Political Institutions and their Effect on Economic Policy

Political Institutions and their Effect on Economic Policy

Imagine, if you will, a country with no political

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.