Venezuelans pose with their ink-stained fingers after voting for the successor of late President Hugo Chavez, in Caracas April 14, 2013. Venezuelans went to the polls to decide whether to honor Chavez's dying wish for a longtime loyalist to continue his hardline socialism or hand power to a young challenger vowing business-friendly changes. REUTERS/Tomas Bravo (VENEZUELA  - Tags: ELECTIONS POLITICS) - RTXYLEV
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Democracy does not cause growth

Guillermo Vuletin, Julia Ruiz Pozuelo, and Amy Slipowitz

Does democracy cause more economic prosperity and growth? This question dates back to Plato and Aristotle’s debate regarding which form of government brings more political and economic gains to society. However, after more than two millennia, there seems to be no clear consensus about whether democracy (in and of itself) indeed delivers more economic growth compared to other more autocratic forms of governments.

Answering this important question has become one of empirical nature. On the one hand, research that relies on cross-country comparisons has questioned the relevance of democracy on economic growth. Counterbalancing these, more recent economic studies that rely on panel data actually tend to support the theory of a sizable effect of democracy on economic growth.

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Indeed, Figure 1 depicts this empirical regularity for 38 democratic transitions during the so-called “Third Wave of Democratization” and the democratization that followed the fall of communism in the early 1990s. The average annual per capita growth rate increases about half a percentage point following a democratic transition. Depicted by red lines, growth after the democratization is statistically larger than before the transition (-0.01 percent versus -0.44 percent, respectively). While small at first glance, the compounding effect of this difference would reduce the time needed for this group of countries to converge towards OECD income levels by a one-third. The evidence portrayed in Figure 1 seem to show that, taken at face value, democracy has a sizable effect on economic growth.

Figure 1. Real GDP p.c. growth around democratic transitions

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Despite this evidence, however, there exists extensive political science research indicating that endogeneity (i.e., reverse causality) considerations may be at work here, and, thus, economic turmoil is responsible for causing or facilitating many democratic transitions. Under this view, the lower (and negative!) growth rate depicted in Figure 1 before the democratic transition may indicate that bad economic performance pushed or catalyzed the end of autocratic regimes. For example, many scholars point to the oil shocks of the 1970s, the related expansion of international lending, and the subsequent debt crises as the origin of the 1980s wave of democratization in Latin America.

In other words, the positive association between democracy and economic growth portrayed by Figure 1 could reflect that either democracy causes more economic growth (the argument pushed by recent economic studies), that economic turmoil causes the emergence of the democratic rule (the argument pushed by extensive political science research) or, to some extent, both. Although disentangling this causality is not an easy task, understanding the true impact of democracy on economic growth remains crucial.

We take on the challenge in our recent study “Democracy does not cause growth: The importance of endogeneity arguments.” To solve this endogeneity puzzle, we propose a novel identification strategy based on a new worldwide survey conducted to 165 democracy experts.  In a snapshot, the study uses democracy experts’ answers to a series of categorical and open-ended questions regarding the underlying forces that gave rise to democracy in each country. Based on this approach, democratic transitions were classified into those occurring for reasons related to economic turmoil—which we call endogenous—and those grounded on more exogenous (to economic growth) reasons including, among others, the death of autocratic leader and political/institutional arguments.

Figure 2 recreates Figure 1 by dividing countries into exogenous (Panel A) and endogenous democratizations (Panel B).

FIGURE 2. REAL GDP P.C. GROWTH AROUND DEMOCRATIC TRANSITIONS: EXOGENOUS VS. ENDOGENOUS DEMOCRATIC TRANSITIONS

Panel A. Exogenous democratic transitions

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Panel B. Endogenous democratic transitions
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The evidence from Figure 2 shows that democracy does not cause growth. Panel A shows that “exogenous democratizations” (those ones that are not contaminated by endogeneity concerns) have no effect on economic growth. Depicted by red lines, growth rates before and after democracy are statistically the same.

As a corollary, Panel B shows that the effect of democracy on economic growth are driven by “endogenous democratizations.” In other words, the common positive association between democracy and economic growth is driven by the wrongful inclusion of endogenous democratic transitions to estimate the effect of democracy on economic growth (which, in turn, give the false impression that democracy causes more growth).

In summary, we show that a further examination into genuine endogeneity considerations indicates that, contrary to recent findings, unfortunately democracy does not seem to be the key to unlocking economic growth.

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