Credit market frictions and political failure

• Main Authors: ANEY, Madhav S., GHATAK, Maitreesh, MORELLI, Massimo
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2016
• Subjects: Adverse selection; Asset liquidation; Market failure; Occupational choice; Political failure; Property rights; Economic Policy
• Online Access: https://ink.library.smu.edu.sg/soe_research/1925
• Institution: Singapore Management University

We study how an excessively favorable regulatory environment for banks could arise even with a perfectly competitive credit market in a median voter world. In our occupational choice model with heterogeneous wealth endowments, market failure due to unobservability of entrepreneurial talent endogenously creates a misalignment between surplus maximizing reforms and reforms that are preferred by the median voter, who is a worker. This is in contrast to the world without market failure where the electorate unanimously vote in favor of surplus maximizing institutional reforms. This paper illustrates how market failure could lead to political failure even in the benchmark political system that is free from capture by interest groups.