5 Institutional Economic Framework Geography Culture Politics Political MACRO-economics Political MICRO-economics Political System = Allocation of Power Resources Economic System = Allocation of Economic Resources
6 political system allocates “de jure” power + “de facto” power inequality by nature, still inequality in society equality by nature, but inequality in society political system allocates “de jure” power + “de facto” power inequality by nature, but equality in society equality by nature, still equality in society = inclusive institutions Why Nations Fail
7 political system allocates “de jure” power + “de facto” power inequality by nature, but equality in society equality by nature, still equality in society Democracy is defined as all individuals can vote, and their voting influences which social choices and policies are adopted.
9 Fundamental Assumptions 1.economic-based: economic incentives on political outcomes 2.conflict: different groups have opposing interests over political outcomes == political institutions 3.political institutions play a central role of solving conflict
10 Some Model Assumptions 1.rationality: individuals have well-defined preferences over outcomes or the consequences of their actions 2.unique policy instrument: income tax rate 3.balanced budget under bureaucratic cost: 4.two-class society:
13 poorrich 13 the poor prefers high tax rate (= high transfer) the rich prefers low tax rate (= low transfer)
Under Full Democracy The poor is majority >> The poor sets tax rate for the whole society. If inequality exists (y p > Transfer r, p >> r. p is set for the whole society, not r. Conflict between rich and poor exists. Under full democracy: no conflict iff no inequality
15 Under Full Autocracy Elites control de jure power, and citizens can exercise de facto power. Elites set tax rate Citizens can make revolution (R); under revolution constraint.
33 2. Only way to reduce conflict is to reduce inequality. If inequality exists, conflict exists. 3. Effective way to reduce inequality (to reduce conflict) is on pre-tax income, not post-tax income. 1. Under inequality, political market and economic market cannot be in equilibrium at the same time, always.
34 4. Bureaucratic cost, including corruption, not only decreases efficiency, but also increases conflict. 5. Almost full democracy is better to reduce conflict in society with high inequality, and near democracy is better than near autocracy. >> in the aspect of INCLUSIVENESS 6. Inclusion of Middle Class and the poor and creating political arena are important for democratization.