Political Institutions and their Effect on Economic Policy
Imagine, if you will, a country with no political
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institutions. A country ruled by anarchy. What kind of
economic policy would this country have or would it have one
at all? Now imagine a country with highly powerful and
regimented political institutions. What kind of economic
policy would this country have? The two fictitious
countries mentioned above would certainly have very
different economic policies. The first would probably be
lucky to even have an economic policy at all.
Its citizens
would live in a world of economic uncertainty, never knowing
what their future may hold. On the other hand, the citizens
of the second country, although possibly unhappy with their
ruler, would at least have a pretty good idea of their
economic future. These citizens would be able to place
their money in banks and exchange it in international
markets. They could save for their future without the fear
of having everything taken from them at any given moment.
What is it though that makes the economic policies of these
countries so different? While there are clearly many
factors that affect a country’s economic policy, in this
paper I would like to argue that the most important one is
the presence or lack of strong political institutions.
In the beginning large nations or political states did
not exist. The law of the land was every man for himself.
As time went on small bands of people began to form. In the
beginning membership in such groups was voluntary, but those
who joined soon learned of the benefits of cooperation.
With time these bands became larger and larger and it was
apparent that some groups were stronger than others. The
strongest of these groups became what is known as “roving
bandits”. (Olson 1993,568). If the “roving bandits” can be
seen as the first form of political institution then the
economic policy they enforced was one of chaos. They
ravaged the countrysides taking whatever they felt they
needed or wanted without any regard as to what would be left
over for the next time they came through. As these “roving
bandits” progressed they realized that if they were to
settle in one area they could easily increase their profits.
“The gigantic increase in output that normally arises from
the provision of a peaceful order and other public goods
gives the stationary bandit a far larger take than he could
obtain without providing government.” (Ibid). The formation
of governments and political institutions by “roving
bandits” led to great economic policy changes.
No longer playing the role of bandits these newly
formed governments ditched their policy of taking what ever
they could get their hands on and replaced it with a system
of taking as much as they could without economically
destroying their subjects. With the use of political
institutions, such as, tax collectors the now “stationary
bandits” were able to enforce a new economic policy. So,
one could say that through the establishment of political
institutions the bandits were able to completely transform
Obviously, transitioning from a complete lack of
political institutions to a system based in institutions is
going to change economic policy, but in today’s world there
are very few places, if any, that completely lack political
institutions. Interestingly enough not only is economic
policy linked to the presence of political institutions it
is also dependent upon the strength of each. Over the last
couple of centuries the industrialized world has put into
place thousands of political institutions. The state has
become the most basic unit of political power. Through
these institutions countries have been able to build
national banks, stock markets, and economic tools such as
the Federal Reserve. Through these institutions governments
have been able to control the flow and value of their money.
As history also tells us the most successful of these
countries have been those whose political institutions are
stable, predictable, and strong. The political institutions
in these countries have been able to implement economic
policies on a broad scale. From the socialism of Norway to
the capitalism of the United States the point is that these
policies would not have been possible without the presence
of strong political institutions. The best way to prove
this point, though, would have to be to ponder the question
of what would happen to the economic policies of these
countries if their institutions were to be weakened
It may seem logical to prove that the strength of
political institutions is directly related to economic
policy by citing examples of strong and weak institutions
and their perspective economic influences. In today’s
global economy, though, this turns out not to be the case.
With the rise of globalization some feel that the authority
of the state is being seriously undermined. As Susan
Strange points out, “A market economy, whether global or
national, needs a lender of last resort, an authority…able
to discipline but also to give confidence to banks and
financial markets, and able to apply Keyensian logic in
times of slow growth and recession”. (Strange 1997, 366).
Strange feels that globalization has caused many political
institutions to lose their power to control the economy.
Due to the free market nature of globalization political
institutions, such as, the Congress and the Parliments may
be completely left out of the economic policy loop. This
assumption becomes even clearer when one takes a look at the
influence the World Trade Organization is capable of
In recent years the World Trade Organization has won
numerous battles for free trade. At first this may seem to
be no big deal and exactly what the WTO is supposed to do,
but the situation changes when one realizes that many of
these victories have come at the cost of laws created by
sovereign nations and their citizens. The WTO has ordered
countries to drop bans, lower tariffs, and even pay
sanctions for acts as simple as preferring to trade with
certain nations. (Citizen’ Guide to the WTO 1999, 6-10).
This would have to be taken as a sign that the WTO and
businesses involved in globalization have taken a great deal
of power away for political institutions in the arena of
economic policy. The case of globalization and the WTO
clearly proves that when the power of political institutions
is weakened so is that institutions power to create and
enforce economic policies. On the other hand one can surely
imagine that if globalization were to some how spark a
period of isolationism the same institutions who are now
losing their power would once again be back in the business
The presence and strength of a country’s political
institutions, as proven above, undoubtedly effects the
economic policies that are put into place, but are there
other factors that are more important? Some may say that
regime type or globalization are more important indicators,
but the fact remains that each of these ideas is directly
related to a country’s political institutions. Regime type
may dictate the type of institutions that exist in any given
country, but the presence and power of these institutions is
what really creates economic policy. In a dictatorship,
does the dictator alone make economic policy? No, of course
not, he places people and institutions in charge of that
sort of thing. In a democracy, does the fact that people
have a voice and a vote dictate what the interest rate will
be? No, this is the sort of thing that is decided by
political institutions. As for globalization, as mentioned
before, it does have an effect on a country’s economic
policy, but mostly because it is capable of weakening an
institution’s power to create policy.
In an ever changing world the economic policies of the
world’s countries are certain to undergo many
transformations. What is important though is the forces
that drive these transformations. It would be a lot simpler
to understand if a country based its economic policy on the
advise of some all knowing economist, but this simply isn’t
the fact. Country’s of today are forced to make their
decision on all sorts of factors. Factors which include
such things as globalization, economic models, and domestic
interest groups. Although each of these factors weigh
heavily on the minds of policy makers the fact remains that
in order to influence economic policies institutions must
exist. A country first, and foremost, must have political
institutions in place charged with the challenge of creating
policy and secondly these institutions must be strong enough
to enforce the decisions they make. Without the creation of
strong political institutions, country’s would probably
still have economic policies no more sophisticated than
those enforced by “roving bandits” centuries ago.
Olson, Mancur. 1993. “Dictatorship, Democracy, and
Development.” American Political Science Review, 87(3):
Public Citizen’s Global Trade Watch (www.tradewatch.org).
1999. A Citizen’s Guide to the World Trade
Organization. Washington D.C.: Working Group on the
Strange, Susan. 1997. “The Erosion of the State.” Current
Works Cited
Olson, Mancur. 1993. “Dictatorship, Democracy, and
Development.” American Political Science Review, 87(3):
567-75.
Public Citizen’s Global Trade Watch (www.tradewatch.org).
1999. A Citizen’s Guide to the World Trade
Organization. Washington D.C.: Working Group on the
WTO/MAI. (ISBN: 1-58231-000-9)
Strange, Susan. 1997. “The Erosion of the State.” Current
History, November: 365-69.