POLITICAL ECONOMY Econ WINTER

Transcription

1 POLITICAL ECONOMY Econ WINTER Francesco Trebbi 1

2 Course Preliminaries Minimalist History of Economic Thought. The interaction of political and economic forces has been at the center of most social sciences since Karl Marx and Friedrich Engels. However, what we do today has little to do with what Political Economy was in the 1890s (that s where the JPE name comes from by the way). The main similitude remains in our interest in truly big social phenomena (i.e. power sharing, redistribution, collective decision-making, conflict, policy influence and distortion, government capture, etc.). We operate in areas that follow the footsteps of Social Choice (Ken Arrow Nobel in 72) and of Public Choice (the Virginia School of James Buchanan Nobel in 86 & Gordon Tullock & the Chicago School in George Stigler Nobel in 82). We also borrow heavily from Political Science Modern Political Economy studies the interaction of political systems with economic ones, in a much more applied and empirical sense than the purely theoretical SC approach and stays clear of the ideological connotations of PC. 2

3 Political Economy: Partial Spectrum of Topics Theory: Pivotal Voting, Information Aggregation, Strategic Voting and Strategic Turnout, Political Accountability and Agency, Multilateral Bargaining, Political Networks. IO/Applied Micro: Regulation, Antitrust, Lobbying, Special Interest Politics, Barriers to Entry, Media Bias. Trade: Trade Policy. Macro: Fiscal Policy, Structural Reform, Public Debt/Defaults, Central Bank Independence. Development: Corruption, Conflict, Political Institutions, Hybrid Regimes, Long- Run Persistence. Political Economy Finance: Financial and Banking Regulation, Value of Political Connections, Corporate Governance. 3 Public Economics: Taxes, Public Goods Provision, Social Security Reform, Jurisdictional Sorting, Gerrymandering. Behavioral: Bounded Rationality in Politica Behavior, Inattention Loss Aversion in Poli Cultural Evolution

4 Course Preliminaries This course will have an heavy empirical component and provide both rigorous conceptual treatment and econometric rigor (I will try my best). Political Economy may not be yet a fully mainstream field in Economics (this is changing). It can complement more established areas such as Public Economics, Trade, Development, Macro/Labor, Behavioral, IO, Finance. If you look around Econ departments you will find people who are essentially full time political economists slotted under artificial field boundaries. You need to be mindful of this for JM. Here some examples: Alberto Alesina, Torsten Persson, Guido Tabellini come from Macro in the 1990 s (Pierre Yared, Columbia GSB now) Daron Acemoglu comes from Macro/Labor in the early 2000 s Tim Besley from Development in the mid 1990 s (Fred Finan, Berkeley, now) Stephen Coate, Brian Knight, from Public in the 1990 s (Ebonya Washington, Yale, now) Roger Myerson, from Theory in the 1990s (Massimo Morelli, Navin Kartik, Columbia, or Marco Battaglini now) 4

5 A Schematic Roadmap Conflict & Insurgency Enforcement Political Behavior in Hybrid Regimes, Democratic Pathologies, Vote Buying Political Behavior in Consolidated Democracies Lobbying, Special Interest Politics, Barriers to Entry, Media Bias. Autocratic Regimes & Leadership Financial and Banking Regulation, Value of Political Connections Institutions: Autocracy vs. Democracy Structural Reform; Crises; Polarization Political Networks 5

6 Course Preliminaries: Logistics Material: All material, including syllabus and lecture notes, is posted on my webpage: I upload all lecture notes online before class. They are comprehensive and detailed. In Class: Lecture starts at 11:00am. I really appreciate your participation during class. Teaching Assistant: Adlai Newson ( adlai.newson@gmail.com) Office Hours: Available after class or by appointment. (Just send me an and they are easily arranged.) Contact: ftrebbi@gmail.com 6

7 Course Preliminaries: Logistics (continued) Course Assessment: PhD students (or research-oriented MA/undergraduates upon special permission by me): 100% Replication++: You will be assigned/chose an academic paper that you not only will need to completely replicate, but you will need to augment in at least two worthy directions (these may include finding lack of robustness along relevant dimensions or show novel results you obtained). A 30 minute in-class presentation of your paper and findings is also required. You will present a written submission of your Replication++ on the last day of exam period. MA students: 100% 2 Midterms + Final (Midterms count one each, final counts three - take the highest three among those five grades and weigh 33% each i.e. the lowest two of those five grades are dropped and the rest is used to determine your course grade). The two midterms will occur on February 14th and March 14th 2019 and will last about 1:20 hours. The midterms will take place at the beginning of class. NOTE: If you cannot make these exam times and you want to take the midterm, you should not take my class. No alternate arrangements will be made. Readings/Must Reads: Assigned (encouraged). I will try to link to lectures. 7

8 Introduction to Institutions: Democracies & Non-Democracies Topic 1

9 Institutions and Political Economy of Development This is a very debated area in political economy & in development economics. We are literally asking the same question as in An Inquiry into the Nature and Causes of the Wealth of Nations (1776): Which deep dimension has the highest explanatory power in predicting income levels of nations? Some candidates: Institutions (North, 1990; Acemoglu and Robinson, 2001; 2006a; 2006b; 2012; Rodrik, Subramanian, Trebbi, 2004) Geography (Sachs, 2003) Culture (Tabellini, 2008) Human Capital (Glaeser, La Porta, Lopez-de-Silanes, Shleifer, 2004; Barro, etc.) As an intro please watch this Nobel sponsored lecture at the IIES Anniversary: Slides for the lecture are posted here: 9

10 Institutions and Political Economy of Development Often broad research questions tend to be hard to define. - What do we even mean with fundamental/deep determinants of economic development? - How do we objectively select among: Institutions (Economic & Political) Geography Culture (Preferences & Beliefs) Human Capital (Education) Trade openness (Trade policy) Chance - Should we even think about mono-causal explanations? 10

11 Institutions and Economic Development Besides methodological concerns, what does fundamental/deep even mean in this context? Exogenous? Can t be. Institutions change over time and for different reasons, that is why identification strategies are important. See Acemoglu, Johnson, Robinson (AER 2001). Culture and preferences evolve endogenously over time as well (through socialization Bisin and Verdier, 2001; Bisin, 2010). Not to mention trade policy or human capital levels of a country. A possible interpretation is that fundamental really means that the absence, shock or evolution of an economic or social dimension produces first order quantitative effects. Something akin to the following picture. 11

12 Real GDP per Capita: South Korea vs North Korea 12

13 Institutions For Institutions, being fundamental probably arises from the fact that they define the boundaries within which all economic decisions are made Example: investment or consumption decisions. Think of Y = AF(K,L). The choice of K and L in an economy are not fundamentals. A is not a fundamental. But the conditions that limit the evolution of A are. The market structures of Arrow-Debreu are essentially this. Production possibilities (technology) & beliefs/preferences (culture) evolve within them. 13

14 Institutions Institutions are the humanly devised constraints that structure political, economic and social interaction. They consist of both informal constraints (sanctions, taboos, customs, traditions, and codes of conduct), and formal rules (constitutions, laws, property rights). Douglas North, Institutions. Journal of Economic Perspectives. Vol. 5, No. 1 (Winter), pp

15 Polity IV Democracy Time Series Source: Polity Project. Monty G. Marshall and Keith Jaggers, Principal Investigators, George Mason University and Colorado State University; Ted Robert Gurr, Founder, University of Maryland. 15

16 Democracies have higher income per capita levels 16

17 Institutions Even with North s definition at hand, institutions are an awfully heterogeneous set (Constitutions? Property rights?). Does not help that North also adds cultural components (Taboos?) Let s focus on political dimensions, which are probably the most foreign for the modal economist. We look at different characteristics of political systems and at what are the consequences of political institutions (e.g. democracy vs. autocracy). Note: In future lectures we will also look at economic institutions (e.g. rule of law, expropriation risk, strength of the contracts, enforcement). See also Acemoglu and Robinson (2012) Why Nations Fail? 17

18 Democracies and Autocracies I want to be precise and give you a well-defined application of how to think about these problems A model of democracy and democratic transitions. Specifically, focus on Acemoglu and Robinson (AER 2001) A Theory of Political Transitions. Many other interesting theories and models of political transitions (see Bidner, Francois & Trebbi, 2016, for references). This is in many respects the workhorse model of The Economic Origins of Dictatorship and Democracy a (Cambridge U Press 2006) book by the same authors and it encompasses the model of Acemoglu and Robinson (QJE 2000) Why Did the West Extend the Franchise? Democracy, Inequality, and Growth in Historical Perspective and many subsequent papers. One of my all-time favorite works by the authors. 18

19 Acemoglu and Robinson (AER 2001) Two groups of agents: The Poor and the Rich (the Elite). Two political states: Democracy (median voter is Poor and controls policy more on this later) and Autocracy (the Elite controls policy). During an Autocracy, the Poor can mount a revolution or not (storming the Bastille) and the Elite can relinquish control (democratization) or not. During a Democracy, the Elite can stage a coup or not. Income is stochastic and the opportunity cost of coups and revolutions will be allowed to change with income, as some of it is lost in the fire. No commitment to future level of taxation is possible. Self-enforcement. 19

20 Setup Infinite horizon. Discrete time. Measure 1 of agents. A fraction >1/2 agents are Poor (p), the rest are Elite/Rich (r). There is an unique consumption good y and a unique productive asset with total stock h. At the beginning of time t=0 the poor owns h p and the rich h r > h p. To parameterize income inequality in this economy we use the parameter θ < such that the share of capital owned by the poor is less than proportional to their size h p = hθ/ and h r = h*(1- θ )/(1-). Higher θ implies lower income inequality (and vice versa), i.e. θ = implies h = h r = h p 20

21 Setup Income accrues from production: y i,t = A t h i for i =p, r where A t indicates aggregate productivity, which follows a stochastic discrete process: A t = A h = 1 with prob. 1-s A t = A l = a with prob. s where a < 1 and indicates a period of recession and s < 1/2, so recessions are relatively rare. All agents maximize expected discounted consumption: E t j j C i,t+j for i = p, r 21

22 Setup Disposable income is given by after-tax income plus (not-group-specific) transfers: (1-τ t )*A t h i +f t Also assume that there is a cost in raising taxes equal to c(τ t )*A t h with c (0)=0, c >0, c >0, c (1)=. The government budget constraint is given by: f t = τ t *A t h p + τ t *A t h r -c(τ t )*A t h = τ t -c(τ t ))*A t h 22

23 Revolution A revolution can be attempted in any nondemocratic period after t = 0. If attempted, it always succeeds. After a revolution the share of capital owned by the poor becomes more proportional to their size h / with θ <. tells how high the returns to the revolution are. The revolution destroys (1 - m) > 0 fraction of resources in the period in which happens. m tells how cheap the revolution is (the higher m, the less the poor lose from revolution). For the poor the return in the period of the revolution is ma t h / and the per period return ever after is A t h /. Note: the discounted net present value of a revolution is W p (R)=(1 - s + sa)*h/ For the rich the revolution is very costly. They lose everything forever, W r (R)=0. This is the disciplining device through which the poor can obtain redistribution or democratization. The rich will always try to avoid revolution. 23

24 Coup d etát A coup can be attempted in any democratic period after t = 1. If attempted, the coup always succeeds. The coup destroys (1 - ) > 0 fraction of resources in the period in which it happens. tells how cheap the coup is (the higher, the less the rich loses from coup). For the poor and for the rich, the return in the period of the coup is A t h i. 24

25 Timing of the game Sequential structure: 1. Nature determines aggregate productivity A t. 2. If there has been a revolution in the past, the poor receive their income, consume, and the period ends. If the state is democracy the poor picks a tax rate τ t. If the state is autocracy the rich picks a tax rate τ t. 3. In a nondemocratic regime the rich decide whether to extend the electoral franchise to the poor. In a democratic regime the rich decide whether to stage a coup. Whoever is in power now can fix a new tax rate τ t for the period. 4. In a nondemocratic regime the poor decide whether to initiate a revolution. If there is a revolution, the poor share the remaining income in the economy. If there is no revolution, the tax rate τ t gets implemented. 5. All receive their income, consume, and the period ends. Note: the poor cannot undertake a revolution immediately after a coup (you need to start in a nondemocratic regime). 25

26 Equilibrium Two players: Poor and Rich representative agents. Equilibrium concept: (pure strategy) Markov Perfect Equilibrium A refinement of subgame perfection, in MPE strategies depend only on the current state of the world and the prior actions taken within the period. The state space is restricted to payoff-relevant elements (e.g. excludes signals, messages between players). MPE is a drastic way of excluding history-dependence in strategies. Imposing Markovian strategies is not an innocuous restriction. For a given level of productivity A, there are three possible states S: (A, D) = poor in power (Democracy) (A, E) = Elite in power (autocracy) (A, R) = Revolution (absorbing state) 26

27 Transition Paths (A, E) (A, E) (A, E) (A, R) (A, D) (A, D) (A, D) (A, E) Democratization Revolution Coup d etát 27

28 Strategies For the rich: r (S τ p ) = {,, τ r }, in state (A,E) extend the franchise () or not (), in state (A,D), given τ p, stage a coup () or not () τ r in state (A,E) or in state (A,D) after a coup (), fix the tax rate by the rich. For the poor: p (S,τ r ) = {, τ p }, in state (A,E), given, τ r, initiate the revolution () or not () τ p in state (A,D) fix the tax rate by the poor. 28

29 Equilibrium A pure strategy Markov Perfect Equilibrium is a strategy combination r* (S τ p ), p* (S,τ r ) such that the strategies r*, p* are best-responses to each other for all possible states. See paper for a more formal definition. 29

30 Analysis: Preliminaries Some preliminaries first. What is the optimal tax rate τ m the poor would set, absent the risk of a coup? Simply maximize the per-period consumption of the poor: Max{( τ t )*A t h p + τ t -c(τ t ))*A t h} which implies c (τ m )=(λ-θ)/λ using the fact that h p = hθ/. So the higher the inequality (the lower θ), the higher the taxes. Notice also that in the absence of political change, taxes would be constant (i.e. would not depend on A t ). 30

31 Analysis: Preliminaries Define δ i (θ) A t the net amount of redistribution that a person of group i receives in state A t when the tax rate is τ m. So, δ i (θ) A t f m τ m *A t h i and from the budget constraint transfers are f m τ m -c(τ m ))*A t h This implies net transfers to the poor: δ r (θ) < 0 < δ p (θ) 31

32 Assumptions Assume revolutions and coups are not worthwhile in periods of economic expansion (i.e. A t = A h = 1). Assumption 1: Sufficient condition for which coups are not profitable in good times. The cost of a coup for a rich agent in normal times (the direct loss from the coup minus taxes paid = (1-)h r + δ r (θ) ) is always larger than the taxes τ m avoided forever (-(1 -s + sa)* δ r (θ)*) That is: (1-)(1-)h r > -(1- s(1-a)) δ r (θ). 32

33 Assumptions Assumption 2: Sufficient condition for which revolutions are not profitable in good times. In state (A t, E) the value of a revolution is V p (A t, R)= m*a t hπ/ + W p (R) The value of never undertaking a revolution and hence never receiving any transfer from the rich from there after is: V p (A t, E)= A t h p + (1 s + sa)*h p Of course this value is a lower bound of the utility under autocracy for the poor (because occasionally there could be redistributive taxation the rich could tax themselves and give to the poor). So we assume that for A t = A h = 1, V p (1, E) > V p (1, R) With this assumption we know there is never going to be any revolution in good times. And this also implies the rich will never redistribute to the poor in good times. 33

34 Analysis We need to derive some intuitive value functions in the different states of the world. What is the value of being in a democracy during good times (A t = 1) for agents i =p, r? V i (1, D) = h i + δ i (θ)+ W i (D) where we make use of the fact that there is never going to be a coup in good times (hence the net transfers are δ i (θ)*1) and the continuation value from next period on of being in state D is: W i (D) = (1-s)*V i (1, D) + s *V i (a, D) which depends on the state of the economy next period (could be a boom or a recession). 34

35 Analysis What is the value of being in a democracy during bad times for agents i =p, r, V i (a, D)? Now, here the situation is tricky for the poor. If they redistribute too much, they can trigger a coup. So they may decide to keep taxes low and transfer less to themselves in bad times just to avoid a coup by the elite. Call this tax rate (if feasible) τ d < τ m. Suppose τ d prevents the coup, then V i (a, D)= v i (a, D τ d )= a(h i + i (θ, τ d ))+ W i (D) where net transfers under the threat of a coup are i (θ, τ d )A t f d τ d *A t h i. Notice that the continuation value is still W i (D) which tells us that if the next period the poor have good times they will increase taxes back up to τ m (at that point this can t trigger a coup because times are good). The poor cannot commit to keep taxes low. 35

36 Analysis Reducing taxes in a democracy may not be enough to prevent a coup though. Let s see what is the decision by the rich about this: V r (a, D)= max { V r (a, E) + (1-v r (a, D τ d )} where the continuation value of a coup () in state (a, D) is: V i (a, E)= ah i + W i (E) which depends on the fact that the rich will be able to set taxes to zero right after the coup (recall there cannot be revolution immediately after a coup, only in the following period). The continuation value from next period on of being in state E is: W i (E) = (1-s)*V i (1, E) + s *V i (a, E) 36

37 Analysis What happens when the Elite is in power? In a boom the rich will set taxes to zero, since there cannot be a revolution by Assumption 2, so for agents i =p, r: V i (1, E) = h i + W i (E) In a recession the rich will have several options : 1. They can democratize () 2. They can decide not to democratize () but they can raise taxes from 0 to τ e to appease the poor and avoid a revolution (). 3. A revolution may occur (). Since we start from an autocracy, if either or then you would never observe a democracy. Since we use V i (a, E) in calculating a deviation from democracy along the equilibrium path in what follows, let us focus on case 1 (). 37

38 Analysis So if then for agents i =p, r: V i (a, E) = a(h i + δ i (θ))+ W i (D) which depends on the fact that the poor will set τ m taxes (recall there cannot be a coup immediately after a democratization, only the following period, so the poor will pick the best tax rate for them) and the continuation value from next period on of being in state D is what we derived earlier. Finally allow for: Assumption 3: Assume revolutions are worse than democracies, so democratizations can help preventing revolutions. V p (a, R) < V p (a, D) (Excludes case 3 in previous slide) This completes the derivation of the value functions. Let s now look at the properties of the equilibrium. 38

39 Coup Constraint In state (a, D) the elite would prefer not to stage a coup if it is too expensive, or: V r (a, E) < v r (a, D τ d ) That is, by replacing the expressions in the previous slides: ah r + W r (E) < a(h r + r (θ, τ d ))+ W r (D) or, more intuitively, W r (E) W r (D)) -a r (θ, τ d ) < ah r (1- ) (18) Capturing power & reducing taxes from τ d to 0 < Cost of the coup. Note: If a is large (recession not too deep) the coup is more expensive and less likely. 39

40 Consolidated Democracy In state (a, D) the elite will never stage a coup for levels of low enough, such that: W r (E) W r (D)) -a r (θ, τ m ) < ah r (1- ) (18) or, more clearly, W r (E) W r (D)) -a r (θ) < ah r (1- ). Capturing power & reducing taxes even when taxes at the maximum τ m < Cost of the coup Substituting the value functions, you get a threshold, a, s):, a, s) sa(h r r (θ)) + s r (θ))/((sah r ) For coups never occur. 40

41 Consolidated Democracy For coups never occur, so increasing decreases the range in which coups might occur: 1., a, s) more equal societies are easier to consolidate (lower need to tax the rich). 2., a, s) a less severe recession make consolidation easier (by increasing the opportunity cost of a coup). 3., a, s) s more frequent recessions make consolidation easier (increasing the frequency at which the rich pay lower taxes makes democracy less costly to the rich). 41

42 Semi-Consolidated Democracy In state (a, D) the elite always stages a coup for levels of high enough, such that: W r (E) W r (D)) -a r (θ,0) > ah r (1- ) (18) or, more clearly, W r (E) W r (D)) - 0 > ah r (1- ). Capturing power & reducing taxes even when taxes are at the minimum τ d =0 > Cost of the coup Substituting the value functions you get a threshold, a, s). For coups always occur during recessions:, a, s) sah r + s r (θ))/((sah r ) For the democracy is semi-consolidated, that is, in order to prevent a coup, during recessions the poor lowers taxes to a level τ d τ m Note: During booms taxes go back up to τ m. Even if the country remains democratic, the off-equilibrium threat of a coup influences tax policy! 42

43 Revolution Constraint In state (a, E) the poor would prefer not to start a revolution if it is not worth it, or: V p (a, R) < v p (a, E τ e ) where the rich may wish to avoid revolution by conceding some redistribution τ e That is: m*ahπ/ + W p (R) < a(h p +d p (θ, τ e ))+ W p (E) (19) where d i (θ, τ e ))af e τ e *ah i and means: Capturing power through the Revolution < Value of living in an autocracy for the poor Note: The elite may have the opportunity of avoiding revolutions by just increasing taxes and redistribute during recessions. However, even giving τ e =τ m may not be enough to satisfy (19). In that case they will need to democratize. 43

44 Democratizations In state (a, E) the poor would always start a revolution if : V p (a, R) > v p (a, E τ m ) where the rich tries to avoid revolution by conceding maximum redistribution τ m That is: m*ahπ / + W p (R) > a(h p + p ())+ W p (E) (20) Substituting the value functions you get a threshold m, a, s). For m > m a revolution is always attractive during recessions even at maximum redistribution τ m : m, a, s) sa(h p + p ())+s h p s+ash/((ah) In this case the rich can only democratize to avoid a revolution. 44

45 Democratizations For m < m the autocracy can prevent the revolution by redistributing resources during recessions, that is, in order to prevent a revolution during recessions the rich increases taxes (on themselves) to a level e m. During booms taxes go back down to 0. Note: Even if the country remains autocratic the threat of a revolution influences tax policy! 45

46 Democratizations For m > m a revolution is always attractive during recessions even at maximum redistribution, so the rich democratize during the recession to avoid a revolution (by Assumption 3). 1. m, a, s) more equal societies are less likely democratize and the poor are more likely to just be happy with redistribution (democracy is not that valuable for the poor). 2. m, a, s) a less severe recessions make societies less likely to democratize and the poor are more likely to just be happy with redistribution (by increasing the opportunity cost of a revolution). 3. m, a, s) s more frequent recessions make societies less likely to democratize and the poor are more likely to just be happy with redistribution (increasing the frequency at which the rich pay higher taxes makes autocracy less costly to the poor). Frequency of recessions acts as a commitment to redistribution. 46

47 Equilibrium (under Assumptions 1-3): Proposition 1. If m < m, a, s), then society remains nondemocratic forever. Intuition: a revolution can always be bought off by the elite with e and the system remains an autocracy. 2. If m > m, a, s) and if, a, s), then society democratizes the first time the state is (a, E) (at the first recession) and it remains a consolidated democracy forever. Intuition: The revolution threat forces democratization and then coups are too costly to stage even when taxes are at the maximum m. 3. If m > m, a, s) and if, a, s)<, a, s), then society democratizes the first time the state is (a, E) (at the first recession) and it remains a semi-consolidated democracy forever. Intuition: The revolution threat forces democratization and then coups are not too costly to stage, so taxes have to be lowered in bad times to d. 4. If m > m, a, s) and if, a, s), then society becomes an unconsolidated democracy the first time the state is (a, E) (at the first recession) and then at every recession it continuously switches regimes. Intuition: Democratizations follow coups. 47

48 Empirical Implications Case 1 E D 1 1 a a a 0 0 e e e OUTPUT REGIME TYPE FISCAL POLICY Case 2 E D a a a m m m m m OUTPUT REGIME TYPE FISCAL POLICY Case 3 E D a a a m m m d d OUTPUT REGIME TYPE FISCAL POLICY Case 4 E D 1 1 a a a m 0 0 m m m 0 m OUTPUT REGIME TYPE FISCAL POLICY 48

49 Examples Case 1. Society remains nondemocratic forever. Several examples where the poor are bought off, like Singapore, Saudi Arabia. Case 2: OECD countries. Extension of the democratic franchise to Western societies. Case 3: Countries that, albeit formally democratic, the threat of coups still constraints redistribution. Egypt (?), Philippines (?) Russia (?) Case 4: African and Latin American countries: continuous alternating between regime types and frequent coups. Often triggered by economic downturns (Chile, Argentina). 49

50 Notes 1. Societies with high asset inequality (low θ) are more likely to have both more coups and revolutions. Hence, they are more likely to be in case 4 and switch back and forth between democracy and autocracy. 2. In our model the richer the country (the higher h) does not imply the more democratic the country. Both coup and revolution constraints are unaffected by the level of h per se. 3. Higher inequality increases fiscal policy variability within each case of equilibrium. 4. Societies where distortions c(.) are lower (less convex) will have higher taxes and less likely to consolidate (the rich fearing higher taxes will have more incentives to stage coups). In a sense distortions are a good commitment device against expropriation of the elite. Note: The paper has also a very interesting second section on consolidation (not covered here). Read it. 50

51 Voluminous Literature on Democratization & Its Consequences Causes of Democratizations/Democratic Transitions. Lipset, 1959 (economic development as a requisite to democracy Modernization Hypothesis); Huntington, 1991; Przeworski, Alvarez, Cheibub, 1996; Barro, 1999; Boix, 2003; Geddes, 2003; Bruckner and Ciccone (Rain and the Democratic Window of Opportunity, 2011); Acemoglu and Robinson (A Theory of Political Transitions, 2001; The Economic Origins of Dictatorship and Democracy, 2006); Acemoglu, Johnson, Robinson and Yared (No effect of income on democracy, 2008); Murtin and Wacziarg, 2013; etc. Socio-economic Consequences of Democratizations Acemoglu, Naidu, Restrepo, and Robinson, 2013;Acemoglu and Robinson (A Theory of Political Transitions, 2001; The Economic Origins of Dictatorship and Democracy, 2006); Przeworski, Alvarez, Cheibub, Limongi, 2000; Bueno de Mesquita, Smith, Siverson, Morrow, 2003; Persson and Tabellini (Democratic Capital, 2009); Rodrik and Wacziarg, 2005; etc. Democracies & Conflict Maoz and Russett, 1992 (Democratic peace); Russett, 1994; Enterline and Greig 2005; Baliga, Lucca, Sjostrom, 2011; etc. Caveat: Massive literature(s), naturally incomplete list. 51

52 A Look Under the Hood of AR (2001) #1: Democratization With Representation Main idea: Extension of the electoral franchise typically involves extending political representation to the poor, who, therefore, push for more redistributive politics. It follows that with democratization higher economic redistribution and more income equality should ensue. Originates in Meltzer and Richard (1981); Acemoglu and Robinson (The Economic Origins of Dictatorship and Democracy, 2006) extends it. Consider here the simple formalization given in Acemoglu, Naidu, Restrepo and Robinson (2013, Handbook of Income Distribution). 52

53 Democratization With Representation Consider a society of measure 1 composed of agents endowed with different income y i and with an income distribution F(y) with mean y m. The (first) policy instrument is a linear tax rate common for all agents (i.e. targeted transfers are not possible). Taxation is distortionary and involves a cost C() differentiable, convex, nondecreasing,with C () =0 The government uses total resources available for policy y m - C() y m just to transferring it back lump sum and in equal amount. Total transfers are equal to T. Hence, the government budget constraint is y m - C() y m T 53

54 Democratization With Representation Obviously, a poor guy supports a high tax rate policy, because he loses proportionally to his income, but he gains an amount proportional to the average income in society y m. Essentially this simple set up allows to set up tax rates redistributing from the rich to the poor. To see this, consider the after-tax income of agent i: y i y m - C() y m which is a concave problem with a unique maximum y m y i y m C ( ). (Anybody with y i at or above y m will prefer zero taxes, but a voter below y m will want redistribution, > 0). Incidentally, what just stated is pretty much what we mean with single-peaked preferences for the voters. 54

55 Median Voter Theorem Voters preferences are single-peaked over the unidimensional policy space. Assume further that: 1. It is an Open Democracy (citizens vote on the policy directly no political representation); 2. Majoritarian voting rule; 3.Voters vote their preferences and are non-strategic (i.e. Sincere Voting). Then, the equilibrium policy of this political system exists, is unique, and is the policy preferred by the agent with median income y med, (more in general, the median voter in the voters distribution of policy preferences). Note: The first formalization of the median voter theorem can be found in Duncan Black s article On the Rationale of Group Decision-making (JPE, 1948). A classic result in Social Choice. 55

56 Democratization With Representation Let us go back to MR-AR model. Suppose that initially the electoral franchise is limited to rich voters with income above the qth percentile of the income distribution, y q. A democratization involves an expansion of the franchise, a reduction in the threshold income to the q quantile, or y q < y q. More people vote now. Define the equilibrium tax rate under the two different thresholds q and q, q and q, and define the respective after-tax income distributions F q and F q. 56

57 Democratization With Representation Proposition 1 in Acemoglu et al, (2013): Suppose that starting from only those above y q being electorally enfranchised there is a further democratization, so that now those above y q < y q are enfranchised. This democratization leads to higher tax rates ( q q ), higher redistribution and more equal distribution of after-tax income, in the sense that F q is more concentrated around its mean than F q. In the Meltzer and Richard (1981) framework, representative democracy has an economic equalization effect through taxation and income redistribution to the poor. Democratizing means shifting political power to the poor, that then maps into policy. This is Meltzer and Richard s main result. 57

58 Democratization With Representation? But what does the evidence say? Focus on Acemoglu, Naidu, Restrepo, and Robinson (2013, Handbook of Income Distribution). 58

59 No Change in Gini Coefficient 59

60 [Reminder: Gini Coefficient] 45 degree line = perfect equality = q% of the population holds q% of total income. Lorenz curve traces the share of total income of the population held cumulatively by the bottom q% of the population. 45 degree line 100% % share of total income held by the people below the q percentile 0 q% of the population 100% (sorted from low to high income) Gini coefficient = 1 Area below the Lorenz curve/area below the 45 degree line Gini coefficient ranges from 0 (maximal equality) to 1 maximal inequality. 60

61 Democratization With Representation? 61

62 Democratization With Representation? What does the evidence says? We focus on Acemoglu, Naidu, Restrepo, and Robinson (2013, Handbook of Income Distribution). democracy does not lead to a uniform decline in post-tax inequality, but can result in changes in fiscal redistribution and economic structure that have ambiguous effects on inequality Two reasons: 1. Negatively, de facto power may remains in the same hands even if the de jure power is transferred to the people (for instance, the elite may co-opt other channels of influence, like lobbying or through the use of vote buying, force or intimidation in elections); 62

63 Landed Elites Capture Democracies & Avoid Redistributing? 63

64 Democratization With Representation? What does the evidence says? We focus on Acemoglu, Naidu, Restrepo, and Robinson (2013, Handbook of Income Distribution). democracy does not lead to a uniform decline in post-tax inequality, but can result in changes in fiscal redistribution and economic structure that have ambiguous effects on inequality Two reasons: 1. Negatively, de facto power may remains in the same hands even if the de jure power is transferred to the people (for instance, the elite may co-opt other channels of influence, like lobbying or through the use of vote buying, force or intimidation in elections); 2. More positively, the opening of political participation may also open economic opportunity. This may trigger an increase of income disparities simply because now talented individuals have suddenly access to worthwhile economic endeavors. 64

65 Economic Opportunities Offered by Democratization May Be Inequality-Increasing: Case of Non-Agricultural Societies 65

66 A Look Under the Hood of AR (2001) #2: Democracy Definitions of democracy vary massively and even reflect on how political economists and political scientists measure whether a country is democratic or not. Few conceptual issues in political science have been subjected to closer or more prolific scrutiny in recent decades than this problem of what democracy is and it is not. a quarter century into the third wave of democratization and the renaissance it brought in comparative democratic studies, we are still far from consensus on what constitutes democracy. And we still struggle to classify ambiguous regimes. Larry Diamond (Journal of Democracy, 2002) 66

67 Democracy Greek etimology Demos = the people. + Cratia = power, rule. Rule by the people. In Aristotle s Politics: Rule by the many in their own interest (i.e. a corrupted regime where the poor exploit the wealthy) Polity (an ideal regime mixture of democracy and oligarchy). Can we define democracy? 67

68 Democracy We can discuss it in order of strictness of threshold 1. Minimalist Conception (Electoral Democracy). 2. Complex procedural plus accessory guarantees/freedoms (e.g. civil and political rights). (e.g. Liberal Democracy) 3. Maximalist requirement (Representative Democracy). Must reflect will of the many in public policy outcomes. Caveat: There is a whole field out there called Democratic Theory, which I can only hope to coarsely summarize here, but nothing more. 68

69 Minimalist Democracy Joseph Schumpeter (1942) Capitalism, Socialism, and Democracy The democratic method is that institutional arrangement for arriving at political decisions in which individuals acquire the power to decide by means of a competitive struggle for the people's vote Purely procedural: A polity is democratic if it has competitive elections allowing for transfer of power without bloodshed (Popper, 1962 p.124). Also known as Procedural or Precessualist concept of democracy. 69

70 Minimalist Democracy Adam Przeworski (Minimalist Conception of Democracy: A Defense, 1999): this is all there is to democracy : that rulers are elected. Argument goes: 1. We want to avoid bloodshed, resolving conflicts through violence i.e. Competitive elections avoid social conflict. 2. The mere possibility of being able to change governments can avoid violence Elections can be a lottery. Any link between elections and representation is severed. 3. Being able to do it by voting has consequences of its own. But elections are not a lottery, it s more like counting heads. If heads mean force, then the outcome of elections tell who s the strongest faction/the distribution of force. Elections inform everyone who would mutiny and against what. 70

71 Liberal Democracy Higher threshold for the definition of a democratic regime. Samuel Huntington (1991) The Third Wave: Democratization in the Late twentieth Century In a democracy its most powerful collective decision makers are selected through fair, honest, and periodic elections in which candidates freely compete for votes. 71

72 Liberal Democracy Higher threshold for the definition of a democratic regime. Robert A. Dahl (1956) A Preface to Democratic Theory Elections must be contested not just in the sense of being competitive among the candidates, but entry into the political arena must be allowed (right to politically organize, to publicly associate, protest) and media must be free and independent. + Political participation has to be guaranteed by rights to vote for masses (wide electoral franchise, universal suffrage) and freedom/fairness in electoral implementation (i.e. no violence, threats, or vote fraud plaguing it). Contestation + Inclusiveness. 72

73 Liberal Democracy Dahl (1971) Polyarchy spells out explicitly 8 institutional guarantees that need to be met (Coppedge, Alvarez, and Maldonado, JOP 2008): 1. freedom of political organization, 2. freedom of expression, 3. the right to vote, 4. broad eligibility for public office, 5. the right to compete for support and for votes, 6. the availability of alternative sources of information, 7. free and fair elections, 8. the dependence of public policies on citizens preferences. 73

74 Liberal Democracy Discussion in Casiano Hacker-Cordón (2001) [ ] Przeworski calls the USA the world s oldest democracy, suggesting that full inclusion and equality of civil and political liberties are not part of the definition: the US could not be classified as a Polyarchy until the 1960 s at the earliest, much later than several other polyarchies. See Dahl (1971) and Therborn (1977) for the correct classification of the USA. 74

75 Representative Democracy Highest threshold: policy outcomes, not just procedures. Almost the ideal Athenian democracy. All that liberal democracy requires should follow through in terms of policy outcomes. Equality in access to political and economic opportunity? Equality in income? For further (more targeted but narrower) reading: Mukand & Rodrik (2015): The Political Economy of Liberal Democracy Bidner, Francois, Trebbi (2015): A Theory of Minimalist Democracy 75

76 A Look Under the Hood of AR (2001) #3: Public Policy in Democracies vs. Autocracies. Important question: Do autocracies and democracies differ in what they do? Numerous scholars point at democratic political institutions as more efficient (Persson and Tabellini 2003, Rodrik and Wacziarg 2005), while others deny any difference. Mulligan, and Sala-i-Martin, Gil (JEP 2004) emphasize how autocracies differ from democracies only in policies restricting political competition and the monopoly of force (military and police spending for instance or censorship and freedom of the press regulation), but not in terms of economic and social policies, once we control for the level of income. Olson (1993) emphasizes policy is different even within autocracies: Stationary Bandits vs. Roving Bandits. See also Glaeser et al. (JOEG 2004) 76

77 But how do you explain this? Economically Successful Autocracies (above 80 th percentile of average growth rates - All world, pooled) Source: Besley and Kudamatsu (2007). 77

78 Policies in Democracies vs. Autocracies Democracies and Autocracies do not seem to differ in gov. spending composition. Source: Mulligan, Sala-i-Martin, Gil (2004). 78

79 Policies in Democracies vs. Autocracies Democracies and Autocracies do not seem to differ much in tax policy. Source: Mulligan, Sala-i-Martin, Gil (2004). 79

80 Policies in Democracies vs. Autocracies Democracies and Autocracies differ in policies affecting Public Office Competition. Source: Mulligan, Sala-i-Martin, Gil (2004). 80

81 Making Autocracy Work Several arguments put forward of why we observe relative success in autocracies. Besley and Kudamatsu (2007) show how we can think about the inner working of autocracies. They start from the empirical regularity that we have discussed so far: Not all autocracies are economic disasters. Some dictatorships are fairly successful economically (Singapore, South Korea between 1960 and 1988, China, etc.) How? Idea similar to the contestable markets hypothesis from Mulligan and Tsui (2007). It is interesting to see how they succeed. A model of selectorate, an elite group to which the leader is accountable and that can kick him out of office. In Political Science a common reference for selectorate theory is Bueno de Masquita et al. (2003). 81

82 Making Autocracy Work Besley and Kudamatsu (2007) : Successful autocracies are the ones were the elite and the leader are not too interlinked. The selectorate has to be able to survive without the leader. So they can discipline him. The majority of coups actually arises within the elite (i.e. the selectorate). Efficient autocracies (those where the leader is accountable to the selectorate) tend to have higher turnover. Even single-party systems tend to have political competition. Just of a more subtle form. 82

83 How Is Power Shared in Africa? An Introduction Francois, Rainer, &Trebbi (ECMA 2015); Newson &Trebbi (CJE 2018) Growing theoretical literature analyzes the organization & evolution of ruling elites in autocratic & institutionally weak polities. (e.g. Acemoglu & Robinson 2003, Bueno de Mesquita et al. 2003) But, due to paucity of data, systematic empirical research is scarce. African autocracies. We study how political power is shared among ethnic elites in African countries. We collect data on the ethnicity of all government ministers between in 15 countries & assess the degree of inclusiveness/ proportionality of African governments. Shed light on the inner workings of autocracies. 83

84 Parliamentary democracies as a benchmark To have a benchmark: Parallel between the ethnic politics in African countries & partisan politics in Parliamentary democracies. In particular, we compare the outcomes of political bargaining among African ethnic elites to the outcomes of legislative bargaining in parliamentary democracies. For work on parliamentary democracies: Ansolabehere, Snyder, Strauss, & Ting (2005) 84

85 Main Findings Much discussion in the literature on how ethnic spoils system works in Africa. Assumption: Winning ethnic group takes it all. Data: False. Not a One-Man Show. Proportionality: Ethnic group s size systematically predicts cabinet seat shares almost 1:1. Leadership premia: The Ethnic group of the leader commands a positive seat premium, but it is comparable to formateur premia in Parliamentary democracies. Linguistic proximity between ethnic groups does not play any role in ministerial allocation. Coalition Size: Winning coalition size is 80% of the population. It is 50% in Parliamentary democracies. (i.e. Rare that an ethnic group with a large base goes unrepresented within an African Cabinet). 85

86 Figure 2: Population Share of Ethnicities Not Represented in Government, African Sample, Pop. Share of Ethnicities Not Represented in Government Benin Cameroon CongoKinshasa Cote d'ivoire Gabon Ghana Guinea Kenya Liberia Nigeria Republic of Congo Sierra Leone 1960m1 1980m1 2000m1 Tanzania Togo Uganda 1960m1 1980m1 2000m1 1960m1 1980m1 2000m1 1960m1 1980m1 2000m1 Graphs by Country Year 86

87 Table 7: Inclusiveness in Parliamentary Democracies and Africa. Share of Voters Not Represented in Government, Average Country Population Share of Ethnicities Not Represented in Government, Average Country Australia Benin Austria Cameroon Belgium Cote d'ivoire Denmark Dem. Rep. of Congo Finland Gabon Germany Ghana Iceland Guinea 7.54 Ireland Kenya 8.93 Italy Liberia Luxembourg Nigeria Netherlands Rep. of Congo Norway Sierra Leone Portugal Tanzania Sweden Togo Uganda Mean T-stat for Difference in Means = 6.48; degrees of freedom = 27; p-value=

88 Figure 1: Share of Voters Not Represented in Government, Parliamentary Democracies, Share of Voters Not Represented in Government Australia Austria Belgium Denmark Finland Germany Iceland Ireland Italy Luxembourg Netherlands Norway 1960m1 1980m1 2000m1 1960m1 1980m1 2000m1 Portugal Sweden 1960m1 1980m1 2000m1 1960m1 1980m1 2000m1 Graphs by Country Year 88

89 Inclusiveness in Parliamentary Democracies and Africa As expected, the size of government coalitions in parliamentary democracies is around 50 percent. But in African countries it is surprisingly high close to 80 percent! African governments are inclusive and very few ethnic groups are ever left out. Furthermore: i) the levels of inclusiveness in African countries are quite stable over time; ii) do not differ much between periods of autocracy & democracy. 89

90 Table 9a: Level of Inclusiveness in Cabinet Seats Allocation and Level of Democracy in Africa, Within-Country Evidence. Pop. Share of Not Represented Ethnicities (1) Pop. Share of Not Represented Ethnicities (Excluding Pol. Transitions) (2) Polity [0.1771] [0.1671] Cabinet Duration [0.1128] [0.1353] Leader Duration [0.0922] [0.1106] R N The share of the sample for which Polity2 0 is 13.66%. All specifications include country and year fixed effects and a linear trend by country. Cabinet and leader duration indicate years since the leader was installed and years from the last occurrence of a simultaneous replacement of more than half the cabinet members, respectively. Standard errors clustered at the country level in brackets. * p<0.05; ** p<

91 Country-Level Analysis: Proportionality For African countries: g = ethnic group, p g /P = g s share of population, y g = g s share of government posts. For Parliamentary democracies: g = political party, p g /P = share of seats in parliament, y g = share of government posts. Definition 1: A perfectly proportional government is one for which p g /P = y g, for any g. Many ways of defining disproportionality (Gallagher, 91). 91

92 Table 8: Disproportionality in Parliamentary Democracies and Africa. Country LSq Disproportionality Average Country LSq Disproportionality Average Australia Benin Austria Cameroon Belgium Cote d'ivoire Denmark Dem. Rep. Congo Finland Gabon Germany Ghana Iceland Guinea Ireland Kenya Italy Liberia Luxembourg Nigeria Netherlands Rep. of Congo Norway Sierra Leone Portugal Tanzania Sweden Togo Uganda Mean T-stat for Difference in Means = 7.07; degrees of freedom = 27; p-value =

93 Figure 5: Least Squares Disproportionality in Cabinet Allocation, African Sample, Benin Cameroon CongoKinshasa Cote d'ivoire Gabon Ghana Guinea Kenya LSq Disproportionality Liberia Nigeria Republic of Congo Sierra Leone Tanzani a Togo Uganda Graphs by Country Year 93

94 Figure 4: Least Squares Disproportionality in Cabinet Allocation, Parliamentary Democracies, Australia Austria Belgium Denmark Finland Germany Iceland Ireland LSq Disproportionality Italy Luxembourg Netherlands Norway Portugal Sweden Graphs by Country Year 94

95 A theory of allocation of patronage positions by an autocratic leader. Our explanation: leader has to worry about two anti-regime threats: insider and outsider threats. These have different technologies. They are balanced by patronage allocations. Outsider (not in ruling coalition) disgruntled & foment dissent; Insiders (in coalition) but can eye the leader s prize. Include insiders to dissuade revolutions by outsiders, but insiders must be dissuaded against coups (coup proofing). Allocations aimed at one threat also potentially affect the other, and vice versa. Allocations depend on returns to leadership, and hence on nature of equilibrium play. Need a model to formalize this, to structure these interactions, to characterize stable outcomes. 95

96 Model Preliminaries An infinite horizon, discrete time economy, Per period discount rate, δ. N ethnicities, the set of ethnicities denoted N = {1,, N} Each ethnicity comprises two types: elites, e, and non-elites, n. The population of non-elites is of size P, ni P. Let N = {1,, N} N i1 96

97 Preliminaries cont. Ethnic group j has elite size e j and non-elite size n j with e j = λn j and λ (0,1) Elites decide whether co-ethnic non-elites support government or not. Each elite controls 1/ λ non-elite. w.l.g. groups are numbered by size e 1 > e 2 > > e N-1 > e N. 97

98 Preliminaries cont. At time 0 leader from group j N selected with probability proportional to group size p j ( N ) N exp( e i 1 j ) exp( e i ) (1) l N indicates the ethnic identity of leader denotes the set of subsets of N. The leader chooses how to allocate leadership posts (cabinet positions/ministries) across the various ethnic groups. Let Ω l denote the set of groups in cabinet other than the leader s group, The country is ruled by an ethnic coalition (Ω l l) 98

99 Patronage Cabinet posts generate patronage to post holders (ministers). (Total cake value 1) Per-member patronage value allocated to elite group j : x j Total patronage going to elite j (if all e j are in govt.): x j e j [0, 1] Leaders able to split ethnic groups in their offers of patronage. Assumption 1: Leaders can split ethnic groups in their offers of patronage. Specifically, a leader of ethnicity l can offer patronage to a subset e j (l) e j of group j; and exclude the remaining e j -e j (l) from their governing coalition. A leader cannot exclude any elite from within his own ethnicity. 99

100 Patronage cont. Ethnic ties bind leaders. Assumption 2: Leaders must share retained patronage equally with all their co-ethnic elites. However, they are able to offer patronage to elites from other ethnicities as they wish. Denote these residual leader group shares: i x (1 x e' ( l)) / e l l i i l Leader also obtains a nontransferable, personal premium, F, from holding office (it captures the personalistic nature of autocratic rents). 100

101 Value Functions Characterize stationary outcomes. Value function follow notation: V j leader (Ω j ) denotes the value of being the leader (happens to be from group j) V j (Ω j ) denotes the value of being in the government coalition to an elite member from ethnicity j conditional on the leader being from ethnicity j (and the member not being the leader himself) V j (Ω l ) denotes the value of being in government coalition to an elite from ethnicity j, conditional on the leader being from ethnicity l V j0 denotes the value function for an elite of ethnicity j excluded from the current government V j transition denotes the net present value of being in a transition, i.e. before a new leader has been picked (more below) 101

102 Transitions Leaders lose power or are deposed for exogenous and endogenous reasons Exogenous: Events outside their control: they may die or a friendly superpower may change its regional policy. Endogenous: Leaders can be deposed by outsiders via a revolution (i.e. civil war, large-scale political violence); Leaders can be deposed by government insiders via a coup d état (i.e. internal powerstruggles). 102

103 Revolutions A revolution whether it succeeds or not destroys value. Total value of all posts reduced to r 1 after a revolution. Cake shrinks from then on. Probability of success depends on relative sizes of combatants. For example: with N I = n l + iω l n i insiders and N 0 rebels, rebels will succeed with probability N 0 / (N I + N 0 ) Winning a revolution leads to deposing the leader, and drawing of a new one, i.e. a transition according to probability p j (N) defined in equation (1). Losing a revolution leads to no change in the status of the government. 103

104 Revolutions A group of potential elite revolutionaries, N 0, excluded from patronage of current government, has an incentive to mount a revolution leading to a civil war if, for each one: N 0 rv transition N 0 N j I N I rv 0 0 N 0 N j V j I 104

105 Revolutions Nash Conjectures in the revolution subgame: In deciding whether to start a revolution, an elite j uses Nash conjectures in determining the number of other elites that would join in. That is, once a revolution commences, all valuations are reduced by 1- r proportionately, thus all outsiders will join a revolution once started. 105

106 Revolutions No revolutions from outside: N P N P 0 transition 0 0 rv j 1 1 rv j j Ω l (2) Provided V j transition / V j 0 1 & V j transition / V j 0 unaffected by the size of the ruling coalition (proved). No revolutions from inside: N 0 n j transition N0 n j rv j 1 rv 0 j P P V j l j Ω l (3) 106

107 Revolutions The leader suffers 0 if there is a revolution attempt. Assume throughout that is large enough to always make it optimal for leaders to dissuade revolutions. This assumption aims at capturing the extremely high cost of revolution for the rulers, in a fashion similar to Acemoglu and Robinson (2001, 2006). Implication: No endogenous revolutions on the equilibrium path. 107

108 Avoiding a Revolution Leaders utility from choosing coalition Ω : W l (Ω) = * (Ω) + V l leader (Ω)* (1- (Ω)) and the revolution indicator is defined as: (Ω) = 0 if both (2) and (3) hold, (4) 1 otherwise Optimal coalition selected by a leader ethnicity l is: Ω l = arg max (Ωl) {W l (Ω)} (5) 108

109 Exogenous Transitions With probability ɛ something exogenous to the model finishes off the leader: Negative health shock; an International Criminal Court arrest mandate; a drone strike. Define this state as a transition state: Probability of an ethnicity having the next leader differs by ethnicity Let this probability be again p j (N) 109

110 Exogenous Transitions cont. Value of being in the transition state is V transition j p j N j( i j j i1, i j j i i i 0 N V ) p ( N ) I( j ) V ( ) I( j ) V Ignore here the small probability event that individual j actually becomes the leader after a transition. 110

111 Timing 111

112 Coups Coups do not destroy patronage value. In spirit of Baron and Ferejohn s (1989) proposer power, assume in each period one member of ruling coalition has the opportunity to attempt a coup. Success chance of a coup is independent of the size of the group of insiders, i.e. anyone may get the opportunity of slipping cyanide in the leader s cup. Assume the attempt is costless, coup succeeds with probability and coup leader becomes the new leader. If challenger j loses, he moves into exclusion state, denoted V j0 and gets: V j 0 0 ((1 )V j 0 V j transition ) (6) 112

113 Avoiding a Coup We focus on the case where leader l transfers sufficient patronage x i to each included elite from group i to ensure they do not exercise a coup opportunity if they get one. No endogenous coups on the equilibrium path (uninsurable coups still allowed). Leader only brings in the cabinet people they can trust and they do everything in their power to make sure this is the case in terms of incentive compatibility. Punchline: Leaders take no (avoidable) chances on people who can kill them. 113

114 How to Avoid a Coup Returns from a coup are gains from future leadership. A coup leader of ethnicity j knows he will also have to dissuade each i elite he may choose to include afterwards if he succeeds. Impose subgame perfection. The j potential leader himself will consider that his conjectured alternative plotter i is also computing an optimal set of patronage transfers to an optimally chosen coalition. If i were to stage a coup he would also have to dissuade his own coalition members from mounting coups against him, and so on Recursive problem. Simple because of assumed stationarity. 114

115 How to Avoid a Coup So the current leader to dissuade j: x j ( x ((1 ) V j F j ( ) ((1 ) V l V leader j (1 )(0 ((1 ) V transition j ( V ) ) 0 transition j j j V transition j )) )) (7) To minimize payments this constraint binds and reduces to: x j (x j F) (8) x j is independent of Ω l, independent of l Current leader l s optimal transfers x i is same as optimal transfers that a coup leader from j would also make to group i, were j to become leader Optimal transfers to any j come from (8). Full vector of realized & shadow prices of group support 115

116 The Optimal Coalition: Size How big should a leader s group of insiders be? Using (2) and (6), there exists a maximal size of excluded individuals such that these outsiders are just indifferent to undertaking a revolution, that is: N 0 (1 r) r(1 ) P Denote n* n * P n* is independent of l. (1 r) 1 r(1 ) 116

117 117 The Optimal Coalition: Size 1 * 1 * 1 * j i j i i i P n P n P n Suppose larger groups included in leader s optimal coalition ahead of smaller ones. Then define j* as the j such that:

118 The Optimal Coalition: Size We can show that large ethnic groups are always in. Why? In equilibrium large groups are cheaper per member. Intuition: leadership is less valuable in large groups because rents have to be shared among more co-ethnics. So the cheapest way to have IC bind for the current leader is to co-opt insiders from larger groups first. Groups 1 to j* -2are the "base set". Any leader will include them whole. The rounding-off differs by leader s own ethnicity and depends on the size of e l. 118

119 119

120 The Optimal Coalition: Size 120

121 The Optimal Coalition: Size 121

122 The Optimal Coalition: Size 122

123 The Optimal Coalition: Size 123