The stabilization role of police spending in a neo‐Keynesian economy with credit market imperfections
| Author | King Yoong Lim,Pengfei Jia |
| DOI | http://doi.org/10.1111/sjpe.12258 |
| Published date | 01 February 2021 |
| Date | 01 February 2021 |
Scott J Polit Econ . 2021;68:103–125. wileyonlinelibrary.com/journal/sjpe
|
103
© 2020 Scottis h Economic Societ y
1 | INTRODUCTION
Since the contrib utions of Becker (1968) and Ehrl ich (1973), a branch of the economic l iterature on crim e has
developed, wh ere macroecono mists attemp t to study the dyna mics and macro economic implic ations of crime.
In a long-run contex t, a negative cri me-growth relat ionship has large ly been estab lished (see, for ins tance,
Imrohoroglu, M erlo, & Rupert, 2006; Imr ohoroglu, Merl o, & Rupert, 2004; Goula s and Zervoyianni , 2015), with
attempts havi ng been made to link crime to the d ifferent aspects of age nts' decisions and societ y, which include,
non-exhaustively, child-rearing time (Neanidis & Papadopoulou, 2013), job-search and labor market institutions
Accepted: 1 June 2 020
DOI: 10 .1111/sjpe.1 2258
ORIGINAL ARTICLE
The stabilization role of police spending in a
neo-Keynesian economy with credit market
imperfections
Pengfei Jia1 | King Yoong Lim2
1School of Econo mics, Nanjing Uni versity,
Nanjing, China
2Nottingham Business School, Notttingham
Trent University, Notttingham, UK
Correspondence
King Yoong Lim, Nottingham Business
School, Notttingham Trent University,
Notttingham, UK.
Email: king.lim@ntu.ac.uk
Abstract
Motivated by a seemingl y persistent “tw in-high” phenom-
enon in Latin Ame rica, we present a novel th eoretical
framework that has lin kages between thr ee institutions
(education, crimin al justice, and credit) to s tudy policy-per-
tinent research que stions with regard s to whether police
spending has the pote ntial to serve as an unconvent ional
policy tool for macro economic management . Based on a
stylized param eterization, we find f ormal and illegal huma n
capital to share com mon cyclical prope rties, which ca n be
"decoupled" under a r ule-based regime to police s pending.
This nonetheless co mes at a cost of a greater propagation of
the credit frict ion-induced financial accelerator ef fect.
KEYWORDS
crime, credit market imperfection, human capital investment,
police spending
JEL CLASSIFI CATION
H39; H50; K42; E44; E61
104
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JIA And LIM
(Engelhardt, Ro cheteau, & Peter, 2008), inequ ality (Burdett, L agos, & Wright, 2003; Kelly, 20 00), and human cap-
ital investme nt choice (Mocan , Billups, & Overla nd, 2005). Never theless, macroeconomist s have thus far short
of examining crim e in a shorter ter m, macroeconom ic stabilizat ion context, due t o the policy link ages between
education, criminal justice system, and financial/credit, being often overlooked by macroeconomists.
This oversight is epi tomized by the theo retical treatm ent of the fiscal v ariable, government expenditure on
public order and safety (commonly dubbed—slightly inaccurately—as police spending in short, despite the spe cific
fiscal compo nent covering budget s to both crimina l justice and judic iary/legal bran ches of the governme nt in-
stitutions), whi ch is merely treated as one of the many c omponents that constitut e government expenditure. A s
such, the commo n (mis)perception is that, th ere is no policy value in this v ariable in terms of it being em ployed as
a policy tool in ma croeconomic managem ent. While this is true in m ost economies where cr ime is insignificant, a n
argument can b e made that this specific fisc al variable has a potential role to se rve as an unconventional policy
tool (that complements/supplements conventional policy tools for macroeconomic stabilization, i.e., monetary
policy) beyond t he common-sense p rescription of hig h level of spending to re duce crime. This is e specially in-
triguing in econ omies where: (a) org anized crime is per sistent and crimi nal activitie s are a significa nt part of an
individual's income-earning opportunities, à la Mocan et al. (2005); (b) robust empirical links between business
cycle fluctu ations and crime are well est ablished (see, for instan ce, Arvanites & Defina , 2006; de Blasio, Maggio,
& Menon, 2016; Bushway, Cook , & Philips, 2012; Detotto & Ot ranto, 2012).
This paper contr ibutes to the literature by pres enting a novel theoretical f ramework that has linkages bet ween
the institutions: education, criminal justice, and credit. Motivated by a seemingly persistent “twin-high” phenomenon
observed in L atin America ( high crime rate, hi gh financial ins tability), we deve lop a model based o n a Mocan
et al. (2005) st yle framework with dif ferentiated human cap ital and criminal act ivities, interacti ng with a production
sector in which the firms face credit frictions.1 We highlight three nove l linkages in our model that relate cr ime to
credit market: (a) or ganized criminal exto rtions impose an addi tional "tax" onto th e unit marginal produc tion costs of
firms, which t hen influences their optimal c hoice of the level of physical capit al and workers employed. Given t hat
firms borrow to p ay their wage costs (Ravenna & Walsh, 2 006), crime therefore dire ctly influences the dema nd for
credit; (b) the phys ical capital stock of f irms is used as collateral fo r loan; crime therefore als o influences the compo-
nent of credit risk p remium that depends on t he collateral; (c) in sett ing its credit risk prem ium for the gross loan rat e,
on top of collateral c harged, bank also accounts f or the aggregate level of crime r ate in the economy. Indeed, thes e
model feature s are consistent with evi dence in the Latin A merican region, 2,3 which as seen in Figu re 1, has a relatively
low level of government e xpenditure on public s afety and a small number of p olice personnel to begi n with.
In addition to the t heoretical contr ibutions, the mod el also sets the sta ge for us to study three p olicy-pertinen t
research ques tions, especially in regard s to whether government expendi ture on public order and safet y (police
spending, in sh ort) has the potential to se rve as an unconventional poli cy tool for macroeconomic s tabilization in
a “twin-high” eco nomy. These questions necessa rily requires us to underst and the cyclical proper ties of the key
1In an economy wh ere criminal ac tivities are a s ignificant p art of an indivi dual's income- earning oppo rtunities, t his creates a dir ect trade-of f of time
between en gaging in forma l market works an d crime. This the n has an effect o n individuals' c hoice in pursui ng formal human c apital accum ulation/
education . Given that exp enditure on pub lic order and saf ety directl y influences cr ime, this means t here is an obviou s linkage betw een formal
education a nd this policy v ariable that cov ers both the cri minal justice an d judiciary/le gal functio ns of a government in stitution in pr actice.
2For instanc e, the material co sts of crime are e stimated to add u p to about 3.6% of GD P for Latin Amer ica (Londoño a nd Guerrero, 2 000; Jaitm an
and Torre, 2017). Cr ime is said to consi stently unde rmine busines s activities a nd therefore di sincentivize h uman capital a ccumulation ( Ayres, 1998).
For the latte r, Londoño and Gue rrero (2000 ) estimate that t he net accumula tion of human cap ital in Latin A merica is half of w hat it ought to be du e
to the prevale nce of crime. For f urther examp les on organize d crime in Latin A merica, see a lso, UNODC (2012 ), and Oguzoglu an d Ranasinghe
(2017).
3Notwiths tanding the mu ltiple episod es of financial c rises seen in La tin America d uring the 1990s, i n terms of the featu re on overall high c rime
rate-induce d business unce rtainty le ading to higher c redit risk prem ium being price d in the region, a co njecture can b e made by examini ng the data
on non-per forming loans (N PL) net of (loan lo ss) provisions to ba nk capital. D espite the regi on has a generall y stable overa ll NPL rate, the aver age
NPL net of (loan l oss) provision in t he region is negat ive. Specifi cally, between 2 006 and 2018, 13 of t he non-Britis h Caribbean L atin America n
economies h ave a negative valu e for the indica tor (for comparis on, the world ave rage is 16.71). This imp lies that bank s in the region make
over-provision for potential loan losses.
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