to private investment, and the degree of specialization, thus decreasing the rate of economic growth.

Public investment in resource-rich settings raises an important set of questions about the relationship between observed public expenditure levels and institutional quality. A significant strand of the policy advice suggests that oil and gas exporters should translate rents into investment for infrastructure. However, there is some evidence that this spending is often poor, in part because of the high volatility in resource revenues (Gelb and Grassman, 2010), and that institutional indicators for these settings tend to be lower (Leite and Weidmann, 1999). This presents a double bind: resource rich-settings have both rents that should be leveraged for greater public investment but also potentially relatively weaker institutional settings.

In the empirical literature, several studies have incorporated measures of corruption and institutional quality. Dal Bó and Rossi (2007) use a panel dataset of eighty electricity distribution firms from thirteen Latin American countries, and their regression results identify a robust negative relationship between corruption and firm efficiency. Haque and Kneller (2008) use a three-stage regression to show that corruption increases public investment, but lowers its rate of return on economic growth. Delavallade (2006) applies a three-stage least squares analysis to a panel of 64 countries from 1996 to 2001, and finds that higher corruption distorts spending away from social expenditures (health, education, and social protection) towards other public services, order, fuel, and energy. The author argues that social sectors may offer less opportunity for embezzlement. Cavallo and Daude (2008) use a system generalized methods of moments (GMM) estimator on a panel of 116 developing countries between 1980 and 2006 to test whether public investment crowds-out private investment. They find that there is generally a strong crowding-out effect, but this effect is reduced in countries with higher scores on the International Country Risk Guide (ICRG)’s index of Political Risk.<sup>9</sup> Another piece of the literature focuses on the institutional context in which public investment decisions are undertaken. Tanzi and Davoodi (1997) use a 1980-1995 panel dataset and find that higher levels of corruption are associated with higher levels of public investment, lower levels of operation and maintenance expenditure, and a lower level of infrastructure quality. In the same vein, Keefer and Knack (2007) investigate whether institutional quality is associated with higher levels of public investment. Using a 1974-1998 averaged cross-sectional dataset and an instrumental variables approach, the authors find that public investment is higher in countries with weak governance institutions or more limited checks and balances on governments. These results support the argument of Pritchett (2000) that cost and capital value of public investment are different concepts and that developing countries have created only little useful capital.

The specific linkage between institutional quality and volatility of capital spending has not been studied in the literature. However, Rodrik (2000), Quinn and Wooley (2001), and Mobarak (2005) all identify a negative relationship between democracy and volatility of economic growth across countries, and Dutt and Mobarak (2007) reveal that democracies are characterized by more stable policy choices. The idea is that the dispersion of decision-making authority (embedding a system of checks and balances, or veto-players) is a determinant of the stability observed in democracies, with respect to both policy and outcomes. The reasons are two. First, in a context of checks and balances policymakers need to obtain cooperation and approval of others. Second, such dispersion of authority mitigates the information problem, as

> 9 The Political Risk index includes the following dimensions: government stability, corruption, bureaucracy quality, law and order, and political conflict.

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