European Economic Review , v42, n7: 1317-41.
This paper addresses the question why investment rates differ so markedly across countries. In the paper a model is laid out explaining why governments in unstable and polarized societies may not have sufficient incentives to undertake legal reform so as to fully protect property rights, and how this may hold back private investment. The model yields testable predictions regarding the link from political instability to the quality of property rights, as well as the link from property rights to investment. These predictions hold up when confronted with cross-country data for around 100 countries. In particular, once I control for the quality of property rights, the different measures of political instability and polarization employed have no direct effect on private investment. Thus, a possible link between political instability and investment is identified. Extensive sensitivity analyses show that the empirical results are robust to an ample of prospective statistical problems.