Democracy, state capacity and public finance

The paper addresses how democracy can affect public finance and state capacity investment. We show that the effect of democracy on public policy can take two forms: direct and indirect. The direct effect transpires when increasing democracy leads to an increase in public expenditure which results in increased public goods provision and reduced political rent. The indirect effect emerges when increased democracy leads to a reduction in state capacity investment and, subsequently, to a reduction in public goods provision. Paradoxically, lower political rents deteriorate the incumbent's incentive to invest in state capacity, at the expense of public goods provision.