The Political Economy of Credible Agreements: Political Settlements, Incentives, and the Configuration of Deals

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Attaining economic and political development requires resolving a set of collective-action problems (CAPs)—that is, problems that arise when individuals following their own inclinations and incentives generate undesirable outcomes for some group. There are two basic types. First-order CAPs involve externalities, common pool resources, public goods, excess conflict, and other market failures. Resolution entails forging agreements about sharing many associated costs and benefits. Implementing such agreements, however, requires creating functional and credible mechanisms for coordination and enforcement: it requires resolving a set of underlying second-order CAPs. Resolution usually involves creating institutions. Institutional creation, in turn, depends on achieving some form of political settlement—that is, a mutual understanding among powerful parties that they will utilize politics rather than violence to settle disputes. By establishing boundaries for violent conflict, political settlements address the most fundamental collective-action problem of development.

Long-term economic development requires managing a series of CAPs that inhibit the emergence of credible commitments by powerful parties—both private and public—that they will not seize the benefits from others’ investments in effort, knowledge, and physical capital. This paper presents a relatively simple game-theoretic model of micro-level exchange agreements—with attention to meso- and macro-level constraints from surrounding economic and political environments. Specifically, the model denotes a set of conditions that facilitate “ordered” (i.e., predictable) as opposed to “disordered” (not predictable) deals. A deal is an exchange agreement that need not have the attributes of a formal contract. The model’s macro-level parameters reflect the relevant a society’s type of political settlement. Its meso-level parameters reflect the relevant configuration of market power and a markets’ internal or external orientation. The model presents a conceptual foundation for evaluating and predicting the success or failure growth-oriented policies.