A political economy model of resource pricing with evidence from the fuel market

A political economy model of resource pricing with evidence from the fuel market

Published Jan 2002

Author

H. Esfahani

Publisher

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An improvement in democratic institutions may initially lead to distortionary economic policies

Why do prices of resource products such as energy differ widely between countries? This paper offers an explanation for this by examining the relationship between institutional developments and economic policy, and in particular, resource pricing.

The existing literature on political economy identifies some of the causes of inefficient redistribution. However, it does not explain the wide policy variations in resource pricing across countries. The paper develops a political economy model of resource pricing to examine these issues. Fuel price data is then used to test the model.

The paper suggests there is a U-shaped relationship between the efficiency of redistribution and the institutional capabilities of the public to monitor and discipline the politicians. The paper indicates that:

  • when the public has no control, politicians can appropriate all the funds from resources like oil towards their private interests
  • when there are strong checks and balances and competitive elections, the public has more control to prevent misappropriation of resources and enjoy the resources, and prefers efficient pricing transfers
  • where there are some improvements in democracy, the public may initially demand a share in the economy’s rent through distortionary policies that transfer the rents in-kind and limit the funds that politicians can divert towards their private interests

Based on these perspectives, the paper suggests that:

  • institutional developments may not always have the same effects on the efficiency of economic policy
  • as democratic institutions develop in a country, governments tend to initially adopt distortionary distributive policies
  • efficient redistributive schemes are usually only adopted at higher stages of institutional development

The paper concludes that this could explain why the spread of democracy has been associated with a proliferation of distortionary policies in developing countries over the past few decades.

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