Financial Institutions and Political Capacity: New Institutional Prescription for Effective Government.

This paper shows that the high quality of financial institutions and high level of political capacity are positively correlated with each other. The government with a higher level of political capacity can provide its society with a better financial system by ensuring sufficient resources. The well established financial infrastructure enables government to mobilize more resources because government can extract its taxes more easily with a transparent financial system that makes people's resources commercially and financially visible. Therefore, financial institutions can be served as a useful device both to increase government's political capacity to mobilize resources and to improve living standard of entire society. A game theoretic model explains how this fundamental provision and extraction mechanism really works and suggests the reason why it is difficult to build advanced financial system in developing democracies. In addition to examining the case of Korea for demonstrating how those two factors are interrelated, I analyze 53 countries for the years 1989 to 1997 using panel data regression models to find general empirical results. ..PAT.-Unpublished Manuscript [ABSTRACT FROM AUTHOR]