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The Twisted Tale of Democracy and Economic Growth

At the turn of the new decade, many anxieties have gripped the world. While countries transition out of an economically devastating year of COVID-19, concerns about the rapid emergence of populist regimes have amassed significant traction worldwide. The political landscape is such that the long-standing utopian perception of democratic principles has also been called into question. Consequently, the relationship between economic growth and democratic regimes has also found a renewed relevance in the world today. However, the essential question dates back to the times of Plato and Aristotle—does a more inclusive and liberal government really cause more economic prosperity? Unfortunately, the answer to this age-old question is shrouded with complexity, a lack of consensus and clashing evidence. 

The conventional belief asserts that democracies do positively reinforce economic growth. Part of this view can be attributed to the natural bias that arises from a casual perception of countries and their economic status. For example, popular democracies in Western Europe are associated with higher standards of living and stability whereas authoritarian regimes like Afghanistan, North Korea and Yemen are known for their poverty, lower standards of living and political turmoil. This view was corroborated by prominent academics Acemoglu, James Robinson, Suresh Naidu and Pascual Restrepo in their recent research paper: Democracy Does Cause Growth. Their findings indicated that countries that switched over to democratic governance experienced a twenty-percent increase in their GDP over a period of twenty-five years, in contrast with what their status would have been had they continued to remain under authoritarian rule. This clearly delineates the fact that there is a noteworthy positive correlation between democratization and economic growth. This implies two possible scenarios where either democracy facilitates economic growth and vice-versa or an external factor positively influences both the variables. 

The view that economic growth facilitates the onset of democratization is one that has been introduced in Lipsett’s Modernization Theory of 1959. His hypothesis was a result of a study of Latin American and European nations which suggested that the chances of the creation and consolidation of a democracy were much higher in economically developed countries in comparison to underdeveloped countries. While this argument was creditable earlier, recent studies have proven its evidence to be wanting in nature. Newer research negates this theory on the basis of a ‘correlation’ being conflated as a ‘causation’ due to the exclusion of important variables such as historical and cultural context. In other words, the new belief states that not enough considerations were made to deduce the causal effect of economic growth on democratization, thus leaving the legitimacy of the Modernization Theory in a vulnerable position. 

In fact, India is an important case study to scrutinize Lipsett’s theory. A facet of Lipsett’s argument focuses on the impact of economic growth on inequality in society. He argues that with an increase in national wealth, the structure of a society transitions from the ‘triangle’ of a few rich and many poor to a ‘diamond’ of a few rich and poor at the ends with a large middle-class sandwiched in-between them. The former structure, he reasons, is vulnerable to authoritarianism since the upper class considers the lower class to be ‘innately inferior’ and thus—irrelevant. However, in the post-independence India, instead of the emergence of an oligarchy of the elite, constitutional safeguards were installed to protect and uplift the downtrodden of the country. Lipsett also proposed that economic growth resulted in higher levels of education which further helped foster democratic values in societies. The logical progression of this proposition is false for India where the emergence of a democracy led to schemes and policies which bolstered the country’s education levels over the years. These two examples are a few of the many that illustrate the ignorance of crucial factors such as historical, foreign and religious influences in the conclusions of the Modernization Theory. 

A particularly interesting aspect of the research conducted by Acemoglu et al. notes that countries which have emerged as democracies in the last sixty years have experienced some form of economic turmoil preceding their transition. The rationale behind this states that dictatorships collapse in the face of economic trouble. Thus, the resultant form of government that takes over is democratic in nature since people demand more inclusion post a period of severe hardship. The 1980s wave of democratization in Latin America is great example to illustrate this theory. The oil shocks of the 1970s and the resultant debt crisis fueled an economic turmoil which was followed by democratic transitions across the continent. Notably, this hypothesis starkly opposes the Modernization Theory, and leaves a challenging alternative argument open for further deliberation. 

The other major contesting view is that democracy encourages economic growth. The study conducted by Acemoglu et al. mentioned earlier plays a significant role in buttressing this argument. Their research particularly focuses on countries which have ‘switched’ from one form of government to another between 1960 to 2010 and account for 122 democratizations and 71 democratic backslidings. According to their findings, civil liberties enjoyed in democratic countries play a key role in aiding economic growth. It also indicates that democratization positively influences economic reform, private investment, the size and capacity of the government and leads to a reduction in social conflict. The level of investment made in citizens in democratic regimes, especially in the healthcare and education sectors, is also significantly higher than the same in autocracies. All of these underlying conditions make for a highly growth-friendly environment which consequently help in boosting the economy. These findings corroborate similar views put forth by Gerring et al. (2005) and Persson and Tabellini (2009) in their earlier studies. 

This view, however, has come under scrutiny in the light of a newer research that claims that democracy has no real impact on economic growth. This study differentiates democracies along the tangent of the conditions underlying the emergence of a democracy. They are either classified as ‘exogenous’ i.e. democracies which originate from non-economic factors like death of an autocratic leader, historical context etc, or ‘endogenous’ i.e. results of economic instability. It is visible from Panel A that exogenous democratization has no effect on economic growth, as a statistical change from 0.77 before democratization to 0.54 post democratization is negligible. However Panel B exhibits that there is a positive change in economic growth with the onset of democratization, as there is a statistical jump from -0.44 to -0.01. In other words, this study suggests that the inclusion of endogenous democracies while studying the impact of democratization on economic growth leads to the false impression that all democracies facilitate economic growth. However, this is not true as is evidenced by growth patterns studied in exogenous democracies. Therefore, the claim that democracies encourage economic growth is considerably weakened, and the debate continues. 

As the title suggests, the relationship between democracy and economic growth is truly a ‘twisted tale’. While we live in a time where this question has not been more relevant, efforts to deduce its answer appear to yield increasingly diverse results. Moreover, countries like China, Singapore and Russia which have managed to achieve high-levels of economic growth despite being authoritarian in nature have only added to the conundrum further. Hopefully, the set of remarkable pre-existing studies will lay adequate groundwork for future research to yield more definitive and widely accepted answers to this age-old puzzle. 

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Panel A: Exogenous Democratic Transitions 

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Panel B: Endogenous Democratic Transitions

Atisha Mahajan is a second year Economics and Political Science Major at Ashoka University. Her twitter can be found at @MahajanAtisha.

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