The fiscal roots of urban bias

Abstract

Why do some countries indulge in urban bias, potentially harming economic development in the process, while others promote a vibrant agricultural sector? Two main explanations have been put forth. On the one hand, market failures, due to information asymmetries, mean that farmers who dearly require credit to succeed are shut out of lending markets, even if lenders could potentially benefit from making loans more readily available. On the other hand, political failures, due to state capture, mean that farmers will be subject to implicit taxes as a way of generating rents for politically powerful, industrial interests in the city. This paper builds on the latter view and corroborates [Bates, Robert. 1981.Markets and States in Tropical Africa.Berkeley, CA: University of California Press.] insight that the state might have its own fiscal reasons for indulging in urban bias since both infant industries in the manufacturing sector and monopsony endowing marketing boards in the agricultural sector potentially provide easy-to-collect revenues. I adduce cross-national empirical support for the fiscal roots view that is robust across measures of state capacity and instrumental variables. A case study of Mexico also provides supporting evidence.