The Spatial Dynamics of State Capacity: How Segregation Undermines Governance in Cities

State capacity is a key determinant of development and institutional performance. I argue that in unequal contexts, income-based residential segregation weakens local state capacity by shaping citizens’ quasi-voluntary compliance with fiscal institutions and limiting politicians’ incentives for investment in state capacity. While existing research shows that local governments provide fewer public goods in segregated cities, I contend that segregation generates spatial inequalities that affect how low-income individuals engage with the state, fostering an equilibrium of informality and low government capacity—a weak state trap. I assess this argument using the case of Brazil using a mixed-methods approach that incorporates instrumental variables, public opinion surveys, and qualitative interviews with local politicians and bureaucrats. I find causal evidence that segregated municipalities exhibit more pronounced spatial inequalities in the allocation of public resources, higher levels of economic informality, lower tax revenue, lower-quality bureaucracies, and are less likely to apply for a federal program designed to strengthen administrative capacity. I further leverage a two-pronged identification strategy to demonstrate that part of the effect of segregation on state capacity is causally mediated by informality. Finally, I use a survey experiment to examine individual-level mechanisms, showing that exposure to informality shapes fiscal attitudes and citizens’ expectations of the state. This paper contributes to research on the endogenous development of state capacity and highlights segregation as a structural barrier to institutional development in unequal societies.