Democratisation Boosts Growth

Making the transition to democracy can have significant economic benefits for a country, according to research by Professors Elias Papaioannou and Gregorios Siourounis, published in the October 2008 issue of the Economic Journal.

Their analysis of the effect of democratisation on growth over the period since 1960 indicates that, on average, democratisations are associated with a one half to one percent increase in annual per capita growth in transition countries.

The authors identify a J-shaped growth pattern: during the transition to democracy, growth is slow and on average negative. But in the medium run and especially in the long run, growth stabilises at a higher level.

This finding parallels Ian Bremmer''s influential theory that ''closed'' societies that ''open'' up experience an initial period of instability. This result also supports Friedrich Hayek''s argument that:

''It is in its dynamic, rather than in its static, aspects that the value of democracy proves itself. As is true of liberty, the benefits of democracy will show themselves only in the long-run, while its more immediate achievements may well be inferior to those of other forms of government.''

Following the US invasion in Iraq and the recent political turmoil in Zimbabwe, leading politicians and commentators have argued that democratisation will bring prosperity and growth to ''pariah'' and economically poorly performing countries.

Others remain sceptical, pointing to the mixed and inconclusive evidence. For example, while most of the First World is democratic, democracy has not brought growth in many developing countries. On the contrary, East Asian economies took off and flourished under authoritarian regimes. China has experienced fast growth rates over the past decades under a one-party regime. At the same time, however, Africa has suffered from kleptocratic dictators.
It comes thus as little surprise that numerous cross-country empirical studies examining the effect of democratic rule on growth have produced mixed and inconclusive results. Yet identifying and quantifying the effect of political freedom on economic performance is much harder than it seems at first glance. There are numerous conceptual, measurement, theoretical and technical challenges:

  • First it is almost impossible to aggregate in one subjective index of political freedom all the various structural features that support democratic rule. As the political scholar Robert Dahl has argued ''democracy has meant different things to different people at different times and places''.
  • Second, democracy is correlated with other institutional characteristics, such as sound judiciary, rule of law, efficient bureaucracy and relatively low regularly barriers. It is thus hard for empirical researchers to isolate the effect of democracy on growth, especially when working with data from a hundred or so countries.
  • Third, the potentially positive effect of democracy on growth might not occur immediately. It needs time to build the necessary supportive institutional structures to democratic rule. In addition, in the initial post-democratisation period, there is usually uncertainty about the consolidation of representative rule.
  • Moreover, democratic transitions tend to occur during economic crises. The autocratic regime of President Suharto in Indonesia collapsed during the East Asian financial meltdown. Likewise most democratic transitions in Latin America took place after the debt crisis of 1983.

Papaioannou and Siourounis address these issues and examine the effect of successful democratic transition on growth during the period 1960-2005. In contrast to previous work that examines the correlation between democracy and growth with cross-sectional models, the authors employ a dynamic before-after event study approach that allows them to quantify the effect of democratisation on growth in transition countries compared with the general evolution of growth in non-reforming countries.

This approach is intriguing for both a theoretical and a practical viewpoint, as it directly answers which are the likely growth patterns of countries that manage to abandon autocracy and consolidate democratic rule.

To account for measurement error that masks inference in applied work, the authors use electoral archives, historical sources and various political freedom proxy measures to construct a new data set of permanent democratic transitions during the so-called Third Wave of Democratisation.

To distinguish between the short, medium and long-run effects of democratisation, the authors use (dynamic panel) econometric techniques with annual data. Their empirical analysis also accounts for country heterogeneity and hard-to-control-for (time-invariant) factors such as culture, geography and historical legacies by studying democratisation in a before-after event study approach.

This allows the author to quantify the impact of democratic transition in countries that switched to representative rule over the past decades rather than comparing economic performance in industrial countries with emerging economies and Third World nations.

''Democratization and Growth'' by Elias Papaioannou and Gregorios Siourounis is published in the October 2008 issue of the Economic Journal.

Elias Papaioannou

Associate Editor of the Economic Journal at London Business School