Governance Regimes, Economic Mobility, and the Composition of Public Investment: Evidence from the Democratization of Villages in India

We develop a quantifiable general-equilibrium model of village governance, motivated by India’s democratization, to study how political institutions shape public goods provision and economic development. The model features two groups, landowners and landless workers, with different preferences over public goods such as irrigation, schools, and employment programs. Households from both groups can enter nonfarm entrepreneurship, but face credit-dependent entry costs. We compare oligarchy, where landowners control public goods decisions, with democracy, where electoral competition determines policy based on the relative sizes of the two groups. The calibrated model predicts that democratization’s effects on public goods and growth are not uniform; they depend on population composition and the ease of occupational mobility through access to credit. Using a 37-year village-level panel from India (1971–2006) and exploiting variation in democratization driven by state and national reforms, we find strong support for these predictions. Financial intermediation shifts landless households’ preferences from wage-enhancing policies toward schooling, increasing nonfarm business entry. As a result, democracy provides fewer schools than oligarchy when credit is unavailable, but more schools when credit is accessible. We also show that transfers to the landless increase schooling under democracy but reduce it under oligarchy. These findings highlight how governance structures and economic conditions jointly determine the effectiveness of development policies.