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Political Institutions and Economic Growth
Introduction A consensus has yet to emerge from the rapidly expanding body of work on the relationship between economic growth and democracy. Although economists and political scientists have offered theories describing this relationship for many years—the strength of the Athenian economy relative to Sparta, for example, is often attributed to the flexibility of Athens’ democracy—formal empirical tests have increased substantially during the 1990s. This recent research, due at least partly to the availability of better measurements of the extent of political rights across countries, has generally been more careful than previous work to differentiate between causality running from economic growth to democracy and from democracy to economic growth. In this essay, I discuss the theoretical background of the ways in which governmental structure (specifically, the level of democracy) may affect economic growth. I also present several theories of how economic conditions may affect a country’s level of democracy, and summarize some of the more recent empirical work in this area. To conclude, I discuss the policy implications that can be drawn from this collection of work. Theoretical Background The effect of democracy on economic growth With the exception of some of the oil-producing Middle Eastern states, the richest countries in the world are democratic, and many of the poorest
Jenny Minier is an assistant professor in the department of economics at the University of Miami. Her research focuses on the interaction between economic growth and institutions such as democracy, stock markets, and trade policy. Her latest paper,“Is Democracy a Normal Good? Evidence from Democratic Movements,” is published in the Southern Economic Journal 67(4), 996-1009, 2001. She may be reached at: firstname.lastname@example.org Knowledge, Technology, & Policy, Winter 2001, Vol. 13, No. 4, pp. 85-93.
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are not. Although casual observation suggests a strong, positive correlation between levels of democracy and income, economic theory does not unambiguously predict the sign of the correlation between democracy and economic growth. The most common argument for a positive correlation between democracy and economic growth is that expressed by Olson (1993, p. 574), who argues that, “the same emphasis on individual rights that is necessary to lasting democracy is also necessary for secure rights to both property and the enforcement of contracts.”A related argument is that the systems of checks and balances present in most democracies make it more difficult for a government to divert funds to less productive activities. Both of these theories argue that democracy’s effect on growth is indirect: the legal institutions, property rights, and“rule of law”inherent in strong democracies are conducive to higher rates of economic growth. Of course, these factors can also be institutionalized in authoritarian regimes. Chile under Pinochet and, more recently, Singapore provide examples of growth-oriented authoritarian regimes. A more direct argument for a positive effect of democracy on economic growth comes from Acemoglu and Robinson (2000). In their model, systems of majority voting increase the “human capital” (education and skills) of a country, increasing growth rates, in two ways. First, under a system of majority voting, people vote directly for more education. Also, by voting for taxation schemes that transfer income from rich to poor, democracies increase the resources available to the poorer classes, enabling them to take advantage of educational opportunities. Majority voting also constitutes one of two main arguments that democracy decreases growth rates. In Acemoglu and Robinson (2000) and Persson and Tabellini (1994), citizens of democracies vote for redistributive taxation, decreasing incentives and thereby decreasing growth rates relative to countries without majority voting. The other main argument against a positive correlation between democracy and growth is that authoritarian regimes, due to their higher levels of centralized power, are better able to coordinate economic growth. Rao (1984) argues this specifically, citing the examples of India under emergency rule in the 1970s and Chile under the Pinochet regime. In democracies, interest groups may weaken a government’s commitment to growth, requiring large amounts of “porkbarrel” spending, as in Olson (1982). Some have even argued that democracy works against property rights. Przeworski and Limongi (1993, p. 52) outline several such arguments from the nineteenth century, ranging from Thomas Macauley’s statement in 1842 that universal suffrage would be,“the end of property and thus of all civilization,” to Karl Marx’s argument that universal suffrage and private property are incompatible. The effect of economic growth on democracy Theories of how economic growth (or income levels) affect levels of democracy are traditionally more in the domain of political scientists than
economists, although economists have recently begun to work in this area. Lipset (1959) details one of the earliest (modern) descriptions of the determinants of democracy; what has become known as the“Lipset hypothesis” (despite Lipset’s reference to Aristotle as the original source) suggests that more developed countries are better suited to democracy than are poorer countries. Lipset’s definition of economic development encompasses education, industrialization, and urbanization, in addition to income. Huntington (1991) also argues that economic development increases citizens’ desire for democracy; he includes the volume of international trade and the size of the middle class, in addition to income and education, as indicators of overall development. In addition, Huntington discusses the role of economic growth, arguing that economic growth both increases the speed at which a country reaches a level of income “suitable” for democracy and acts to destabilize an existing authoritarian regime. Specifically, he states that economic growth,“raises expectations, exacerbates inequalities, and creates stresses and strains in the social fabric that stimulate political mobilization and demands for political participation.” (p. 69). Moore (1996), Rueschemeyer, Stephens, and Stephens (1992), and Acemoglu and Robinson (2000) elaborate on this argument. Moore (1996) argues that a sizable middle class is crucial for the development of democracy, whereas in the models of Rueschemeyer et al. (1992) and Acemoglu and Robinson (2000), economic development empowers previously disenfranchised groups, such as working classes and women, making it increasingly difficult for political élites to exclude these groups from political participation.1 Although both scholars and citizens often take a country’s regime type as exogenous or previously determined, countries do undergo periods of transition from one type to another. In a series of papers, Yi Feng and Paul Zak2 present several related models of democratic transition. In Feng and Zak (1999), a democratic transition can occur in a growing economy or during a period of economic crisis. In their model, as an economy grows, an increasing proportion of citizens become politically active, demanding increased political freedoms. On the other hand, if an economy experiences economic crisis, its government is weakened and a transition to a new regime occurs. These transitions continue until a regime that can maintain economic growth is in place. The precise timing of regime change is determined by changes in income distribution, government policies, and citizens’ preferences for civil liberties, in addition to per capita income. Empirical Evidence Most of the early theoretical studies of democracy and economic growth suggest only correlations between the variables, rather than formal mechanisms through which democracy affects growth. Because of this, many empirical studies of the relationship between democracy and growth have incorporated some measure of democracy into conventional cross-section growth regressions, effectively asking, “What is the correlation between
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democracy and economic growth, controlling for other variables believed to influence growth?” With the appearance of more fully specified models of the channels through which democracy may affect economic growth, empirical studies have begun to take more varied approaches. In order to investigate the relationship between democracy and growth empirically, it is necessary to identify an appropriate measure of “democracy”or“political rights.”In empirical economic studies, the most frequently used measure of democracy is the index of political rights constructed by Freedom House, also known as the Gastil index. 3 This is a subjective index ranging from one (most free politically) to seven (least free), constructed from a checklist of components of democracy based on local and international printed materials, field visits, and communications with observers and citizens. Freedom House defines democracy as,“at a minimum…a political system in which the people choose their authoritative leaders freely from among competing groups and individuals not chosen by the government.” (1997, pp. 192-193)4 Sirowy and Inkeles (1990) and Przeworski and Limongi (1993) provide surveys of empirical studies of economic growth and democracy, covering both the economic and political science literature. Przeworski and Limongi (1993, p. 51) conclude that “social scientists know surprisingly little: our guess is that political institutions do matter for growth,”but that the specifications of the studies they survey do not capture the relevant differences. In the following, I discuss more recent contributions. The effect of democracy on growth In economics, Barro (1996) is one of the best-known empirical studies of the relationship between democracy and economic growth. Controlling for other political and economic variables believed to affect economic growth, such as initial GDP per capita, education levels, investment rates, and government consumption expenditures, Barro finds a slightly negative (but not statistically significant) correlation between democracy and growth in GDP per capita. He also presents evidence of a nonlinear or“inverse U-shaped” relationship in which democracy and growth are positively correlated at low levels of democracy and negatively related at higher levels. Allowing for this type of nonlinear relationship results in statistically significant estimates. In a study differentiated by its much longer timeframe, De Long and Shleifer (1993) study population growth rates in European cities from 1050 to 1800. Over such a long time period, population growth is a reasonable proxy for increases in standards of living. De Long and Shleifer divide cities into those ruled by absolutist “princes” and those ruled by other arrangements, which they term “merchants” but which also includes constitutional monarchies. Their theory is that the difference in economic growth rates between the two types of regimes is due to differences in the security of property rights, and they find strong evidence that countries governed by absolutist regimes grew more slowly than those governed by strong constitutions or by merchants. They conclude (p. 700),
European historians have often written to celebrate the firm establishment of princely authority….But from the perspective of the welfare of the people alive at the time, or of the long-term growth of the economy, princely success is economic failure….The rise of an absolutist government and the establishment of princely authority are, from a perspective that values economic growth, events to be mourned and not celebrated.
In addition to a better understanding of the overall relationship between democracy and economic growth, economists are interested in the channels through which democracy affects growth. While democracy may have some direct effects on growth, it is also possible that a country’s level of democracy may affect its growth performance indirectly. This could occur in two ways. Democracy may affect variables (such as education or investment) that in turn influence growth rates. For example, democracies are frequently assumed to have more egalitarian educational policies than authoritarian regimes, since mass political participation translates into more people voting for better education for their children (see Acemoglu and Robinson ). Alternatively, countries with different levels of democracy may utilize the factors of production available to them differently. More technically, the aggregate production function relating these inputs to output may differ across levels of democracy. To see this intuitively, consider two countries that receive identical amounts of foreign aid or investment. In the totalitarian regime, the dictator allocates the new funds to the building of a third presidential palace, while in the democracy, the government channels the funds toward investment in infrastructure. (Of course, the opposite is also plausible—the dictator may be able to direct funds to primary education, while the democracy feels obligated to reward supporters or court potential votes with nonproductive assistance.) Helliwell (1994) is the best-known investigation of the first type of indirect effects, testing for both direct and indirect (through the channels of education and investment) effects of democracy on growth. He uses a system of simultaneous equations to control for dual causality between democracy and income. He estimates a negative but not statistically significant effect of democracy on economic growth, controlling for other factors, but finds that this effect is offset by the increased levels of education and investment that occur in democracies. (As in most empirical and theoretical studies, levels of education and investment are both positively correlated with economic growth.) After controlling for these simultaneous effects, he concludes that there is little difference in growth rates between democratic and non-democratic countries. The second type of indirect effects—that democracies and non-democracies differ in how effectively they use given amounts of inputs—is the focus of Minier (1998). She uses a statistical technique known as a regression tree to endogenously split a sample of 96 countries into groups of countries considered “most similar” with respect to estimated aggregate production functions. The advantage of this technique is that it selects the
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level on which to split the data: the researcher does not have to arbitrarily decide to split on the median level of some variable, for example. This is particularly valuable in the case of democracy: although the theoretical split into “democracies” and “non-democracies” is straightforward, many countries fall somewhere in between (for example, a country may offer full suffrage but require governmental approval of all candidates). Additionally, splits can be considered on any number of potential split variables: in Minier (1998), the splits on democracy that occur are judged “better” splits of the data than splits based on literacy or GDP per capita. The alternative of no splits of the data is also considered.5 After isolating the poor and low literacy countries, the remaining subsample of 47 non-poor, high literacy countries is split based on the level of democracy, suggesting that democracy does in fact affect how efficiently countries use the inputs available to them. Among this group, the low democracy countries have a much stronger estimated correlation between investment in physical capital and economic growth; the high democracy countries have a stronger correlation between education and economic growth. As potential explanations, Minier suggests that governments of less democratic countries may be able to direct investment into more productive activities, because they are not required to make concessions to special interests and lobbying groups. She also suggests that the higher correlation between education and economic growth in democracies may be due to the existence of more opportunities for citizens of democracies, increasing the returns to education. In a related study, Rodrik (1999) finds that wages in manufacturing sectors are higher in democracies. This relationship appears to hold even after controlling for other political factors, such as the rule of law, political stability and civil liberties. Rodrik hypothesizes that this relationship may be due to opportunities for more efficient bargaining between employers and employees in democracies, and/or that the benefits of democracy, such as more secure property rights and higher levels of political stability, offset the cost of high wages to employers. The effects of income levels and growth on democracy Much of the research concerned specifically with the effect of economic growth (as opposed to levels of income) on democracy is based on anecdotal evidence. For example, Huntington (1991) cites the role of rapid economic growth in the moves toward democracy of countries such as Greece, Spain, Brazil, South Korea, and Taiwan. Barro (1996, 1999) regresses observed levels of democracy (based on the Freedom House index) on a range of variables, including income levels, previous levels of democracy, measures of educational attainment, urbanization, and population. Controlling for these variables, he finds a positive and statistically significant correlation between democracy levels and income. He concludes that, “improvements in the standard of living…substantially raise the probability that political institutions will
become more democratic over time. Hence, political freedom emerges as a sort of luxury good.” (Barro does not include recent economic growth as a potential predictor of democracy levels.) Helliwell (1994) also finds a robust and positive effect of income levels on democracy. Many papers interpret these predictions of the level of democracy as studies of the determinants of the “demand” for democracy. Minier (2001) tests the relationship between economic growth or income levels and the demand for democracy more directly. She created a data set of democratic movements, and uses it to indicate the presence of a widespread demand for democracy. Using logit analysis, she finds that the probability of a democratic movement occurring is increasing in levels of GDP per capita up to approximately $5,000; the probability of a democratic movement occurring falls with income at higher income levels. There is no relationship between economic growth over the preceding five-year period and the probability of a democratic movement occurring, controlling for other variables. Policy Implications Perhaps the most important policy implication that could be drawn from this literature is whether it is optimal for developed countries and international organizations to encourage democracy in authoritarian developing countries, where economic growth is likely to be a concern. Many have argued—anecdotes of India, Costa Rica, and Botswana aside—that democracy is incompatible with lower levels of development. Minier (1998) tests this implication more directly, by comparing countries that became democratic to a priori similar countries that did not. She identifies 13 countries that experienced substantial increases in democracy and 22 countries that experienced large decreases in democracy during the period 1965-87. For each country that experienced a change, she forms a “control group” of countries that, prior to the change in democracy, were similar in terms of income per capita and democracy levels to the countries that underwent changes in democracy. Over five-year periods, per capita income in countries that had just become democratic increased by 2 percent, on average, while a priori similar countries averaged a decrease of 1 percent. Countries that experienced decreases in democracy grew by approximately 8 percent over the subsequent five-year period, while the control group average was nearly 15 percent. The differences are magnified over periods of ten and fifteen years: countries that increased democracy experienced economic growth of 32 percent, on average, over the fifteen years following the change, relative to an average of 6 percent among the control groups, while countries that experienced a decrease in democracy grew by 8 percent relative to a control group average of 35 percent. Furthermore, there is no evidence that the democratic transitions were more successful in increasing growth rates among higher income countries. Although not all of these differences are statistically significant, it is important to note that they provide no evidence that countries that be-
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came democratic grew more slowly than if they had remained authoritarian. There are clearly many reasons to encourage democracy for its own sake; although there is not much evidence to support encouraging democracy for economic reasons, there seems to be little reason to discourage democracy for fear of adverse growth consequences. Notes
1. 2. 3. 4. 5. Rueschemeyer et al. (1992) approaches the issue from the political science perspective, while Acemoglu and Robinson (2000) and Moore (1996) address it as economists. See Feng and Zak (1999, 2000) and Zak and Feng (1998). More information is available online (http://www.freedomhouse.org), including recent and historical values of the index for all countries rated. Bollen (1993) discusses some of the criticisms against the Gastil index and compares it to similar rankings. See Minier (1998) for a more complete description of the regression tree procedure.
Acemoglu, D. & Robinson, J. (2000). Why did the West Extend the Franchise? Democracy, inequality, and growth in historical perspective. Quarterly Journal of Economics 115(4), 1167-1199. Barro, R. J. (1996). Democracy and Growth. Journal of Economic Growth 1(1), 1-27. Barro, R. J. (1999). Determinants of Democracy. Journal of Political Economy 107(6, part 2), S158-183. Bollen, K. (1993). Liberal Democracy: Validity and Method Factors in Cross-National Measures. American Journal of Political Science 37, 1207-30. De Long, J. & Shleifer, A. (1993). Princes and Merchants: European city growth before the Industrial Revolution. Journal of Law and Economics 36, 671-702. Feng, Y. & Zak, P. (1999). The Determinants of Democratic Transitions. Journal of Conflict Resolution 43(2), 162-177. Feng, Y. & Zak, P. (2000). Growth and the Transition to Democracy. working paper. Freedom House (1997). Survey Methodology. Freedom Review, 192-93. Helliwell, J. (1994). Empirical Linkages between Democracy and Economic Growth. British Journal of Political Science 24, 225-248. Huntington, S. (1991). The Third Wave: Democratization in the late Twentieth century. Norman, OK: University of Oklahoma. Lipset, S. (1959). Some Social Requisites of Democracy: Economic development and political legitimacy. American Political Science Review 82, 942-963. Minier, J. (1998). Democracy and Growth: Alternative approaches. Journal of Economic Growth 3(3), 241-66. Minier, J. (2001). Is Democracy a Normal Good? Evidence from Democratic Movements. Southern Economic Journal, 67(4), 996-1009. Moore, B. (1966). Social Origins of Dictatorship and Democracy: Lord and peasant in the making of the modern world. Boston: Beacon. Olson, M. (1963). Rapid Growth as a Destabilizing Force. Journal of Economic History 23, 529-52. Olson, M. (1982). The Rise and Decline of Nations. New Haven: Yale University Press. Olson, M. (1993). Dictatorship, Democracy and Development. American Political Science Review 87, 567-576. Persson, T. & Tabellini, G. (1994). Is Inequality Harmful for Growth? American Economic Review 84(3), 600-621. Przeworski, A. & Limongi, L. (1993). Political Regimes and Economic Growth. Journal of Economic Perspectives 7(3), 51-69.
Rao, V. (1984). Democracy and Economic Development. Studies in Comparative International Development 19, 67-81. Rodrik, D. (1999). Democracies Pay Higher Wages. Quarterly Journal of Economics 114(3), 707-738. Rueschemeyer, D., Stephens, E., & Stephens, J. (1992). Capitalist Development and Democracy. Chicago: University of Chicago Press. Sirowy, L. and Inkeles, A. (1990). The Effects of Democracy on Economic Growth and Income Inequality: A review. Studies in Comparative International Development 25, 12657. Zak, P. & Feng, Y. (1998). A Dynamic Theory of the Transition to Democracy. working paper.
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