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This paper provides a framework that decomposes aggregate total factor productivity (TFP) into a component reflecting relative efficiency across sectors, and another component that reflects the absolute level of efficiency. A development accounting analysis suggests that as much as 85% of the international variation in aggregate TFP can be attributed to variation in relative efficiency across sectors. Estimation results show that recent findings highlighting the importance of strong protection of property rights, financial development and geographical advantage for the level of TFP, can be explained by their impact on relative efficiency.

We document empirically that rich countries are more politically cohesive than poorer countries. In order to explain this regularity, we provide a model where political cohesion is linked to the emergence of a fully functioning market economy. Without market exchange, the welfare of inherently selfish individuals will be mutually independent. As a result, political negotiations, echoing the preferences of the citizens of society, will be dog-eat-dog in nature. Whoever has greater bargaining power will be willing to make decisions that enhance the productivity of his supporters at the expense of other groups in society. If the gains from specialization become sufficiently large, however, a market economy will emerge. From being essentially non-cohesive under self-sufficiency, the political decision making process becomes cohesive in the market economy, as the welfare of individuals will be mutually interdependent due to the exchange of goods. We refer to this latter state as "capitalist cohesion".