However, others have not, leaving many of their members trapped in

poverty.

The big question, therefore, is why some societies have been more successful than

others. North’s answer focused on political elites, as these are the people who

ultimately determine national policy. North argued that elites tend to set policies that

serve their own interests first and foremost. If these policies also benefit poorer and

less powerful groups, well and good; if not, tough – as long as those groups do not

threaten to revolt as a result. North also observed that, historically, some elite

groups have seen their interests as being advanced by the expansion of trade. This

could be because they themselves have invested in trading enterprises or because

they realise that tax revenues are maximised when trade expands. By contrast, other

elite groups have made their wealth by taxing productive activity in such a way that

the growth of such activity has been discouraged. The elite have accumulated

wealth, but total economic activity has remained insufficient to raise the majority of

the population out of poverty.

How satisfying do you find this explanation? What questions does it

leave unanswered? Answer

North’s explanation recognises that elites are self-seeking and, therefore,

that states do not pursue a simple vision of the public interest. It illustrates in very general terms how the private interests of elites can coincide with

those of poorer members of their societies, but also how the two can clash. On the other hand, the existence of elites is taken as given: there is no

theory as to how they come to power in the first place or what they have to

do to retain power, other than to avoid provoking revolution. It is thus at best a partial explanation of state success/failure.

Bates (1995) applauded North’s work, but argued that new institutional economics

analysis alone will rarely be enough to explain the origins of institutions. He argued

that, whilst market failures require responses, there are often multiple possible

responses to a given failure. For example, there would be chaos on the roads if

drivers were not required to drive on a particular side. However, the problem can

equally be solved by requiring them all to drive on the right or on the left. Which of

these solutions is chosen is not a matter of economics, but of politics. This is directly

analogous to Bates’ (1989) discussion of the Coase theorem and the allocation of

property rights. Politics is fundamental to observed policy outcomes.

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1.4 State activities

Before we examine political economy as a discipline that can shed light on why states

function as they do, it is worth thinking a little more about what states do. So far we

have touched on both the design and implementation of policy (including service

delivery) and noted a number of objectives that policy might seek to pursue.

Fundamentally, state policies may be thought of as pursuing one (or both) of the

following broad objectives.

Provision of public goods

Basic economic theory highlights the correction of market failure as the most

important role of government. Depending on the nature of the market failure,

policies to correct for it could take the form of:

regulation of private market activity, for example, to correct for monopoly

power or externalities

provision of public goods or services, either directly or by contracting

commercial or NGO suppliers. Examples of such goods and services include:

health and education services; roads, telecommunications and other

infrastructure; agricultural research, extension and irrigation investment

the establishment of institutions to facilitate information exchange, assist

contract enforcement and protect property rights.

Whilst we specifically labelled the second of these policies as ‘Provision of public

goods or services’, in fact all of these functions of the state can be thought of as the

provision of public goods in a broader sense, as regulation and institutions that

support market transactions are themselves public goods.

Political economy analysis of developed economies tends to focus more on

redistribution – our second category below – than on the provision of public goods

and services. This may be because policies for redistribution are easier to model than

the provision of public goods or because political economy theories based on interest

groups generate particularly clear hypotheses regarding policies for redistribution. It

is also, in part, because so much public expenditure in developed economies with

large welfare states is redistributive in nature.

On the other hand, at the early stages of development, and hence income, effective

demand for commercial services tends to be low. Thus, public provision of basic

goods and services assumes a greater importance than it does later on. Public

investment, for example, in roads and telecommunications infrastructure, may also

have leverage in private investment, for example, in transport services or

agricultural marketing services. Efficient regulation and institutions to support private

market activity are also important.

There is, however, a paradox: effective state interventions are arguably the most

critical to development efforts at precisely those early stages of development when

state capacity to deliver them might be expected to be lowest (Kydd, 2009).

Smallholder agricultural growth, seen by the course authors as critical to the early

stages of economic development in many countries, is heavily dependent on the

development of effective (public and private) support services. Unlike commercial

farms, with their larger capital bases and larger volumes, individual smallholder

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farmers cannot intensify production without effective services delivered close to their

farm gate. We thus pay particular attention to the political economy conditions that

have supported or discouraged investment in public goods in support of smallholder

agricultural growth.

Redistribution of assets or incomes

Redistribution of assets may be achieved by the reassignment of property rights, for

example, to land, from one individual or group to another. Redistribution of incomes

may be achieved through taxation or subsidy. Trade policy instruments can achieve

similar ends, with tariff protection giving similar support to subsidies for producers of

selected goods. It is relatively easy to identify the immediate beneficiaries of such

policies, which is attractive to political economists who wish to model the

determinants of policy intervention.

In 1988 an influential World Bank study by Krueger et al (1988) assessed the extent

to which macroeconomic and sectoral policies in 18 developing countries subsidised

or taxed agricultural activities. It found that poorer countries tended to tax their

agricultural sectors more heavily than less poor countries, through both direct

taxation (including export taxes) and indirect means (principally overvalued

exchange rates and tariff support for import-substituting industries). This was

despite the fact that agricultural growth was very important to the development

prospects of the poorest countries. Meanwhile, rich countries tend to provide the

greatest subsidies to their farmers, despite the fact that their farmers represent only

a small proportion of national economic activity. Recently, a second major World

Bank project – the Distortions to Agricultural Incentives project – has revisited the

questions first researched by Krueger et al 20 years previously. Whilst general levels

of taxation of agricultural activities in developing countries have fallen, it still remains

true that poorer countries tax their agricultural sectors more heavily than less poor

countries. Some Asian countries are now beginning to subsidise their agricultural

sectors, rather as many OECD countries do, as national incomes rise (Anderson,

2010).

So far we have talked about the establishment and (re)distribution of property rights

as if they were two different things, with the former having more of a public good

and market development function and the latter being redistributive. However, in

reality, the establishment and distribution of property rights often occur

simultaneously, which makes for interesting political economy analysis.

Bates (1989) neatly illustrates the importance of the distribution of property rights

for both the nature and the speed of economic growth. He takes as his point of

departure the classic case of the railway and the trackside farmers discussed by

Coase (1960). There is an externality, in that sparks from the (steam) railway may

cause the farmers’ crops or trees to catch fire. Should the railway compensate the

farmers for their loss or does the presence of the crops so close to the line constrain

the railway’s freedom to run trains? Which way compensation should flow depends

on the assignment of property rights. Bates (1989) argues that, in a poor agrarian

economy, a general practice of assigning property rights in favour of ‘capital’ is likely

to result in an inegalitarian development path characterised by the production of

luxury goods and services, which employs relatively few people. By contrast, the

assignment of property rights in favour of smallholder farmers will tend to favour a

much more egalitarian development path, as millions of poor households accumulate

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modest amounts – enough in turn to stimulate large amounts of business for semi-

skilled artisans and labour-intensive manufacturing enterprises.

A note on local public goods

The discussion so far has implicitly assumed that most policy-making occurs at a

national level. However, most nations have multiple tiers of government. In large

countries such as China, India or the US, the only way for government to be at all

effective is if there is a significant devolution of policy-making responsibility to state,

provincial or district governments. Meanwhile, smaller countries exhibit considerable

variation in the extent to which central government has devolved responsibility for

policy-making and implementation to local government. Such differences may reflect

differences in ethnic diversity, history or simply where an influential President has

come from and whether (s)he perceives the best means of increasing the resource

flows to his/her region as being through centralised decisions or the granting of a

larger share of national budgets to local government.

In this light, Rausser and Roland (2009) argue that the 2-fold distinction between

public good provision and redistributive policies just presented is inadequate and that

a further distinction should be made between national and local public goods. Local

public goods benefit all the people in a particular area, but, as the name suggests,

that area is quite small – perhaps a district, small town or even just a village.

Examples might be a local health post, well or village school or a tarmac road that

links a particular district to a regional market centre. Rausser and Roland (2009)

argue that, from a political economy perspective, provision of local public goods has

more in common with redistributive policies than with the provision of national public

goods.

Can you see why this might be?

Answer

Local public goods may actually favour particular groups over others (eg a

school or road built to serve village A, rather than village B). Rausser and

Roland (2009) thus argue that their allocation is subject to the same sorts of lobbying and rent-seeking activities as national redistributive policies,

albeit on a smaller scale. Some support for this view comes from the literature on decentralisation. For example, Bardhan (1996) argues that local

elites often ‘capture’ decentralised policy-making processes, as poor groups

are rarely organised at local level. However, at times, poor groups are able to lobby effectively if they concentrate all their scarce resources on one

national campaign. If so, policy outcomes may be more egalitarian under centralised, rather than decentralised, decision-making.

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Section 1 Self Assessment Questions

uestion 1

True or false?

Evidence of market failure is a necessary and sufficient condition for state

intervention.

uestion 2

Which of the following explanations for state failure is most closely associated with

political economy analysis?

(a) imperfect information

(b) poor public sector management

(c) private interest state

(d) weak policy-making capacity

Q

Q

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2.0 INTRODUCING POLITICAL ECONOMY

Section Overview

Political economy analysis helps us to understand why states, in particular, perform

as they do. It explores the interaction of political and economic processes within a

society, examining how policy-makers acquire power and the implications that this

has for subsequent policy-making. In turn, economic outcomes affect the relative

wealth of different groups, with implications for the distribution of political power and

the direction of policy in the future. This section introduces political economy analysis

and what it sets out to do. It then presents a generic political economy model that

can help us to identify the key drivers of observed policy outcomes in a wide range of

social, political and economic settings.

Section Learning Outcomes

By the end of this section, students should be able to:

explain the basic objectives of political economy analysis and the distinction

between macro-, sector- and problem-level analysis

describe the main building blocks of a basic political economy model and

explain the importance of each.

2.1 Defining characteristics of political economy analysis

According to Collinson (2003):

‘Political economy analysis is concerned with the interaction of political

and economic processes within a society: the distribution of power and

wealth between different groups and individuals, and the processes that

create, sustain and transform these relationships over time. ’

Source: Collinson (2003) p. 3.

As the name suggests, political economy is concerned with how political forces

influence the economy and economic outcomes. However, the interactions run both

ways and political economy is interested in both. Thus, it is economic activity that

generates the resources that are required to sustain political activity, for example,

election campaign expenses. Moreover, whilst policy might lead to a certain

economic activity prospering, this success in itself can generate a political

constituency with an interest in maintaining the economic activity, because a sizeable

number of people now benefit from it.

As was noted above, the distribution of benefits from economic activity tends to be a

neglected aspect of much pure economic analysis. However, within political economy

analysis it takes centre stage. Political economists are very interested in who gains

and who loses from a particular policy. This is likely to provide important clues as to

which groups or individuals support the continuation of the policy, as well as to which

groups might be drawn into a coalition seeking to change it.

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Using economic tools to examine political phenomena

Another characteristic of political economy analysis is that it uses economic tools to

examine political phenomena. As in economics, a characteristic of political economy

analysis is the assumption that individual (political) agents are both self-seeking

and rational. Economics examines how rational individuals use the resources at their

disposal (capital, labour, land etc) to maximise some utility function (for example,

maximising profits, income or consumption) by producing goods and services and

participating in markets. In a similar vein, political economy examines how such

individuals maximise their utility by participating in political activity. Again they have

capital and labour (time) at their disposal and they can use these to influence

political processes so as to generate policy outcomes that benefit them.

DFID (2009) thus sees political behaviour as being shaped by:

Interests: those with the ability to influence policy do so in such a way as to

further their own economic and/or political interests. Those outside of

government may be particularly concerned with economic outcomes. Those

inside government might have their own private economic interests, as earlier

discussions highlighted. However, they also have political interests, most

obviously to retain their positions of power.

Ideas: ideology remains an important driver of policy, alongside direct

economic or political interests. Where individuals are constrained by bounded

rationality, such that they cannot reliably assess all the possible outcomes

from all the different (policy or voting) choices open to them, ideology gives

them a (more or less accurate) guide as to what they should do in order to

remain consistent with their basic beliefs and values in life. Incorporating ideas

or ideology into political economy models also allows for the fact that some

political action is motivated by factors other than pure self-interest. Some

people do genuinely enter politics because they want to make the world a

better place, although whether that remains their guiding motivation

throughout their political career is another question!

Institutions: as explained by North (1990), institutions are the formal or

informal ‘rules of the game’ that structure human behaviour. Generally, there

are formal political rules, including a constitution, that define matters such as

how leaders are chosen and how a new policy can be introduced. In practice,

informal norms and ways of doing things might be as influential in shaping

actual outcomes. All these rules help to structure the incentives facing political

actors.

Levels and choices

DFID (2009) describe tools of political economy analysis that are relevant to three

levels:

Macro-level or country analysis: at this level one can understand how the

big decisions, for example, with respect to the selection of political leaders or

the allocation of budgets, are made. One would expect the most powerful

interest groups – whether they be industrial, ethnic or otherwise – to be visible

at this level. Macro analysis might also consider how the highest level political

institutions function: what are the rules of the game facing top political

players? One might also expect a country’s history to shape prevailing

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ideologies and ideas about how things should work and why.

Sector-level analysis: this examines in more depth the forces shaping policy

formation and decision-making at the level of an individual sector or industry.

The more important and prominent the sector is within the national economy,

the greater one would expect the influence of national level forces to be over

decision-making within the sector. However, the possibilities facing all sectors

are to some extent constrained by the broader macro context, including

budget, macro-economic policy etc. Meanwhile, one would expect actors who

do not feature in high-level political debates and events nevertheless to exert

influence over outcomes in their particular sector. At this level, sectoral and

local rules will also be critical to outcomes and hence fiercely contested by the

relevant players.

Problem-driven analysis: this is a highly practical approach that starts from

a particular problem that needs solving and proceeds to examine all the forces

(actors and interests, ideas, institutions) that have a bearing on it. According

to DFID (2009), the World Bank developed this approach to understand

situations where policy reforms that were desirable from a growth or poverty

reduction perspective seemed to be continually blocked.

In the author’s experience, many agencies are now becoming interested in the latter

type of analysis. However, this interest may be driven by the hope that political

economy analysis can provide a ‘magic bullet ’ to overcome obstacles that have

frustrated technical development efforts. In fact, macro-level analysis may serve to

reveal just how deeply embedded those obstacles are, such that some ‘desirable’

interventions are simply not politically feasible under existing political conditions.

Consistent with DFID (2009), a better way to think of these three levels of analysis is

as a ‘nested’ set. Moving to a lower level of analysis permits examination of an issue

(for example, a particular policy) in more detail, enabling a clearer focus on what

might be done by whom to bring change. However, at lower levels of analysis, one

also has to accept that certain institutions, norms and preferences are given or

‘exogenous’, ie beyond the control of actors operating at that particular level. In

other words, political economy dynamics at higher levels constrain the options

realistically open to players operating at lower levels.

There are, of course, feedback mechanisms ‘up’ the system. Thus, spectacular

growth of a particular agricultural commodity system may eventually alter the

political economy dynamics of the whole of the agricultural sector, including

allocation of budget and which groups and interests seek to gain control over the

major institutions influencing the sector as a whole. However, this takes time.

Indeed, one may differentiate the three levels according to the timescales over which

change is typically expected:

Macro-level: change here can be gradual or dramatic (think of revolutions!).

Either way, though, major changes may take decades to occur. Acemoglu and

Robinson (2013) analyse some changes that have unfolded over centuries.

Sector-level: some changes can occur quite rapidly, but major features of the

sectoral landscape can still remain constant for decades, reinforced by the

interest groups that emerge to defend and support them (Bates, 1989).

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Problem-level: this level of analysis is framed in terms of needs and

opportunities for immediate action, ie the problem that is to be solved.

However, whilst analysis can generate recommendations for immediate actions

to be taken by particular actors, it is worth reiterating the caution above that

some problems have deep roots (in the sector- or macro-level political

economy) and so are not as amenable to change as might at first be hoped.

By way of illustration, 2.1.1 suggests generic questions that a sector-level political

economy analysis might investigate. Note that these questions reflect the particular

interests of an aid donor in a given sector.

2.1.1 Sample questions for conducting sector-level political economy analysis

‘Roles and responsibilities: Who are the key stakeholders in the sector? What are the

formal/informal roles and mandates of different players? What is the balance between

central/local authorities in provision of services?

Ownership structure and financing: what is the balance between public and private

ownership? How is the sector financed (eg public-private partnerships, user fees, taxes,

donor support)?

Power relations: to what extent is power vested in the hands of specific

individuals/groups? How do different interest groups outside government (eg private

sector, NGOs, consumer groups, the media) seek to influence policy?

Historical legacies: what is the past history of the sector, including previous reform

initiatives? How does this influence current stakeholder perceptions?

Corruption and rent-seeking: Is there significant corruption and rent-seeking in the

sector? Where is this most prevalent (eg at point of delivery, procurement, allocation of

jobs)? Who benefits most from this? How is patronage being used?

Service delivery: who are the primary beneficiaries of service delivery? Are particular

social, regional or ethnic groups included/excluded? Are subsidies provided and which

groups benefit most from these?

Ideologies and values: what are the dominant ideologies and values which shape views

around the sector? To what extent may these serve to constrain change?

Decision-making: How are decisions made within the sector? Who is party to these

decision-making processes?

Implementation issues: Once made, are decisions implemented? Where are the key

bottlenecks in the system? Is failure to implement due to lack of capacity or other

political economy reasons?

Potential for reform: Who are likely to be the ‘winners’ and ‘losers’ from particular

reforms? Are there any key reform champions within the sector? Who is likely to resist

reforms and why? Are there ‘second-best’ reforms which might overcome this

opposition?’

Source: DFID (2009) p. 12, itself drawing on work by ODI and World Bank.

In a similar way, we can think of basic types of decisions or sets of choices that

macro-level political economy analysis investigates. The two basic types of decisions,

both of which will be explored in this module, are:

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How are political leaders chosen and held accountable? In democratic systems,

this relates to the rules and practice of electoral politics.

Which policies are selected and why? Formal and informal rules shape this

process. However, the outcomes – the actual policies that are selected – are

influenced heavily by the interests of the various actors involved and, driven by

this, by their engagement in the policy process.

The two sets of choices – selection of leaders and policies – are linked,

albeit imperfectly. Can you explain what the linkage is and why it is imperfect?

Answer

Irrespective of who selects them, leaders are selected at least in part on the

basis of the policies that they are expected to pursue if they are given

power. However, there are a number of possible reasons why the selection of leaders does not fully determine the selection of policies that are

subsequently pursued. These include the fact that those who select the leaders only have imperfect information regarding the policy decisions that

those leaders take once they are in power. Hence, leaders are only partially accountable for their policy decisions. Those who select leaders care more

about some policies than others. Thus, leaders’ decisions on key policies

might be scrutinised carefully, whereas they might enjoy considerable freedom to set policies in other areas – and in these areas be open to the

influence of interest groups who were not critical to their original selection as leaders. In addition, circumstances can change during a term of office

and/or new information can come to light, such that leaders change their

view on the appropriate policy to be followed.

2.2 A generic political economy model

Drazen (2008) argues that all political economic systems can be analysed with

reference to the same basic political economy model. This is not meant in any way to

deny the distinctive historical, cultural or economic features that are undoubtedly

present in any given context. Rather, it argues that the way that these influence the

selection of leaders and policies can be analysed using the same ‘toolkit’ for all

countries.

Consistent with the material that we have presented above, Drazen’s model has

three main building blocks:

political actors

their interests or objectives

the political mechanisms and constraints (ie institutions) that are in place.

Political actors

Drazen (2008) distinguishes four groups of actors within a political economy system,

although, as you will note, two of these are sub-groups that are nested within a

third.

Policy-makers: exactly who makes policy varies from country to country.

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They may or may not have been elected and they may or may not have to get

their proposals approved by members of an elected legislature or parliament

(which gives the latter a role in shaping policy). Almost inevitably, actual policy

will also be shaped by those who are tasked with implementing it, which often

means members or agencies of the bureaucracy or civil service.

Citizenry: an initially unexpected feature of the model is that the citizens, as

citizens, do not exert any influence over decision-making. However, policy-

makers are assumed to take their preferences into account (to a greater or

lesser degree) when designing policy.

Selectorate: citizens only exert any direct influence over decision-making if

they are also part of the selectorate. This is arguably the key component of

Drazen’s model. The selectorate are ‘the group who actually selects leaders or

who control the instruments of power that enable a leader to remain in office ’

(Drazen, 2008: p. 24). Thus, in a pure democracy, this equates to the

electorate. However, in most real world democracies, some people are more

influential than others. Thus, certain individuals and groups – for example,

media barons and powerful business interests – exert particular influence over

the choice of leaders and policies, due to their ability to finance political

campaigns or to influence voting behaviour in other ways. At the other end of

the spectrum, in dictatorships, the selectorate is the powerful individuals and

groups (often quite small in number, but likely to include the heads of the

armed forces and security services) that keep the dictator in power or,

alternatively, have the capability of removing him if they are not sufficiently

rewarded by his rule.

Coalition: the selectorate are all those who can exert an influence over the

choice of leader or policy. However, in practice, the leader does not need the

support of all of these; just sufficient of them to keep him in power or to

approve a particular policy. This ‘sufficient’ subset Drazen calls the leader’s

coalition. In a democracy, the coalition is the electoral majority required to

vote the government or leader in, plus the interest groups or other financiers

required to fund the election campaign. In a dictatorship, the coalition and the

selectorate are likely to be quite similar; dictators have a habit of getting rid of

influential individuals who fall outside their trusted circle.

Consider a country with which you are familiar. Note down actors or

groups who you believe form the selectorate and the coalition within the country. How confident are you that you have produced fair lists, ie that

you really understand how leaders are able to attain and retain power in your chosen country? As you get the opportunity, discuss your lists with

friends or colleagues who also think about the politics of the country, with any experts that you know, and perhaps with fellow students.

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Political actors’ interests

Consistent with an economistic approach, actors’ interests and objectives can be

specified in terms of utility functions. According to Drazen, the utility functions of

political leaders are likely to include general societal welfare, ideological

preferences for particular outcomes and their own private interests. Their primary

private interest is generally assumed to be the acquisition and/or retention of

power, as this is the key to enjoying the ‘perks’ of office, whether these perks are

prestige, power for its own sake or the financial benefits that can flow from being in

office.

Political leaders are individual human beings, so the relative weightings that they

attach to societal welfare, ideological preferences and their own private interests will

vary from individual to individual. One would expect that a leader who attached

greater weight to the pursuit of societal welfare and less to their own private

interests would generate better policy outcomes for the majority of people in his/her

country. However, Grossman and Helpman (1995) present a model that generates

the alternative, counter-intuitive outcome, so this is a debatable point.

An important question, but one to which there may not be a ready answer, is: what

determines the relative weightings that political leaders attach to the various

components of their utility functions? Drazen rejects suggestions that policy

outcomes are poorer in low-income countries (causing them to remain poor) because

political leaders attach greater weight to their own private interests than do their

counterparts in developed economies. Instead he suggests that differences in policy

choices and outcomes should be sought in other components of the model, namely

the demands made on leaders by the selectorate and the quality of the rules

governing leaders’ actions.

Drazen recognises that this is a controversial position. What is your view

on this? Answer

At first glance the observation that many leaders in low-income countries are extremely rich, whilst the majority of their populations remain poor,

seems to challenge Drazen’s position. However, it is hard to make a case that human beings in one part of the world are systematically more selfish

than others. For example, most religious faiths would claim that the human

condition (ie sin) is universal. Moreover, one does not have to go too far back in history in, say, the UK, to reach times where a tiny aristocratic elite

lived in luxury whilst extracting heavy taxation from a mass of impoverished peasants. In the intervening period, the selectorate has become larger and

more inclusive, hence modifying the demands that they impose on leaders, and the rules governing the behaviour and accountability of leaders have

been dramatically tightened. These points tend to support Drazen’s position.

Many would argue that it is the effectiveness of the checks and balances on political leaders’ exercise of power that determines the quality of policy in

the medium-long term. In turn, however, it is the selectorate that has to insist on the imposition of these checks and balances in exchange for their

support.

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If it is the selectorate that is the key component of Drazen’s model, then it is the

interests and objectives of the selectorate that drive policy outcomes. This is because

political leaders have to keep enough of the selectorate happy in order to retain

power.

As with political leaders, Drazen conceives of a utility function for selectorate

members that is made up of multiple components. The two main components are:

Personal consumption of private and public goods, which is clearly influenced

by government taxes and transfers plus investment in public goods. Thus,

members of the selectorate should choose leaders whom they expect will

implement policies that benefit them.

The utility that comes from particular policy outcomes being realised (even if

these do not personally benefit them). This links back to our discussion of the

importance of ideology.

Of course, the selectorate is not homogeneous and nor is the coalition. Thus, a key

issue in political economy is how the preferences of diverse members are

aggregated to generate policy priorities and designs.

Finally, Drazen observes that there may be some competition between members of

the selectorate to be included in the coalition. This is because selectorate members

expect to be better off from being in the coalition than being excluded from it, in

which case their policy priorities are unlikely to be realised. (Note that this

competition is unlikely to be observed amongst individual voters, but it could be

where interest groups are concerned, where multiple parties have to form a coalition

government or in non-democracies.) Under such circumstances, the leader or top

leadership gains some bargaining power relative to coalition members and may not

have to give them as much (in terms of private benefits) as would have been the

case in the absence of such competition.

Political mechanisms and constraints

Following the line of argument that there are two basic types of political economy

decisions, there are two main sets of institutional mechanisms and constraints that

political economists need to study: those that set the ‘rules of the game’ for the

selection of leaders and those that structure the process by which policies are made.

With regard to the selection of leaders, the mechanisms include not just the formal

rules governing voting, but also the informal mechanisms that candidates use to

garner support, including promising policies that will benefit particular supporter

groups or political constituencies and (where they can get away with it) the direct

giving of gifts in exchange for votes. Constraints include the formal rules that govern

and control such behaviour. The effectiveness with which these rules are enforced

must, of course, also be considered!

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Section 2 Self Assessment Questions

uestion 3

True or false?

Identifying who wins and who loses from a particular policy is one of the central

concerns of economic analysis.

uestion 4

Fill in the missing word/phrase.

The two basic sets of choices that political economy analysis investigates concern the

selection of (1) political leaders and (2) _______.

uestion 5

In Drazen’s model, which of the following groups decides which leader acquires or

retains power?

(a) citizens

(b) selectorate

(c) coalition

Q

Q

Q

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3.0 RENTS

Section Overview

In this final section we introduce the concept of rents. Drazen (2008) assumes that

leaders seek support by promising to generate benefits for supporters once in power.

Benefit streams generated by state intervention of various forms are called rents.

Allocation of rents is thus a fundamental political activity, but rents can also be

allocated in ways that are either beneficial or highly damaging to economic growth

and development.

Section Learning Outcome

By the end of this section, students should be able to:

distinguish different types of rents and explain their potential contributions to

economic growth and development.

3.1 Different types of rents and their allocation

Khan (2000a) defines rents as the super-normal returns (in excess of opportunity

costs) that an individual or firm obtains from a particular activity as a result of a

particular policy intervention. Rents can arise from a favourable allocation of property

rights (for example, the provision of high quality land in an accessible or well-

serviced area, or the granting of a legal monopoly to supply a particular good or

service to a particular market) or from receipt of some form of public transfer or

subsidy.

Khan (2000a) distinguishes six types of rents:

1. Monopoly rents, which are generally considered bad things, but which may be

unavoidable in certain circumstances and which can be accompanied by

conditions that encourage welfare-enhancing behaviour.

2. Natural resource rents, which flow from the (property) right to harvest or

exploit a resource. Some assignment of property rights is generally considered

necessary to encourage sustainable or measured exploitation of a resource –

the alternative being ‘open access’.

3. Transfer rents, which are generally considered to contribute little to growth,

but carry a deadweight cost when funded out of taxation due to both the costs

of levying the taxes and their disincentive effect on the affected economic

activity. A possible, but controversial, exception is where transfer rents

facilitate what Marx called ‘primitive accumulation’ – the accumulation of

sufficient capital by privileged groups to permit investment in productive

activities characterised by high fixed costs or economies of scale.

4. Schumpeterian rents, which reward innovation (ex post). Patent protection is

the most obvious example here, the principal policy challenge being to provide

protection for long enough to encourage innovation, but no so long that

consumers are unduly penalised through higher prices.

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5. Learning rents, which are similar to Schumpeterian rents, except that they

are intended to encourage learning from global leaders and adaptation to local

conditions (rather than cutting edge innovation) and they are offered ex ante

(with appropriate conditionality) rather than ex post. Khan (2000a) argues that

wise administration of learning rents lay at the heart of the South Korean

industrialisation strategy in the 1960s–1980s, but that a highly disciplined state

is required if such rents are indeed to encourage learning. The alternative is

that recipients establish a cosy relationship with the relevant state agency, such

that they continue to receive rents without ever delivering the desired

outcomes for national industrial strategy.

6. Rents (rewards) for good management, flowing from its ability to

overcome asymmetric information problems related to labour motivation.

Khan (2000a) argues that smart development policy allocates rents in such a way

that they leverage desirable private sector activity, for example, innovation or

learning. In this way, growth can occur even in the midst of fairly high levels of

corruption and rent-seeking, as was the experience in parts of Asia in the second half

of the 20th century. On the other hand, where powerful interest groups (commercial

or political) secure rent flows without generating growth in return, the overall result

is economic stagnation and persistent poverty.

Try to relate Khan (2000a)’s conditions for the developmental use of

learning rents to Drazen (2008)’s model whereby political leaders offer rents to selectorate members in exchange for their support. Do you see

a tension here? Answer

In Drazen (2008)’s model, political leaders need the support of selectorate members and, therefore, offer them rents in exchange for their support.

Whilst Drazen recognises that competition among selectorate members to be

in the ‘coalition’ may strengthen the bargaining position of leaders, it is still the case that selectorate members have plenty of bargaining power when it

comes to key policies. By contrast, the developmental use of learning rents requires that the top political leadership and state bureaucracy enjoy some

autonomy, at least from major commercial interests, so as to be able to set and enforce rules for the receipt of learning rents through state (industrial)

policy. Does this imply that these major commercial interests are not a key

part of the selectorate after all? Alternatively, are industrial leaders compensated in a different way for their support for the regime, for example

through ideological satisfaction or through separate, private rewards?

Khan (2000b) differentiates countries that are characterised by centralised and

decentralised rent distribution dynamics. In the former, a strong (in the sense of

competent) state allied to a politically secure (in the short term, at least)

government decide who will receive rents and what conditions they must fulfil in

order to receive them. In the latter, the government needs the support of various

interest groups in order to maintain power, so has to bow to many of their policy

demands. In this case, the state exerts much less strategic control over rent

allocation, which reduces its ability to manipulate it for developmental ends.

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How can a government attain the position needed to exert centralised control over

rent allocation? Possibilities include:

Enjoying the strong support of the army, which may itself be compensated

handsomely for its loyalty.

Enjoying strong popular support, perhaps linked to its firm handling of

business. How long could this be sustained, however, especially if

dissatisfaction within the business community eventually led to reduced

investment and growth?

Consensus amongst a sufficient number of elite members (leading politicians,

businessmen etc) that the industrial and other policies being adopted are

necessary for national development at that point in time.

Finally, Khan (1995; 2005) also contrasts the pattern of rent distribution within

stylised high and low income countries. In the former, budgets are large and

institutional checks and balances on the exercise of power are strong. Therefore,

political activity tends to focus on influencing how government revenues are raised

and how expenditure is allocated. By contrast, in low income countries, state budgets

are too low to ensure the support of sufficient selectorate members through

legitimate policy measures alone. At the same time, because many assets have low

values (given generally low returns in a low income economy) and because legal

institutions are weak, the protection of property rights is weak. Governments,

therefore, commonly resort to the reallocation of property rights – for example,

through land allocations or privatisation of state-owned companies at low cost – as a

way of rewarding influential supporters. Such actions may be perfectly legal, but

some are of questionable legality or even illegal.

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Section 3 Self Assessment Question

uestion 6

Which of the following types of rents are inherently conditional on the recipients

exhibiting certain desired behaviours (even if the conditionality is at times applied

rather laxly)?

(a) monopoly rent

(b) natural resource rent

(c) transfer rent

(d) Schumpeterian rent

(e) learning rent

(f) rent for good management

Q

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UNIT SUMMARY

This unit began by reviewing how influential schools of economic thought see the role

of the state, and then explored reasons for so-called state failure. It introduced basic

elements of political economy analysis, which examines the interaction of political

and economic processes within a society and can shed some light on why states

actually act as they do (and why they formulate the policies that they do). Finally, it

introduced the concept of rents and showed how distribution of rents is both central

to political activity and critical to economic development outcomes.

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UNIT SELF ASSESSMENT QUESTIONS

uestion 1

Outline the link between property rights and rents, ac cording to writers such as

Bates or Khan.

uestion 2

Explain the importance of the identity and preferences of the selectorate within

Drazen’s model.

Q

Q

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KEY TERMS AND CONCEPTS

bounded rationality Originally attributed to Simon (1957), bounded rationality

recognises that there are limits to the ability of individuals to

take rational decisions and hence to behave in a fully rational

way, even if this is what they would like to do. Simon argued

that there are limits to the ability of individuals to process all

the information available to them, hence to work out the

consequences of all possible courses of action, so as to choose

the ones that maximise their utility. We also note that, despite

at times being deluged with information, individuals still rarely

possess perfect information.

legislature Branch of government with responsibility for passing legislation.

normative economics A branch of economics focusing on what ‘ought to’ happen. It

implies the use of subjective or value judgements. As opposed

to positive economics, which studies actual economic

phenomena and tries to describe and explain the reality.

rent-seeking Activities by individuals or firms that are designed to capture

economic rent through manipulation of the process of policy-

making or implementation. These are often contrasted with

‘productive’ activities that generate income through production

and trade. Note that even Khan (2000b), whose basic thesis is

that rent-seeking and growth can coincide when rents are

managed in such a way that they encourage productive

activities, treats rent-seeking activities by potential beneficiaries

as a deadweight cost.

rents The super-normal returns (in excess of opportunity costs) that

an individual or firm obtains from a particular activity as a result

of a particular policy intervention.

selectorate ‘… the group who actually selects leaders or who control the

instruments of power that enable a leader to remain in office’

(Drazen, 2008: p. 24).