How Does State Capacity Affect Economic Growth?

Encyclopedia: Freedom of Enterprise, Open Markets, Money and Credit
“How many twenty-second-century bureaucrats did it take to change a light panel? We'll have a sub-committee meeting and get back to you with an estimate.”
- Peter F. Hamilton, Great North Road, June 12, 2012
If you ask the average person about what they first think of when ‘government’ comes to mind, they might imagine politicians and other high-level policymakers. However, while politicians create policies to achieve their economic, social, and political goals, ultimately they are not the ones enforcing the policies they pass. This task is left to “myriad government agencies, staffed by thousands of bureaucrats and state personnel,” though the effectiveness of these institutions and personnel can vary wildly from country to country. State capacity is the extent to which governments can “effectively implement their policies and achieve their goals,” and it is affected by numerous factors ranging from tax revenue, administrative competency, and territorial sovereignty.States with high capacity will quickly see their policies bear fruit, while governments with a weaker tax base or incompetent civil service may not see an impact from even their most ambitious reforms.
State capacity also has a number of downstream effects on a polity, one of which is its impact on economic health. Governments create the ‘rules of the game’ that shape an economy, and entrepreneurs prefer that these rules are transparent, consistent, and efficient. When a government is incapable of promptly implementing policies or enforces policies inconsistently, it creates uncertainty for entrepreneurs. Will their property rights be enforced? Will crimes be swiftly punished? Will every business be held to the same standard in government regulations? These concerns may be cause for apprehension, since investments are already intrinsically risky and added uncertainty makes it difficult to predict profits and losses. Because of this, it stands to reason that entrepreneurs in a state with low capacity might invest more conservatively to protect against heightened risk. But does this intuition hold in practice? In this case study you will use datasets from the DemCap Analytics (DCA) tool to determine whether state capacity has a positive relationship with economic growth. You will also answer questions that require you to consider what aspects of a state contribute most to its capacity, as well as what reforms could help governments bolster their state capacity.
What Is State Capacity?
While we have already established what state capacity means broadly, what different factors contribute to a state having high or low capacity? One is well-defined territorial boundaries. A state needs to have full control over all areas within its borders to effectively administer them. If a region is experiencing a territorial dispute between two states, for instance, then both governments would have a difficult time enforcing their laws there because it would be unclear who actually had the authority to enforce laws. In addition to territorial control, tax revenue is also a huge predictor of state capacity. An effective bureaucracy requires resources to pay employees to manage programs and ensure compliance with new laws. A state with less tax revenue has fewer resources to devote to its departments, meaning they will have fewer employees, and that the employees they do have will have more responsibilities. High tax revenues relative to GDP ensure that government agencies have enough resources to complete the administrative tasks expected of them. Finally, “loyal and skilled” bureaucrats are a large part of state capacity. While financial resources are a necessary component of a well-functioning bureaucracy, state capacity still requires that the civil service employs competent and motivated bureaucrats to perform its functions. We will consider each of these in turn in the following paragraphs.
Sovereignty and State Capacity
It is generally accepted that a necessary precondition for state capacity is “effective establishment of sovereignty and effective military control of an area.” States can only enforce their laws if they have complete control over a region, so any territorial disputes could drastically decrease a state’s capacity in a disputed region. States with weak territorial sovereignty can often devolve into weak or failed states that are incapable of protecting their citizens or delivering basic political goods.
Taxation
Taxation allows governments to finance expensive public bureaucracies to implement their policies. Many lower or middle-income countries, such as India, have historically struggled to implement their policies because state agencies are understaffed and under-resourced. This link between tax revenue and state capacity that some political economists use the former as a proxy for the latter.
Bureaucratic Competency
Even if governments have unlimited funds, they need motivated personnel on the ground to execute their policy directives. Though they are not directly involved in creating laws, the implementation of state policy goals largely hinges on the “level of effort” junior bureaucrats and front-line providers put into their jobs. Passionate and driven bureaucrats who take pride in their jobs are more likely to faithfully execute state policies than disinterested ones, so state capacity hinges in part on the type of bureaucrats working in government departments.
Creating a culture of highly competent civil servants requires a lot, but incentives that are influenced by the “specific nature of bureaucratic work,” namely its ambiguity and complexity, can help. Punitive measures that punish bureaucrats for failing to meet performance goals are counterproductive, since so many competing agencies affect policy implementation that direct attribution of success and blame can be difficult. For instance, a study of the Ghanaian civil service found that almost 30 government organizations worked on policy, 23 on physical infrastructure, and 20 on permits and regulations. Instead, bureaucracies should strive to recruit intrinsically motivated and mission-oriented agents, and it should afford them the autonomy to do their jobs without hierarchical monitoring. This helps bolster morale and fosters a professional culture where bureaucrats are enthusiastic about their jobs and are empowered to do their work without micromanagement.
Why Might State Capacity Affect Economic Growth?
Having established what state capacity is, one might ask how it affects economic growth. Entrepreneurs crave stability. Investments are intrinsically risky, but investors must navigate additional uncertainty if their country of business cannot effectively enforce its laws and guarantee property rights. Countries with a high level of state capacity have the resources and personnel necessary to guarantee that when “a peaceful and predictable means” through which legal disputes can be resolved. Additionally, they have institutional norms of impartiality that help limit corruption and ensure the equal application of laws to all parties.
Economists have shown that these supposed benefits of high state capacity hold in practice. Valerie Bockstette and colleagues find that the ”depth of experience with state-level institutions,” alternatively known as institutional antiquity, was significantly correlated with per capita income and the rate of economic growth across a large set of countries. In other words, more experienced bureaucracies that have proven themselves capable of large-scale administration typically exist in countries with higher economic growth.
Assignment
- Do you think that your government does a good job at implementing the policies it passes? Why or why not?
- Open the DCA tool and access the below datasets which measure some facet of state capacity. Fill out the below chart. What do you notice? Do these three variables seem to correlate with each other? As one increases, what do you notice in the others?
- Tax revenue as a share of GDP (2022)
- Percentage Territorial Control (2023)
- Rigorous and Impartial Public Administration (2023)
Tax % % Territory Control Rigorous Admin Canada Chile Sudan Vietnam Italy
- Next, fill in the chart below on economic indicators for these same countries using these datasets from the DCA Tool. Compare these results to those you collected in question 1. What do you notice about the relationship between ‘state capacity’ and economic performance (i.e. as the variables in question 1 change in ways that indicate higher state capacity, how does economic performance change)? Does this match with your expectations based on the assignment text? Why or why not?
- Real GDP Per Capita, Global (2019)
- Unemployment Rate
GDP Per Capita (2019) Unemployment Rate (2019) Canada Chile Sudan VIetnam Italy
- What do you think is the easiest way to improve its bureaucracy and, by extension, its state capacity? Is paying bureaucrats more the answer, or are there other more immaterial ways to recruit motivated workers to federal agencies?
- Of the three variables discussed in this assignment (territorial sovereignty, taxation, and bureaucratic competence), which do you think is most important in determining a state’s capacity? Are all three necessary for a state to effectively implement its policies?