I recommend "Why Nations Fail" by Daron Acemoglu and James Robinson to anybody interested in the role of the state in economic development. It's hard to think of a more important question, and the book is a brilliant compendium of stories that bear on the issue, drawn from centuries of economic history and from all corners of the planet. The closest thing to it is "Guns, Germs and Steel"--which is brilliant too, in its way, but less persuasive about the necessary and sufficient conditions for sustained economic growth. "Why Nations Fail" has been warmly and even extravagantly praised. At the level-headed end of the spectrum is this review by Bill Easterly, which I thought very perceptive.
Much as I liked the book, I explain in a review of my own for Bloomberg that I have reservations.
The book puts heavy emphasis on "inclusive" institutions--meaning, in the economic domain, property rights and the rest. Development is all about inclusive institutions, the authors say. My problem is that "inclusive" is one of those terms that demand agreement and shut down thought. If you say "property rights and contract enforcement", a skeptic is encouraged to reply, "That's fine if you've got property, but what about those who don't?" If you say "inclusive institutions", the skeptic is invited to keep his mouth shut. No right-thinking person can object to "inclusion".
As I mention in the review, the late, great Mancur Olson gave a lot of thought to these issues. His term for Acemoglu's and Robinson's "inclusive institutions" was "market-augmenting government". That's less comfortable, and more honest.
Olson believed, like Acemoglu and Robinson, that democracy helps to ground and protect the critical pro-growth institutions. But his reasoning was a bit different.
Observation of two-party democracies tells us that incumbents like to run on a "you-never-had-it-so- good" record. An incumbent obviously would not leave himself with such a record if, like the self-interested autocrat, he took for himself the largest possible net surplus from the society. But we are too favorable to democracy if we assume that the incumbent party or president will maximize his chances of reelection simply by making the electorate as a whole as well-off as possible.
A candidate needs only a majority to win, and he might be able to "buy" a majority by transferring income from the population at large to a prospective majority. The taxes needed for this transfer would impair incentives and reduce society's output just as an autocrat's redistribution to himself does. Would this competition to buy votes generate as much distortion of incentives through taxation as a rational autocracy does? That is, would a vote-buying democratic leader, like the rational autocrat, have an incentive to push tax rates to the revenue-maximizing level?
No. Though both the majority and the autocrat have an encompassing interest in the society because they control tax collections, the majority in addition earns a significant share of the market income of the society, and this gives it a more encompassing interest in the productivity of the society. The majority's interest in its market earnings induces it to redistribute less to itself than an autocrat redistributes to himself.
That's from Olson's Dictatorship, Democracy, and Development--best known for its account of "roving bandits", "stationary bandits", and the beginnings of government. An important advantage of a less rose-tinted view of voters' desires is that it directs attention to ways in which democracies can go wrong, a topic Olson studied in depth. (See The Logic of Collective Action.) If narrow interest groups, with small encompassing interests, get control of government, they will divert income in their direction even if it makes the majority worse off. (Calling Simon Johnson.)
Needless to say, political freedom is desirable in itself, regardless of its economic consequences. We ought to want it even if it made us poorer. The economic case for democracy happens to be strong as well--but it's subtle, and needing a little more in the way of qualification. I'd say it's less to do with "inclusion" than with individualism. Collectivism is "inclusive" but it's also economically harmful. Democracies promote growth if they successfully disperse and balance the power of rival interests. In doing that, their emphasis on individual rights is what counts. As Olson put it:
[Democracies] have the extraordinary virtue that the same emphasis on individual rights that is necessary to lasting democracy is also necessary for secure rights to both property and the enforcement of contracts.