Dispatch #92: Building strong states: The political & economic foundations of state capacity
This dispatch delves into Timothy Besley/Torsten Persson's exploration of state capacity; how legal & fiscal institutions evolve through economic incentives, political stability & public goods demands
In this dispatch, I continue exploring the meaning of state capacity by delving into canonical research on state capacity.
Timothy Besley and Torsten Persson's paper, The Origins of State Capacity: Property Rights, Taxation, and Politics, provides a profound theoretical framework for understanding how states develop their capacity to enforce property rights, raise taxes, and provide public goods. Moving beyond conventional historical explanations that focus on wars or colonial legacies, the authors delve into the economic and political incentives shaping state-building, offering rich insights into why some nations develop robust institutions while others fail.
Understanding state capacity: A dual framework
State capacity refers to a government’s ability to effectively implement policies, enforce laws, and support markets. Besley and Persson categorize state capacity into two key dimensions:
Legal capacity: The ability to enforce contracts and protect property rights. A state with strong legal capacity creates a secure environment for businesses and individuals, fostering investments and market growth.
Fiscal capacity: The ability to raise taxes efficiently. This ensures governments can fund public goods, from infrastructure to welfare programs, without excessive reliance on debt or external aid.
A central argument of the paper is the complementarity between these capacities. Legal capacity supports markets and generates taxable economic activity, while fiscal capacity provides the revenue necessary to strengthen legal institutions. This interdependence creates a virtuous cycle of institutional development, particularly in states committed to long-term growth.
Historical context: The role of wars and crises
Historically, scholars like Charles Tilly have argued that wars were pivotal in building state capacity. The fiscal demands of war often led governments to establish systems for taxation and resource mobilization, which then became permanent fixtures. For instance:
Britain introduced income taxes during the Napoleonic Wars to finance military campaigns, later expanding its fiscal system during World War II.
The U.S. established the Internal Revenue Service (IRS) during the Civil War to manage war-related fiscal pressures.
The authors extend this argument by emphasizing that wars are a specific instance of a broader phenomenon: the need for common-interest public goods. Whether through war or welfare, states that successfully provide such goods tend to invest more in legal and fiscal capacities.
Political economy of state-building
A standout feature of Besley and Persson's analysis is their focus on the political determinants of state capacity. While economic needs drive investments in institutions, political contexts determine whether those investments are made and how effective they are.
Redistributive politics
Political elites often have conflicting interests that influence state capacity development. For instance, elites may resist investments in fiscal capacity if it leads to redistributive taxation. Conversely, elites with a stake in economic growth may champion stronger property rights and market-supporting institutions. This dynamic explains why states with entrenched inequality often have weaker fiscal systems, as elites prioritize their economic security over broader public goods.
Identity and inclusiveness
The inclusiveness of political institutions plays a crucial role in state-building. Democracies, with their emphasis on representation and accountability, are more likely to invest in legal and fiscal capacity. However, even in democracies, identity politics—such as ethnic or religious divisions—can skew investments, with states favouring certain groups over others. For instance, in ethnically diverse societies, ruling coalitions may underinvest in regions dominated by minority groups, perpetuating inequality and undermining national cohesion.
Stability and long-term investment
Political stability is another critical factor. Stable governments with long-term horizons are more likely to invest in state capacity, as they can reap the benefits of those investments over time. In contrast, unstable regimes or those prone to frequent changes in leadership often focus on short-term gains, neglecting the institutional foundations necessary for sustained growth.
Theoretical model: A dynamic perspective
The authors propose a dynamic, intertemporal model to explain the evolution of state capacity. Key takeaways include:
Complementarity: Investments in legal and fiscal capacity reinforce each other. For example, stronger property rights (legal capacity) boost economic activity, which expands the tax base (fiscal capacity).
Economic and political incentives: States are more likely to invest in capacity when:
Economic gains from trade or market development are high.
The demand for public goods, such as defence or welfare, is significant.
Political stability reduces uncertainty, encouraging long-term planning.
Role of wealth and trade: Wealthier countries or those with higher economic gains from trade are more likely to invest in state capacity. This explains the correlation between economic development and institutional quality.
Inclusive vs. extractive institutions: Inclusive political regimes, which represent a broad spectrum of society, tend to prioritize public goods over elite interests, fostering better institutions. Extractive regimes, on the other hand, often underinvest in state capacity to maintain elite dominance.
Case studies and empirical evidence
The authors back their theoretical arguments with historical and empirical examples:
Sweden: Early investments in taxation systems during the 13th century laid the groundwork for its modern welfare state.
Britain: The Glorious Revolution of 1688 ushered in a period of political stability and elite cooperation, enabling significant investments in fiscal and legal capacity. These institutions proved crucial during the Napoleonic Wars and the Industrial Revolution.
United States: The establishment of the IRS during the Civil War exemplifies how crises can drive institutional innovation.
Cross-country data further support the model’s predictions, showing positive correlations between taxation, financial development, and economic growth.
Policy implications
For policymakers, the paper offers several actionable insights:
Invest in complementary capacities: Strengthening both legal and fiscal systems yields the greatest long-term benefits.
Focus on public goods: Prioritizing common-interest goods, such as education or infrastructure, can create the political consensus needed for institutional reforms.
Address political constraints: Successful reforms must align with the interests of political elites while ensuring inclusivity and minority representation.
Conclusion: Building Better States
Besley and Persson’s work is a landmark contribution to our understanding of state capacity. By integrating economic and political factors into a unified framework, they offer a nuanced perspective on why states succeed or fail in building robust institutions. Their findings underscore that state-building is not just a technical challenge but also a deeply political one.
For nations striving to strengthen governance and promote development, this paper serves as both a diagnostic tool and a guide. By addressing political constraints and investing strategically in legal and fiscal systems, states can lay the foundation for sustained growth and stability. This approach is particularly relevant in today’s world, where the challenges of inequality, polarization, and global crises demand stronger and more resilient institutions.