Endogenous economic policy and the structure of production: theory and evidence

Soo, K T (2005) Endogenous economic policy and the structure of production: theory and evidence. Working Paper. The Department of Economics, Lancaster University.

Abstract

This paper develops and tests a model that predicts a positive relationship between absolute levels of capital stock and how favourable are policies toward capital. The theoretical model we use is a model of campaign contributions and electoral competition, extended to consider the implications for factor mobility and hence the structure of production. There are two main predictions. First, countries with more capital stock tend to implement more pro-capital policies. Second, in a two country model, the country that initially has more capital will be able to attract capital infows from the other country. Given additional assumptions on the production side, this yields the prediction that the more different are countries.policies, the more different will be the set of goods which they produce. These predictions of the model are confrmed using panel data on cross-state differences in policies and economic outcomes in India.