Tuesday
Mar252014

Democracy, What Is It Good For?

In an earlier post, we reported on our research joint with Suresh Naidu and Pascual Restrepo, “Democracy, Redistribution and Inequality”, which showed very limited effects of democracy on inequality.

So one would be excused for paraphrasing Edwin Starr’s famous song and Ian Morris’s forthcoming book, War! What Is It Good for?, and ask “democracy, what is it good for?”

Certainly not economic growth, most would reason.

This conclusion is based on a consensus engulfing both academia and the popular press that democracy is at its best irrelevant for growth, and perhaps even a hindrance.

For example, Tom Friedman wrote in the pages of The New York Times:

One-party nondemocracy certainly has its drawbacks. But when it is led by a reasonably enlightened group of people, as China is today, it can also have great advantages. That one party can just impose the politically difficult but critically important policies needed to move a society forward in the 21st century,”

Friedman wasn’t making this up. Robert Barro, who has written several papers on the topic, argued in his book Getting it Right: Markets and Choices in a Free Society:

More political rights do not have an effect on growth… The first lesson is that democracy is not the key to economic growth.

A recent survey of the recent literature similarly concludes:

The net effect of democracy on growth performance cross-nationally over the last five decades is negative or null.

Equally dominant is the view that democracy isn’t right for low-income countries (which are often the ones trying to turn their societies into democracies). The pages of The New York Times again summarize what most of the popular press seems to have accepted as axiomatic, this time in the words of David Brooks defending the Egyptian military coup,

It’s not that Egypt doesn’t have a recipe for a democratic transition. It seems to lack even the basic mental ingredients.

Judge Posner also agrees with this conclusion (even though, to the best of our knowledge, he does not go so far as supporting Egypt’s murderous generals), and writes

Dictatorship will often be optimal for very poor countries. Such countries tend not only to have simple economies but also to lack the cultural and institutional preconditions to democracy.

Our paper Democracy, Redistribution and Inequality” was in fact part of a broader project investigating the implications of democracy for both economic growth and inequality.

Our main paper (again joint with Suresh Naidu and Pascual Restrepo) is out, and as the title suggests “Democracy Does Cause Growth, it sharply disagrees with this consensus.

The curious thing is that our paper is not actually the first one to find a positive effect of democracy and economic growth, but it is true that the literature contains many papers that find no effects or sometimes even negative effects.

We think there is a simple reason for this, which can be seen in the next figure. This figure shows the evolution of GDP per capita following a democratization event compared to nondemocracies (all democratizations are lined up to date 0 so as to visually trace out average growth following democratization relative to the control countries in which there is no democratization).

 

The first thing that jumps out from the figure is that a typical democratization takes place when a country is undergoing an economic crisis (a point first emphasized in an earlier paper we wrote with Simon Johnson and Pierre Yared, “Income and Democracy”, and later investigated in greater detail in work by Markus Brückner and Antonio Ciccone.

What this implies is that unless one takes care of modeling the dynamics of GDP per capita carefully, one can reach any conclusion one likes from this pattern. Imagine, for example, aggregating the data into five-year intervals (as much of the previous literature does) and consider shifting where these five intervals start from in this figure. You will quickly convince yourself that one could easily find that democracy could be bad for growth (because GDP per capita is declining in the five-year interval in which democratizations are taking place).

Another major problem plaguing the previous literature is that many of the measures of democracy are ridden with measurement error. To deal with this problem, we follow work by Elias Papaioannou and Gregorios Siourounis, and constructed a 0-1 index of democracy using multiple sources, which minimizes the extent of measurement error (in particular by removing spurious movements in the democracy score of many low-income countries).

Using such an index, annual observations, country fixed effects (so as to control for various institutional and other country-level determinants of both democracy and economic growth) and econometric models that control for the dynamics of GDP per capita, we find quite well-estimated positive effects of democracy on growth.

In fact, once these 0-1 measures are used and the dynamics of GDP per capita are control for (even in a very rudimentary fashion), the positive effects of democracy on growth are very robust.

We also report instrumental-variables estimates, exploiting the fact that democratizations often occur in the form of regional waves (as noted by Samuel Huntington in The Third Wave). These estimates also show robust positive effects of democracy on GDP per capita of similar magnitude to the other models we report.

Our baseline estimates suggest that a country that democratizes increases its GDP per capita by about 20% in the next 20-30 years. Not a trivial effect at all.

Is there any evidence that democracy is only good for already developed economies? The answer is no. Though we do find that democratizations are associated with larger increases in GDP per capita in countries with higher levels of secondary schooling, there is no evidence that democracy is bad for economic growth in low income economies or even in economies with low levels of schooling.

In all, the evidence seems to be fairly clear that democracy is good for economic growth.

Why? This is a harder question to answer. Our evidence shows that democracies are better at implementing economic reforms, and also increase education. They also probably increase the provision of public goods (though the evidence here is a little less robust).

But none of this is conclusive evidence.

Our results from the two papers combined thus suggest an intriguing pattern: contrary to what many have presumed, democracy doesn’t have a huge effect on inequality. But also contrary to what seems to have been almost a consensus, democracy does have a robust and fairly sizable positive effect on economic growth.

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