Introduction

Models of economic systems involving government intervention must by definition incorporate policy instruments. Before the seminal work of Stigler (1971) on the theory of economic regulation and Downs (1957) on the theory of democracy, economists tended to view these policy instruments as exogenously determined. Although this specification is appropriate for some analytical problems, it certainly abstracts from the realities of political-economic life. For most applications, economic policy is dependent on the economic structure, with policy variables codetermined with endogenous economic variables generated from the political-economic system under examination.

Where government intervention has continued for a sufficiently long duration, it often exhibits certain regularities that may be captured by incorporating endogenous governmental behavior. As a result, it is often desirable for explanation and prediction purposes to establish hypotheses concerning the formation of the observed political regularities.

Political behavior may be viewed as a process of accommodation among conflicting interests. This chapter develops a conceptual formulation of the political economy that explicitly recognizes the various policy-making centers and interest groups in the political-economic system. Our theory views the political economy as a bargaining game among organized groups with conflicting interests. A political equilibrium is identified with the solution of the corresponding bargaining game. In this game, some groups are too poorly organized for bargaining, but even so, their uncoordinated reaction to policy choices affects the policy process.

Organization of the Political System

A political system, or a polity, arises whenever market-coordinated individual actions are superseded by some form of non-market collective action.