Using data covering 175 countries from 1960 to 2010, Acemoglu et al (2019) estimate that, on average, democratization alone increases GDP by 20 percent in a 25-year horizon. These effects seem to be unrelated to the initial level of economic development, although they are larger in countries with greater levels of secondary education.
Picture by Element5 Digital, Unsplash
The elephant in the room
More than 30 years have passed since the Cold War was concluded with the victory of the democratic US over the communist USSR. Since then, however, the unprecedented economic growth in China and the relative stagnation of Western democratic nations inevitably question the once dominant position of democracy. Is it still our best chance for prosperity? An increasing number of people nowadays tends to disagree. Acemoglu et. al hop in to the rescue.
The subject is inherently tricky. To substantiate their claim that democracy indeed causes growth, the authors face several challenges:
The accurate definition of what constitutes a democracy is inherently elusive
It can be hard to measure real changes in democratic institutions even through Democratic Score indexes
Unobserved characteristics. Democracies differ to non-democracies in institutional, historical, cultural aspects that are inherently hard to isolate, but affect GDP nonetheless
Time-varying unobservable characteristics. These parameters change as time passes.
Econometrics at the service of Democracy
To determine what indeed constitutes a democracy and a democratic transition the authors create an index out of, among others, two pivotal data sets – the Freedom House and Polity IV. Consequently, they consider a country as democratic when several sources agree to that status. More specifically, they grant democratic status to a country for a given year if the Freedom House classifies it as “free” or “partially free” and the Polity IV assigns a positive score at the period. When either of the main sources is unavailable, the authors refer to the rest of the existing literature on this country.
Having established what constitutes a (transition to) democracy, the authors move on to tackle the challenges in measuring the actual effect it has on growth. They initially measure the direct effect that democratization has on countries. However, this approach does not safeguard against omitted underlying variables that affect both democracy and GDP. They hence implement what is known as an Instrumental Variable (IV) strategy. In essence, the IV method invokes a variable that affects the variables of interest but is not correlated with the any confounding factors. In our example, this role is assumed by using the regional nature of democratisation.
Political science literature emphasizes that transitions to and away from democracy often take place in regional waves; a country is more likely to transition to democracy or nondemocracy when the same transition recently occurred in other countries in the same region. This is illustrated in Figure 1 below, which shows how historically after a country switch towards or away from democracy (year ‘zero’) its neighbours tend to follow.
Figure 1: Democratization (towards and away) happens in waves
Source: Acemoglu et al (2019), Bonsai Economics
How does democracy increase prosperity?
The case for a positive effect of democracy on GDP has been made. How does it materialize though? The authors suggest it takes place through a delicate process where democracies contribute to growth by:
Increasing investment
Encouraging institutional reforms that disperse economic and political power to broader social strata
Improving the provision of schooling and health care
Reducing social unrest
In other words, democracies encourage and allow people to invest more resources in the economy, are better in keeping people educated and healthy, and make clashes for power less urgent. The same processes can take place in nondemocracies but with a smaller reform potential; powerful actors thriving in autocratic states are more likely to successfully resist their broad introduction. Economic privileges are not shared lightly by the haves.
The future of Democracy
Scepticism about the performance of democratic institutions is as old as democracy itself. Works such as the one summarized in this article allow us to also be optimistic on the prospects of democratic institutions; the authors make a cogent case that despite occasional setbacks, societies where all citizens (demos) have access to the social decision-making process (kratos), are the best candidates for long-term prosperity.
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