Working Paper: CEPR ID: DP8533
Authors: Madhav Aney; Maitreesh Ghatak; Massimo Morelli
Abstract: We study how inefficiencies of market failure may be further amplified by political choices made by interest groups created in the inefficient market. We take an occupational choice framework, where agents are endowed heterogeneously with wealth and talent. In our model, market failure due to unobservability of talent endogenously creates a class structure that affects voting on institutional reform. In contrast to the world without market failure where the electorate unanimously vote in favour of surplus maximising institutional reform, we find that the preferences of these classes are often aligned in ways that creates a tension between surplus maximisingand politically feasible institutional reforms.
Keywords: adverse selection; asset liquidation; market failure; occupational choice; political failure; property rights
JEL Codes: O12; O16; O17
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Market failure (due to unobservability of talent) (D29) | Class structure formation (H19) |
| Class structure formation (H19) | Altered voter preferences (D72) |
| Altered voter preferences (D72) | Political failure (failure to choose surplus-maximizing institutions) (H19) |
| Market failure (due to unobservability of talent) (D29) | Political failure (failure to choose surplus-maximizing institutions) (H19) |
| Emergence of constituencies with conflicting interests (D72) | Political landscape complications (D72) |