The Growth Effect of State Capacity Revisited

Abstract

I provide new empirical estimates of the effect of state capacity on economic development across countries over the period 1960–2022. Specifically, I construct a comprehensive state capacity index based on six different dimensions of effective state institutions available in the Varieties of Democracy (V-Dem) dataset. Then, I estimate heterogeneous parameter models under a common factor framework. My empirical strategy explicitly allows the growth effect of state capacity to differ across countries and accounts for unobserved common factors. My preferred estimates indicate that a one-standard-deviation increase in the V-Dem-based state capacity index predicts a rise in income per person by roughly 6%–7%. The magnitude of such impact equates to less than half of that implied by conventional estimates obtained under highly restrictive assumptions of slope homogeneity and cross-sectional independence. Furthermore, I provide partial evidence suggesting that worldwide heterogeneity in the economic importance of state capacity is deeply rooted in prehistorically determined population diversity, state history, long-term relatedness between countries, and interpersonal trust.