The BBVA Foundation Frontiers of Knowledge Award in Economics, Finance and Management has gone in this fifteenth edition to Timothy Besley (London School of Economics), Torsten Persson (Institute of International Economic Studies, Stockholm University) and Guido Tabellini (Bocconi University,) for “illuminating the connections between the economic and political worlds” and “transforming the field of political economy,” in the words of the committee’s citation. The three awardees, together with the late Alberto Alesina (Harvard University), have employed both theoretical and empirical tools to examine “how political institutions and processes shape economic policies and outcomes on one hand, and how economic factors shape political institutions on the other,” contributing decisively to shape the field of modern political economy.
The work of Besley, Persson and Tabellini, the citation concludes, “has enriched economics by drawing important connections between the economy and politics,” and “has spawned a flourishing literature in several areas of the social sciences.”
An evidence-based field of study
The organization of states and their institutional structures in relation to the socioeconomic realities of their citizens has been an object of study since at least the mid-18th century, led by thinkers such as Adam Smith or David Ricardo. But these great theorists of classical economics had to make do with hypothetical cases and constructs, having no firm data to rely on, a situation that endured until the ascension of statistics in the 20th century, as John Maynard Keynes complained in his day.
In recent decades, with information more readily available, the new political economy pioneered by the awardees has brought with it two main innovations: the primacy of empirical inquiry and the use of the tools and techniques of modern economic science. Their research, which has been widely cited by social scientists of every branch, country and school of thought, forms the core of a whole new field of study — Modern Political Economy — that exhibits all the clarity of robust theory applied to solid, evidence-driven analysis. Proof of its success is a statistic quoted by Francesco Trebbi, Professor of Business and Public Policy at the University of California, Berkeley and one of the nominators of the new laureates, to the effect that “around one tenth of top journal publications in economics every year (according to the NBER Political Economy program meeting in April 2019)” build squarely on their approach.
For Mónica Martínez Bravo, a professor in the Centre for Monetary and Financial Studies (CEMFI), the awardees’ work stands out in this thriving field “for leading and lighting the way for other researchers to follow, proposing and developing new aspects and approaches to unravel the linkages between politics and economics. Beyond simply seeking to understand the sociopolitical context for public policymaking, they model the behavior of agents – citizens, institutions and organizations – and make it the centerpiece of the theoretical framework. And then they develop empirical tests to find whether these theories are supported by the facts.”
There is a broadening consensus around both the importance of institutional quality for economic development, and the potentially damaging effects of inequality on economic growth. In the last 15 years these ideas have found their way into the reports of multilateral organizations like the World Bank. Ideas drawn from the increasingly influential field of modern political economy, and elaborated by the awardees in a series of publications outstanding in their scope, quality and impact.
The first wave of the new political economy
In the mid-1970s, Torsten Persson (Stockholm, 1954) was dividing his time between higher education and his military training. He initially had his sights set on studying medicine, but changed tack in light of the experience of talking to his fellow soldiers and a visit to late Francoist Spain: “I thought I needed to widen my views on the world around me, to try and understand society, and that led me to economics and political science.”
Around the same time, in Italy, Guido Tabellini was becoming convinced that “big mistakes” were being made in economic policy: “We had a very high inflation rate, were accumulating large government debt and going through a financial crisis. Not because the economy was weak, but because policymakers were enacting very bad policies. And so, for many of us, trying to understand why those bad policies were chosen over more efficient alternatives was something that sparked our curiosity.” Among the many was his friend Alberto Alesina, another of the figures behind the birth of the new political economy who sadly died in 2020.
Tabellini and Persson would discover their shared motivations when their respective academic careers took them to the University of California, Los Angeles (UCLA) in 1989-1990. Both believed traditional analysis had been hamstrung because it looked in one direction only; at the way that policymaking acted on the real economy. What was needed, they felt, was to dig deeper and ask how economic policies were actually arrived at, how they were chosen and how they reflected the institutional environment in which they were formed: “In what would become the first wave of the political economy revolution,” Professor Persson relates, “the punchline, if you like, was that it was political and economic forces together that determined which policies got enacted in a given country.”
The result of their exchanges was the 1990 book Macroeconomic Policy, Credibility and Politics, which Persson views as the cornerstone of modern political economy, followed by talks at congresses and in lecture halls where they continued to work up their ideas. In the year 2000 they published Political Economics. Explaining Economic Policy, now a standard in its field. In both these works the authors combine insights from the macroeconomic literature on the time-consistency of policy with the theories of public choice and rational choice, as well as game theory, to explore how politics interacts with the economy in the shaping of economic policies.
In their later book, The Economic Effects of Constitutions, published in 2005, they used long time series for a number of countries to study the linkages between constitutional structures — whether a country has a presidential or parliamentary system or if the electoral rules are majoritarian, proportional or representative — and economic policymaking in areas like taxation, income redistribution programs or the provision of public goods. What they pursued in their research was a deep understanding of the institutional environment in each study state, “and all this information was there in the data,” Persson explains.
From theory to empirical evidence
At these early stages the field advanced in parallel with economics as a whole: from theory to empirical inquiry. “Many assumptions of the rational expectations theory are not applicable in real circumstances,” Tabellini points out. “So in political economics, a lot of attention is now going to how beliefs and opinions are formed. And to do that we need to exploit insights from psychology and sociology, to understand how our value systems largely influence behaviors like, for instance, the way we vote.”
Observation and empirical analysis would thus take center stage, backed by interaction with other disciplines. Political science, for instance, had elucidated how the party system in a given state tends to favor single-party or coalition governments. Persson and Tabellini expanded on this insight to show that these same trends could determine such key economic variables as levels of public spending or public debt, since a country with frequent coalition governments will lean towards greater government spending. “Political scientists had not got that far,” Tabellini remarks, “while, on the economics side, little thought had gone to how policy decisions reflect the incentives of the policymakers.”
In an extensive body of research they have found that “a clear separation of the executive and legislative powers subject to proper checks and balances is a way to prevent the abuse of power and to guarantee the smooth functioning of a democratic system,” in the words of the citation, or argued that a country’s economic growth policies can be structurally undermined by inequalities in wealth and income distribution.
The pillars of prosperity
In parallel, Timothy Besley had embarked on his own line of research at Princeton University, informed in part by Persson and Tabellini’s work as the LSE professor recalls: “In my early work I studied the impact of having term limits on politicians. In some countries, politicians have to retire, so U.S. presidents, for instance, can only serve two terms and then they have to leave. So [with Anne Case] we looked at the impact of term limits on incentives, and found that when a politician is subject to a term limit, they’re clearly not going to be thinking beyond the end of their time in office.” One consequence of this attitude was that public spending and debt rose at a higher rate.
That same year, in 1995, Besley was invited to a conference Torsten Persson was organizing in Italy in a bid to bring together researchers with an interest in this young and burgeoning field. Shortly after, the three awardees formed an interdisciplinary research group that would meet two or three times a year, and professors Besley and Persson began work on their co-publications.
Among the most far-reaching was their book Pillars of Prosperity (2011) examining he determinants and consequences of what they called “state capacity.” The three pillars referred to are, in Besley’s words: “firstly, the power to raise taxes; secondly, the ability to make and enforce laws; and, thirdly, the state’s capacity to spend wisely on things that make their citizens’ lives better, be it health systems, education systems or infrastructure.”
These three pillars, his research finds, are closely interrelated: “If you’re going to make your citizens’ lives better by providing healthcare, for instance, you need to build collective capacity. And that links to the power to raise taxes, because citizens are only willing to be taxed if the revenues are used wisely, to create, say, improvements in their lives.” Not only interrelated, then, but mutually reinforcing. “It’s not God-given that you can tax the population,” Professor Persson adds. “You need to build institutions in order to have a well-working tax system. You can’t just decide to do it. It requires purposeful action and looking for investments on behalf of the state. So we wanted to study under what circumstances a state would have appropriate motives to invest in its development.”
Besley’s subsequent research, building on the three pillars of prosperity theory, helps explain why some countries have failed to deliver development and remain fragile at best. He talks in this respect about three types of state: those whose state capacity is strong, with the pillars of prosperity in place, which are generally referred to as successful or common interest states; a second group whose regimes are perpetuated through the use of force and repression. They may display some of the defining characteristics of the pillars of prosperity, but can only sustain them by means of powerful armies, police forces subservient to their interests, changes in political mechanisms as their needs dictate, and censorship and control of the media. The term used for them is special interest states. And finally, we have the weak states, those that have failed even to establish long-run systems. Rulers come and go and they have not built state capacities to any meaningful extent.
In its citation, the committee also singles out Timothy Besley’s work on the role played by property rights and other institutions, like labor market regulation or political accountability, in the economic outcomes of developing countries. “It’s a central feature of modern political economy,” he explains. “Capitalist market systems need a way of establishing and maintaining property rights. If you have property rights, you can create incentives to invest that translate into economic growth. And so, you have economic benefits from a state that is able to build legal capacity.” Plus, as Tabellini says of tax systems, if the state sees it as good and necessary to establish or uphold property rights, it needs to have a firm grasp of the kind of politics that support them. “It’s not enough to say they’re a good idea. You have to understand how to actually bring them about and ensure their enforcement.”
