DP8533 Can Market Failure Cause Political Failure
|Author(s):||Madhav Aney, Maitreesh Ghatak, Massimo Morelli|
|Publication Date:||August 2011|
|Keyword(s):||adverse selection, asset liquidation, market failure, occupational choice, political failure, property rights|
|JEL(s):||O12, O16, O17|
|Programme Areas:||Public Economics, Industrial Organization|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=8533|
We study how inefficiencies of market failure may be further amplified by political choices made by interest groups created in the inefficient market. We take an occupational choice framework, where agents are endowed heterogeneously with wealth and talent. In our model, market failure due to unobservability of talent endogenously creates a class structure that affects voting on institutional reform. In contrast to the world without market failure where the electorate unanimously vote in favour of surplus maximising institutional reform, we find that the preferences of these classes are often aligned in ways that creates a tension between surplus maximising and politically feasible institutional reforms.