Econ growth and hist development

Income and Democracy

Acemoglu et al. (2008)

Casper Worm Hansen

UCPH, Department of Economics

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 Purpose of todays lecture
• Introduction/motivation

• Income democracy: Acemoglu et al. (2008)

• Discussion

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Let’s start with a broad introduction
to the subject

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 Introduction
• What is the origin of the vast differences in political rights
across countries in the world

• What accounts for the divergence in political institutions?

• Is democracy more sustainable at high levels of income

than at low levels?
– May inform why efforts to impose democracy are difficult

• Are growth, and democracy, driven by good institutions

(property rights, etc.) or are they endogenous, primarily a
function of wealth or income?

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 Introduction
What is democracy?
• “Democracy is associated with a set of institutions such
as free and fair elections, the accountability of
politicians to the electorate, and free entry into
politics.” (Acemoglu type definition)

• Important for the empirical analysis—what is the

measurement?
• Typical, an index known as the Polity IV (V) index, as an
overall measure of democracy, is used.
• There are alternatives, as the next slide suggests.

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Measurement of democracy

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Measurement of democracy

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‘The democratic divergence’

Database:
(Polity V):
Download here:
POLITY index 8
‘The democratic divergence’

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 Now to the paper:
Acemoglu et al. (2008)

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 Income and democracy
Why - in theory - should income cause the level of democracy to increase?

The Lipset or Modernization hypothesis after Lipset (APSR, 1959):

– New social groups emerge, including a middle class, which are empowered by
the spread of communication technologies and higher education standards.
This creates demand for democratic governance from a growing numbers of
citizens who eventually succeed in their demand

– Modernization as measured by:

1. industrialization,
2. urbanization,
3. Wealth (GDP per capita), and
4. education

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 Income and democracy
• Why - in theory - should income cause the
level of democracy to increase? (continued)

– Lack of a well-articulated theory?

– How to theoretical model modernization?

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 Income and democracy
Main aim (question) of the paper:

– Revisits the relationship between income per

capita and democracy:

𝑦𝑦 ↑ ⇒ 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 ↑

Causal?

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Democracy (polity) and GDP per Capita

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Democracy (freedom house) and GDP per
Capita

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 Income and democracy
What are the problem when attempting to apply a causal
interpretation to such correlations?

– Reverse causality
• Democracy  y

– Omitted variables
• The correlations could be due to a third factor (e.g., country-
specific, historical factors influencing both political and economic
development)

Such issues would bias the OLS estimates (the correlations) 

we cannot interpret them as causal

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 Income and democracy
At that point in time (around 2008), most
studies, which argues that y  democracy, are
based on cross-country evidence, where
omitted variables are a particular problem

– Thus, most papers are basically flawed in their

conclusions (Acemoglu et al. argue)

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 Income and democracy
Their contribution:

– Investigating the issue in a panel framework,

where country fixed effects can be excluded from
the error term

– They further apply an IV-panel approach

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 Income and democracy
Their main findings:

– Once controlling for country-fixed effects, the

correlation disappears

– No causal effect from income to democracy

– Though, the evidence suggests a positive correlation

in the very long run (the last 500 year)
• How should one interpret this?
• They argue that this is due to some critical junctures and
attempt to convince the reader by regression analysis

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 Let’s dig into the analysis

We start out by looking at some ‘preliminary

evidence’

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 Income and democracy
‘Short run’ using the polity score

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 Income and democracy
‘short run’ using freedom house

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 Income and democracy
‘long run’ using the polity score

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Data

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 Data
The democracy data:
1. Freedom house
• Only available for the post-war period
• Ranges from 0-10

2. Polity IV database (Polity2 variable)

• Available from 1800
• Ranges from -10 to 10 (rescaled to 0 to 1)

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 Data: Polity IV (now V) measure
The Polity IV measure is based on the following
characteristics:

1) competitiveness of executive recruitment

2) openness of executive recruitment
3) constraints that exist on the executive
4) regulation of political participation
5) competitiveness of political participation

This is a continuous measure from aggregating the above,

ranging from -10 to 10.

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Empirical strategy

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 Empirical strategy
The econometric model:

Where
– 𝑑𝑑𝑖𝑖𝑖𝑖 is democracy in country i period t
– 𝑑𝑑𝑖𝑖𝑖𝑖−1 is democracy in former period (lagged value)
– 𝑦𝑦𝑖𝑖𝑖𝑖−1 is lagged value of log GDP per capita
– 𝒙𝒙𝒙𝑖𝑖𝑖𝑖−1 is a set of time varying confounders
– 𝜇𝜇𝑡𝑡 is time fixed effects
– 𝛿𝛿𝑖𝑖 is country fixed effects
– 𝑢𝑢𝑖𝑖𝑖𝑖 is the error term

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 Empirical strategy
– If this eq. is estimated by pooled OLS, we need to,
assume that 𝑐𝑐𝑐𝑐𝑐𝑐 𝑦𝑦𝑡𝑡𝑡𝑡 , 𝛿𝛿𝑖𝑖 = 0 and 𝑐𝑐𝑐𝑐𝑐𝑐 𝑦𝑦𝑡𝑡𝑡𝑡 , 𝑢𝑢𝑖𝑖𝑖𝑖 =
0
• could also be written as 𝑐𝑐𝑐𝑐𝑐𝑐 𝑦𝑦𝑡𝑡𝑡𝑡 , 𝑢𝑢𝑖𝑖𝑖𝑖 + 𝛿𝛿𝑖𝑖 = 0

– However, when applying the FE-estimator, we’ll

“only” need to assume that 𝑐𝑐𝑐𝑐𝑐𝑐 𝑦𝑦𝑡𝑡𝑡𝑡 , 𝑢𝑢𝑖𝑖𝑖𝑖 = 0

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 Empirical strategy
– In other words, use the FE-approach, because
here we fix the time invariant stuff out of the error
term
• In principle one can apply Hausman test (RE vs FE)

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 Empirical strategy

– The presence of lagged dependent value is intended to

capture persistence in democracy

– This creates a problem  Nickell Bias or lagged dependent

variable bias (by construction 𝑐𝑐𝑐𝑐𝑐𝑐(𝑑𝑑𝑖𝑖𝑖𝑖−1 , 𝑢𝑢𝑖𝑖𝑖𝑖 ) ≠ 0)

Solution:
– Arellano-Bond (diff) GMM estimation, where we use
further lagged values of democracy as instruments for
𝑑𝑑𝑖𝑖𝑖𝑖−1 .
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Results

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Main results 5 lags of
logged
GDP/capita
[p-value]

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Robustness

Macroeconomics of Development
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 Further robustness

– While FE-estimation takes care of country-fixed

effects, we cannot be sure that the identifying
assumption is satisfied. That is, 𝑐𝑐𝑐𝑐𝑐𝑐 𝑦𝑦𝑖𝑖𝑖𝑖−1 , 𝑢𝑢𝑖𝑖𝑖𝑖 =
0

– This assumption can be broken:

1. Reverse causality
2. Time varying omitted varibales.

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 Further robustness

– For these reasons, they use savings rates and

trade shares as time varying instruments for GDP
per capita (IV-panel approach)
• Shift-share type IV
• Other papers look at [short-run] shocks (e.g., rainfall –
Brückner and Ciccone, 2011)

– Nevertheless, they reach similar conclusions when

deploying this framework

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What if we consider the correlation during the
last 100 years?

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Long run: Income and democracy

Macroeconomics of Development
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What about the very long run?

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 Income and democracy
Positive correlation, but possibly biased

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 Very long run: Income and democracy
Section VI.A (p.827) in words:
Eliminate this one
Critical juncture by further controls
(setup of Estimates
institutions, etc. ) not biased

Estimate
biased

time
1500 1850 1960 2000

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Income and democracy

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 Income and democracy
Weak conditional relationship

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