The Price of Institutional Design: Biased Territorial Representation and Argentina’s Great Depression, 1998–2002

This year marks four decades since the publication of James O’Connor’s landmark The Fiscal Crisis of the State.¹ In this groundbreaking contribution, O’Connor argues that the capitalist state faces two major challenges to withstand inexorable fiscal crises. The first hinges on the ability of the state to balance its expenditure compromises and revenue competences. The second unveils how the state may become prey to a host of special interests organized around labor, business, or the poor. These political pressures, in essence, engender a great deal of inefficiencies, in addition to the proliferation and perpetuation of pork-barrel policies.

While O’Connor wrote his book at the onset of the 1970s Oil Crises, the world has since then undergone a more or less permanent fiscal crisis. Several factors underlie the imbalances that cause countries to experience such crises. Previous work has emphasized the causal effects of distortionary macroeconomic policies, external conditions such as large abrupt changes in world interest rates or the terms of trade, and the quality of governance in emerging market countries.² However, a budding corpus of scholarship in political economy set out to provide evidence that probably the fundamental cause of fiscal instability is its institutional nature. In addressing the institutional dimension of the political economy of crises, Bates’ seminal work on Africa and his subsequent study of the collapse of the International Coffee Organization show that in institutionally weak societies, elites and politicians count on various ways of expropriating different segments of the society via different fiscal policies.³ It is the presence of this type of expropriation and the power struggle to control the state to take advantage of the resulting rents that underlie fiscal instability. Arguably, weak institutions impinge on several dimensions. For example, Acemoglu and Robinson show how “weak institutions” might encourage coups and revolutions, leading to political and economic instability.⁴ Alternatively, institutional failures may also make fiscal adjustment unlikely. In an important paper, Rodrik suggests that countries with weak institutions are unable to deal with major economic shocks, suggesting an important interaction between global trends and institutions.⁵ In theoretical terms, institutional weakness then leads to structural fiscal vulnerability. The underlying assumption, then, is that institutional weakness amounts to a main source of predicaments in distributive politics. Framing political dynamics in terms of their transaction costs,⁶ contested institutions engender opportunity structures for politicians and elites to expropriate collective goods and rents. Weak institutional designs are vulnerable, the argument goes, because they fall short of enforcing rules of the game to cope with policy uncertainty and crisis. Strong institutional frameworks, by the same token, constrain politicians and political elites, restraining excessive political horsetrading and its related collective-action problems.

This article takes aim at this prevailing conventional wisdom and suggests that institutions, be they weak or strong, can at times undermine the normative purposes for which they were created in the first place. What is more, strong, historically persistent, institutional arrangements have unintended distortionary fiscal consequences that extant institutionalist research often fails to acknowledge. My main contention is that transaction costs and related public policy approaches overstate the merits of equilibrium models of institutional persistence. In fact, the aspects being praised by said approaches such as institutional resilience may ultimately compound deadlocked and perennially malfunctioning political arrangements. These analytical perspectives actually overlook instances of perverse institutionalization of political power, namely when groups and entities holding political power at a certain point have strong incentives to manipulate institutional arrangements to protect their interests in the future.

In this study, I focus on the manipulation of territorial institutional design, which results from the political empowerment of economically marginal subnational units that at times occurs in federal and decentralizing polities. While said empowerment, bequeathed as the legislative overrepresentation of economically vulnerable territorial units, is bestowed in a historical compensatory spirit, it often perpetuates a vicious circle of inefficient (one could argue, unfair) territorial redistribution. In this regard, this article aims to underscore how federal institutions beget unintended economic and fiscal results. Likewise, it seeks to...