This chapter focuses on the productive role of government in improving the environment for doing business. Improvements in the performance of government are measured as total factor productivity and differences in income across countries can be explained by differences in the quality of their economic institutions. This makes it essential to understand why some countries make the right investments in legal institutions and deploy such legal capacity effectively. A running theme of the chapter is the possibility of a complementarity between the extractive (taxation) and the productive (supporting markets) roles of government. This is at the heart of the empirical observation that market development and state development move hand in hand. But the key insight from this is that we have to understand the incentives of a government to make investments to improve the workings of the economy.
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