Less democratic countries not only fail to sustain growth, but also see its fruits undone by
large slowdowns or periods of decline that follow their growth spurts. A key driver of this susceptibility to dramatic growth collapses is that less democratic countries have less diversified production structures, relying heavily on only a few sectors.
Research by David Cuberes and Michal Jerzmanowski suggests that stabilising the economy through greater diversification will reduce the frequency of dramatic collapses, but at the same time make spectacular accelerations less likely.
Their study, published in the October 2009 issue of the Economic Journal, also suggests to policy-makers that appropriate policies – foremost, a reduction in barriers to entry – during
the boom years could be used to enhance diversification and help the economy avoid a growth reversal.
The study looks at growth reversals: a phenomenon where a decade or so of spectacular economic success is followed by equally dramatic growth collapse. It finds such reversals to be common across countries and over time. Most importantly, less democratic countries are more likely to experience large growth reversals.
The researchers propose a mechanism by which the success and collapse parts of the cycle are linked through the economy''s industrial structure. This relationship could be driven by the fact that less democratic countries have less diversified production structures of the economy: they rely heavily on only a few sectors.
If the fortunes of these sectors are good, the economy grows rapidly. But once the advantage shifts to the under-represented sectors, the economy collapses. In support of this hypothesis, the study documents that less democratic countries do indeed have much more concentrated industrial structures.
Over the last two decades, empirical research on economic growth has focused attention primarily on the differences in average long-term economic growth between countries – that
is, trying to understand why Singapore''s income has grown at an average rate of 7% and increased 10-fold over the last 40 years while that of Mali has hardly grown at all.
This body of research has generated many valuable insights but we still lack answers to many important questions. For example, one of the key unresolved questions is about the impact of democracy on growth.
At the same time, some new work suggests the need to focus on within-country growth variation; the fact that on average Mali''s income did not increase is not a consequence of permanent stagnation but rather of the fact that Mali''s economic growth comes and goes –
that is, there are periods of rapid progress but there are also periods of stagnation and
Understanding the nature and cause of these growth ''up and downs'' appears key to designing successful development strategies. Growth reversals (or cycles) are in fact quite ubiquitous but more common in poorer countries.
But the key finding of this study is that this relationship is spurious. Controlling for the level of democracy, income ceases to matter. It is less democratic countries not poor countries that are more susceptible to growth cycles.
The likelihood of experiencing a growth cycle is negatively related to the level of democracy: a 10% increase in the index of democracy reduces the probability of experiencing a growth reversal by around 2%.
The study shows that non-democracies, with higher barriers to entry of new firms, suffer from greater sectoral concentration and experience large up-and-down growth cycles.
''Democracy, Diversification, and Growth Reversals'' by David Cuberes and Michal Jerzmanowski is published in the October 2009 issue of the Economic Journal.