London School of Economics EOPP: Economic Organisation and Public Policy Programme LSE
EOPP: Economic Organisation and Public Policy Programme

Current EOPP Research:
Can Market Failure Cause Political Failure

Madhav Aney and Maitreesh Ghatak (with Massimo Morelli, Columbia)

Abstract:

How can market failure interact with choice of institutional reform made by an electorate? The authors study this question in the framework of occupational choice where agents are endowed heterogeneously with wealth and talent. In their model, market failure due to unobservability of talent endogenously creates a class structure that affects vote on institutional reform. They find that the preferences of these classes may be highly non monotonic in wealth and are often aligned in ways that creates a tension between institutional reforms that are growth maximizing and those that are politically feasible. This is in contrast to the world without market failure where the electorate unanimously votes in favour of surplus maximizing institutional reform. They find that inefficiencies of market failure may be further amplified by political choices made by interest groups created in the inefficient market.

Related paper

Can Market Failure Cause Political Failure?