The evolution of the welfare state over the last few decades has differed strikingly across countries in the world. For example, spending on social benefits as a fraction of GDP has substantially increased in the US since 1980, remained stable in Canada, and declined in Sweden. To explain these different trends, I propose a model with agents that are heterogeneous in occupation and wealth, and who vote on social benefits over the course of their lifetime. The model highlights the key role of “aspirational voters”—members of the middle class who support pro-business policies and sacrifice social benefits hoping to become future entrepreneurs. The importance of aspirational voters, in turn, depends on wealth inequality. The model predicts that social spending should increase in rich countries with high wealth inequality, while it should decline if inequality is low. A calibrated version of the model successfully predicts the observed trends of social spending in 18 out of 24 countries from all continents.

This article explores the political and economic origins of size-contingent Employment Protection Legislation (EPL), which imposes stricter requirements on larger firms. The theory is based on the political conflict between workers and entrepreneurs that is shaped by endogenous occupational decisions. The equilibrium policy protects only workers in larger firms, regardless of the government’s political orientation. Firms strategically adjust their labor demand in response to the size-contingent policy, causing welfare distortions. These distortions can be eliminated by balancing the bargaining power of workers and entrepreneurs. A dynamic extension of the model rationalizes the long-term stability of size-contingent EPL within countries.

I exploit the staggered adoption of U.S. state-level Employment Protection Legislation (EPL) to study its effects on labor earnings and firms’ profits. I find that EPL has unintended regressive consequences. EPL harms smaller firms and their workers, while only benefiting larger firms and their workers. The effects on smaller firms are driven by EPL limiting access to credit and raising debt costs, forcing them to reduce investment and employment. Conversely, larger firms expand their operations due to a decrease in their cost of debt. A model with heterogeneous firms and endogenous financial constraints guides the empirical analysis.

This paper models policy-making as an intricate process in which governments balance political and economic considerations. I incorporate this view into a macro model with heterogeneous agents who face idiosyncratic shocks and express their political sentiments. I provide analytical results when political sentiments are uniformly distributed and independent over time. The model endogenously sorts people into three categories depending on their policy demands; the “indifferent”, “the sensible”, and “the senseless” citizens. Policy-making responds mainly to the dynamics of sensible agents, but the survival of the government can be threatened by senseless agents. I expand the model to consider a general distribution of sentiments that depends on past sentiments so that the government takes into account the future threats of its current policy decisions. The model allows for a structural empirical approach to disentangle how economic versus political grounds have influenced policy decisions and the process of development across countries.