NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

External Shocks, Politics and Private Investment: Some Theory and Empirical Evidence

Sule Ozler, Dani Rodrik

NBER Working Paper No. 3960
Issued in January 1992
NBER Program(s):      ITI   IFM

The manner in which the political system responds to external economic shocks in developing countries is a key determinant of the private investment response. We look at a simple model of political-economic equilibrium to make this intuition more precise. and develop the idea of a "political transmission mechanism." Even in the confines of this simple model, we find that ambiguities abound: domestic politics can magnify or dampen the effect of the external shock. In our empirical work. we find that a high level of urbanization magnifies the investment reduction in response to an external shock. This is consistent with the supposition that high levels of urbanization are conducive to distributive politics with pernicious economic effects. We also find that the provision of political rights is conducive to superior private investment behavior.

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Document Object Identifier (DOI): 10.3386/w3960

Published: Journal of Development Economics July, 1992

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