Political Institutions and their Effect on Economic Policy

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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.

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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.


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Political Institutions and their Effect on Economic Policy. (2018, Aug 24). Retrieved from


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