Political Risk: The Institutional Dimension

The argument developed in this paper is that the political arrangements and institutions that help leaders stay in office are not necessarily the ones that promote economic growth and prosperity. Indeed political leaders can remain in office more securely by rewarding the groups that keep them in power with privileged access to public resources. The net result is that the leadership remains in office but at the price of poor economic performance. It is not that the consequences of mismanaging the economy are unforeseen; rather the increased chances of an economic crisis are an acceptable price to pay if it means avoiding a political crisis which challenges the leaders' hold on power. Political survival, not peace and prosperity, is what determines the choice of policies. In this way bad economics can be good politics. The principal hypothesis addressed is that the smaller the size of the winning coalition the more the leadership depends on distributing private goods to the coalition members in order to purchase their loyalty, and, therefore the greater is the level of political risk. The ultimate effects of coalition size and the corruption attending the competition for private goods are the reduction of foreign direct investment per capita. These hypotheses were tested in a three stage least squares (3SLS) simultaneous estimation. The results generally supported the theoretical expectations.