Working Paper: NBER ID: w15194
Authors: Mark Aguiar; Manuel Amador
Abstract: In this paper, we propose a tractable variant of the open economy neoclassical growth model that emphasizes political economy and contracting frictions. The political economy frictions involve disagreement and political turnover, while the contracting friction is a lack of commitment regarding foreign debt and expropriation. We show that the political economy frictions induce growth dynamics in a limited-commitment environment that would otherwise move immediately to the steady state. In particular, greater political disagreement corresponds to a high tax rate on investment, which declines slowly over time, generating slow convergence to the steady state. While in the standard neoclassical growth model capital's share in production plays an important role in determining the speed of convergence, this parameter is replaced by political disagreement in our open economy reformulation. Moreover, while political frictions shorten the horizon of the government, the government may still pursue a path of tax rates in which the first best investment is achieved in the long run, although the transition may be slow. The model rationalizes why openness has different implications for growth depending on the political environment, why institutions such as respect for property rights evolve over time, why governments in open countries that grow rapidly tend to accumulate net foreign assets rather than liabilities, and why foreign aid may not affect growth.
Keywords: No keywords provided
JEL Codes: F21; F43; O23; P16; P45
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Higher political disagreement (D72) | Slower convergence to the steady state (D50) |
| Higher political disagreement (D72) | Higher tax rate on investment (H29) |
| Higher tax rate on investment (H29) | Slower convergence to the steady state (D50) |
| Political disagreement (D72) | Prioritization of immediate consumption over long-term investment (D15) |
| Foreign aid conditioned on tax rates or debt repayment (F35) | Affects long-term dynamics of capital accumulation (E22) |
| Unconditioned foreign aid (F35) | Does not affect long-term dynamics of capital accumulation (D25) |
| Different political environments (D72) | Varied growth outcomes in response to financial globalization (F65) |