Creditor protection and the dynamics of the distribution in oligarchic societies

Abstract

This paper analyzes the impact of weak contracting institutions on economic development and the wealth distribution in a Ramsey-type growth model. We show that, at low levels of accumulation, weak contracting institutions strongly favor the economic elite: By preventing market entry, such institutions provide the "oligarchs" with cheap access to credit-which is highly beneficial as long as capital is scarce. At the same time, a broad crosssection of society faces only low returns so that capital accumulation is slowed down and the capital stock gets concentrated in the hands of the elite. At higher levels of development, however, weak contracting institutions are harmful to all segments of society and institutional reform becomes unanimously supported. So the model helps to explain the pervasiveness of weak contracting institutions in less-advanced economies.

Oligarchic Versus Democratic Societies

“…The tax rate on entrepreneurs, τ t , is set. 1] or (more formally) the mapping a t : [0, 1] → {A L , A H }, which assigns a productivity level to each individual j , and similarly for [e j t ], et cetera. Entry barriers and taxes will be set by different agents in different political regimes as will be specified below.…”

“…There is now a growing consensus that institutions protecting the property rights of producers are essential for successful long-run economic performance. 1 Nevertheless, "protection of property rights" is not a panacea; many oligarchic societies where political power is in the hands of the economic elite (e.g., the major producers/investors in the economy) provide a high degree of protection to these asset holders but do not always achieve successful economic growth. 2 Perhaps the clearest example is provided by the Caribbean plantation colonies, where political power was concentrated in the hands of the monopoly of plantation owners; while the elite's property rights were highly secure, the large majority of the population-the slaves-had few political or economic rights.…”

Nonlinearity in the financial development–income inequality nexus

“…Thus, the poor are often excluded from finance and unable to invest sufficiently in human and physical capital. Furthermore, as demonstrated by Oechslin (2009) and argued by many others, only at the early stages of development when capital is scarce, a powerful group has strong incentives to push for such distortions; at more advanced stages where capital is no longer scarce, all segments of society unanimously support strong contracting institutions.…”

Foreign Direct Investment and Income Inequality: Human Capital Matters

“…However, economies with low levels of initial human capital will attract less technologyintensive FDI, and this type of FDI will play a smaller role in the future development of these economies (Aitken and Harrison, 1999). 6 For instance, a strong protection of property rights through the legal system is associated with higher FDI flows (Habib and Zurawicki, 2002;Egger and Winner, 2006), and makes appropriation of the poor's income through rent seeking by the rich impossible (Rajan andZingales, 2003a, 2003b;Gradstein, 2007;Oechslin, 2009). Better public governance that reduces opportunities for rent seeking and increases quality of education and health care is related to lower income inequality and greater foreign investment (Gupta et al, 2002;Gyimah-Brempong, 2002).…”

“…For instance, a strong protection of property rights through the legal system is associated with higher FDI flows (Habib and Zurawicki, ; Egger and Winner, ), and makes appropriation of the poor's income through rent seeking by the rich impossible (Rajan and Zingales, , ; Gradstein, ; Oechslin, ). Better public governance that reduces opportunities for rent seeking and increases quality of education and health care is related to lower income inequality and greater foreign investment (Gupta et al., ; Gyimah‐Brempong, ).…”