The Quality of Institutions and the Composition of Government Expenditure: a Theoretical Model

This paper investigates the effect of redistributive politics on the composition of government expenditure. By applying a dynamic and complete information game, it is shown that the quality of institutions is a key determinant of how much the government revenue is spent on public goods. The main finding of this paper is that in democracies with high quality of institution, less transfer is demanded through election period, but when the quality of institutions is low, voters prefer more direct transfer despite the high positive externality of public goods on production (and income), this fact in turn can lead to populism. This model can explain why in some occasions, the majority of population vote for a populist candidate who promises extreme redistributive policies at the expense of other policies which are harmful for economic growth in the long-run.