Endogenous Policy and Cross-Country Growth Empirics

This paper presents an accumulation-driven growth model where investment depends on public policy which in turn depends on economically important fundamentals. It is argued that conditioning on factor accumulation in growth regressions that also include policy variables may be problematic. When policy is endogenous the measured effects of policy on growth will generally be biased. Based on the model and OECD data, the signs of the biases are derived. It is shown that the measured effects on growth of tax variables related to the tax base are biased upwards and redistribution variables are generally biased downwards. Based on these signed biases the paper discusses some empirical results that seem puzzling from a theoretical viewpoint.