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 my 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.