Are All Democracies Equally Good? The Role of Interactions between Political Environment and Inequality for Rule of Law

This paper studies the endogenous evolution of economic and political institutions and the interdependencies with the rocess of economic development. Favorable economic institutions in form of a state of law and the absence of societal conflict are not assumed exogenously under certain political systems, but arise in equilibrium. The model delivers several new results. Efficient oligarchies can emerge in equilibrium and persist supported by all groups. Democracies are neither necessary nor sufficient to implement a state of law, even if they may be instrumental. A taxonomy of politico-economic equilibria shows the evolution of institutions depending on economic inequality. We find a non monotonic relationship between inequality and state of law. The model allows to analytically characterize the dynamic emergence of different institutions, highlighting the role of natural resource abundance and inequality for endogenous institutional change and the timing of democratic transitions. The model can generate episodes of reversal of fortunes as result of endogenous institutional change. A simple simulation illustrates the evolution of the economy.