Politico-economic transition

Political and economic transitions of non-market economies often go hand in hand. We propose an economic theory of this transition process, which highlights how the success of such a transition depends upon the policies chosen in the new democratic environment. In this paper, economic success is characterized by the continual adoption of new technology (and economic growth), which requires costly human capital investment. The political choice is whether to allow the adoption of new technology. As a non-market economy begins its transition, agents with human capital specific to a particular technology find it in their interest to vote against continued innovation. As such, the transition to a market economy can be choked off. Our theory has the following features: (i) an economic transition is associated with a substantial drop in output; (ii) it is in the interest of large groups in the population to resist laissez-faire, as factor payments equal marginal products in the post-reform economy; (iii) although the joint move to democracy and a market economy does make people better off, it is insufficient for the transition to be successful, as the number of agents with a vested interest against continued innovation grows; and (iv) a temporary restriction on voting rights which ensures a laissez-faire regime is sufficient to produce long-run prosperity. This restriction may not be only one capable of overcoming the anti-innovation interests. Other mechanisms such as supermajority rules on policy changes may also guarantee laissez-faire.