Barriers to Investment in Polarized Societies

Abstract

I present a tractable dynamic model of political economy where disagreements about the composition of public spending result in implementation of short-sighted policies. Excessive taxation reduces the return to physical capital and hence investment rates, which slows down growth along the transition. In the long run, output, consumption and welfare are inefficiently low. The larger is the degree of polarization, the greater is the inefficiency. Political stability mitigates the effects of polarization by making the incumbent internalize the dynamic inefficiencies introduced by the choice of growth-retarding policies. JEL: D72, E22, E23, E62, H25, O16, O17