Optimal Political Institutions in the Shadow of Conflict
Abstract: Two players with conflicting interests make investments and then decide whether to trigger a conflict or maintain peace. In case of conflict, these investments determine the players’ fighting strength and hence their payoffs. In case of peace, preexisting common political institutions determine the players’ payoffs as a function of their investments. We consider the set of political institutions with full information and full commitment and characterize the set of investments compatible with peace. We show that, to maintain peace, the most efficient political institutions may nonetheless distort the players’ investments away from the first-best levels. We find conditions under which this distortion is so large, that political institutions capable of maintaining peace do not exist. Therefore, we provide a novel explanation to why rational players may engage in an inefficient conflict, and to why inefficient political institutions exist.
