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Political Institutions and Economic Growth

Jenny Minier

Introduction

A consensus has yet to emerge from the rapidly expanding body of work
on the relationship between economic growth and democracy. Although
economists and political scientists have offered theories describing this
relationship for many years—the strength of the Athenian economy rela-
tive to Sparta, for example, is often attributed to the flexibility of Athens’
democracy—formal empirical tests have increased substantially during the
1990s. This recent research, due at least partly to the availability of better
measurements of the extent of political rights across countries, has gener-
ally been more careful than previous work to differentiate between causal-
ity running from economic growth to democracy and from democracy to
economic growth.
In this essay, I discuss the theoretical background of the ways in which
governmental structure (specifically, the level of democracy) may affect
economic growth. I also present several theories of how economic condi-
tions may affect a country’s level of democracy, and summarize some of
the more recent empirical work in this area. To conclude, I discuss the policy
implications that can be drawn from this collection of work.

Theoretical Background

The effect of democracy on economic growth

With the exception of some of the oil-producing Middle Eastern states,

the richest countries in the world are democratic, and many of the poorest

Jenny Minier is an assistant professor in the department of economics at the University of Miami.
Her research focuses on the interaction between economic growth and institutions such as democ-
racy, stock markets, and trade policy. Her latest paper,“Is Democracy a Normal Good? Evidence from
Democratic Movements,” is published in the Southern Economic Journal 67(4), 996-1009, 2001. She
may be reached at: jminier@exchange.sba.miami.edu
Knowledge, Technology, & Policy, Winter 2001, Vol. 13, No. 4, pp. 85-93.
86 Knowledge, Technology, & Policy / Winter 2001

are not. Although casual observation suggests a strong, positive correla-

tion between levels of democracy and income, economic theory does not
unambiguously predict the sign of the correlation between democracy and
economic growth.
The most common argument for a positive correlation between democ-
racy and economic growth is that expressed by Olson (1993, p. 574), who
argues that, “the same emphasis on individual rights that is necessary to
lasting democracy is also necessary for secure rights to both property and
the enforcement of contracts.”A related argument is that the systems of checks
and balances present in most democracies make it more difficult for a govern-
ment to divert funds to less productive activities. Both of these theories argue
that democracy’s effect on growth is indirect: the legal institutions, property
rights, and“rule of law”inherent in strong democracies are conducive to higher
rates of economic growth. Of course, these factors can also be institutional-
ized in authoritarian regimes. Chile under Pinochet and, more recently,
Singapore provide examples of growth-oriented authoritarian regimes.
A more direct argument for a positive effect of democracy on economic
growth comes from Acemoglu and Robinson (2000). In their model, sys-
tems of majority voting increase the “human capital” (education and skills)
of a country, increasing growth rates, in two ways. First, under a system of
majority voting, people vote directly for more education. Also, by voting
for taxation schemes that transfer income from rich to poor, democracies
increase the resources available to the poorer classes, enabling them to
take advantage of educational opportunities.
Majority voting also constitutes one of two main arguments that de-
mocracy decreases growth rates. In Acemoglu and Robinson (2000) and
Persson and Tabellini (1994), citizens of democracies vote for redistributive
taxation, decreasing incentives and thereby decreasing growth rates rela-
tive to countries without majority voting. The other main argument against
a positive correlation between democracy and growth is that authoritarian
regimes, due to their higher levels of centralized power, are better able to
coordinate economic growth. Rao (1984) argues this specifically, citing the
examples of India under emergency rule in the 1970s and Chile under the
Pinochet regime. In democracies, interest groups may weaken a
government’s commitment to growth, requiring large amounts of “pork-
barrel” spending, as in Olson (1982).
Some have even argued that democracy works against property rights.
Przeworski and Limongi (1993, p. 52) outline several such arguments from
the nineteenth century, ranging from Thomas Macauley’s statement in 1842
that universal suffrage would be,“the end of property and thus of all civili-
zation,” to Karl Marx’s argument that universal suffrage and private prop-
erty are incompatible.

The effect of economic growth on democracy

Theories of how economic growth (or income levels) affect levels of de-
mocracy are traditionally more in the domain of political scientists than
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economists, although economists have recently begun to work in this area.

Lipset (1959) details one of the earliest (modern) descriptions of the deter-
minants of democracy; what has become known as the“Lipset hypothesis”
(despite Lipset’s reference to Aristotle as the original source) suggests that
more developed countries are better suited to democracy than are poorer
countries. Lipset’s definition of economic development encompasses edu-
cation, industrialization, and urbanization, in addition to income.
Huntington (1991) also argues that economic development increases citi-
zens’ desire for democracy; he includes the volume of international trade
and the size of the middle class, in addition to income and education, as
indicators of overall development. In addition, Huntington discusses the
role of economic growth, arguing that economic growth both increases the
speed at which a country reaches a level of income “suitable” for democ-
racy and acts to destabilize an existing authoritarian regime. Specifically,
he states that economic growth,“raises expectations, exacerbates inequali-
ties, and creates stresses and strains in the social fabric that stimulate po-
litical mobilization and demands for political participation.” (p. 69).
Moore (1996), Rueschemeyer, Stephens, and Stephens (1992), and
Acemoglu and Robinson (2000) elaborate on this argument. Moore (1996)
argues that a sizable middle class is crucial for the development of democ-
racy, whereas in the models of Rueschemeyer et al. (1992) and Acemoglu
and Robinson (2000), economic development empowers previously disen-
franchised groups, such as working classes and women, making it increas-
ingly difficult for political élites to exclude these groups from political
participation.1
Although both scholars and citizens often take a country’s regime type
as exogenous or previously determined, countries do undergo periods of
transition from one type to another. In a series of papers, Yi Feng and Paul
Zak2 present several related models of democratic transition. In Feng and
Zak (1999), a democratic transition can occur in a growing economy or
during a period of economic crisis. In their model, as an economy grows,
an increasing proportion of citizens become politically active, demanding
increased political freedoms. On the other hand, if an economy experi-
ences economic crisis, its government is weakened and a transition to a
new regime occurs. These transitions continue until a regime that can main-
tain economic growth is in place. The precise timing of regime change is
determined by changes in income distribution, government policies, and
citizens’ preferences for civil liberties, in addition to per capita income.

Empirical Evidence

Most of the early theoretical studies of democracy and economic growth

suggest only correlations between the variables, rather than formal mecha-
nisms through which democracy affects growth. Because of this, many
empirical studies of the relationship between democracy and growth have
incorporated some measure of democracy into conventional cross-section
growth regressions, effectively asking, “What is the correlation between
88 Knowledge, Technology, & Policy / Winter 2001

democracy and economic growth, controlling for other variables believed

to influence growth?” With the appearance of more fully specified models
of the channels through which democracy may affect economic growth,
empirical studies have begun to take more varied approaches.
In order to investigate the relationship between democracy and growth
empirically, it is necessary to identify an appropriate measure of “democ-
racy”or“political rights.”In empirical economic studies, the most frequently
used measure of democracy is the index of political rights constructed by
Freedom House, also known as the Gastil index. 3 This is a subjective index
ranging from one (most free politically) to seven (least free), constructed
from a checklist of components of democracy based on local and interna-
tional printed materials, field visits, and communications with observers
and citizens. Freedom House defines democracy as,“at a minimum…a po-
litical system in which the people choose their authoritative leaders freely
from among competing groups and individuals not chosen by the govern-
ment.” (1997, pp. 192-193)4
Sirowy and Inkeles (1990) and Przeworski and Limongi (1993) provide
surveys of empirical studies of economic growth and democracy, covering
both the economic and political science literature. Przeworski and Limongi
(1993, p. 51) conclude that “social scientists know surprisingly little: our
guess is that political institutions do matter for growth,”but that the speci-
fications of the studies they survey do not capture the relevant differences.
In the following, I discuss more recent contributions.

The effect of democracy on growth

In economics, Barro (1996) is one of the best-known empirical studies of

the relationship between democracy and economic growth. Controlling for
other political and economic variables believed to affect economic growth,
such as initial GDP per capita, education levels, investment rates, and govern-
ment consumption expenditures, Barro finds a slightly negative (but not sta-
tistically significant) correlation between democracy and growth in GDP
per capita. He also presents evidence of a nonlinear or“inverse U-shaped”
relationship in which democracy and growth are positively correlated at low
levels of democracy and negatively related at higher levels. Allowing for this
type of nonlinear relationship results in statistically significant estimates.
In a study differentiated by its much longer timeframe, De Long and
Shleifer (1993) study population growth rates in European cities from 1050
to 1800. Over such a long time period, population growth is a reasonable
proxy for increases in standards of living. De Long and Shleifer divide cit-
ies into those ruled by absolutist “princes” and those ruled by other ar-
rangements, which they term “merchants” but which also includes
constitutional monarchies. Their theory is that the difference in economic
growth rates between the two types of regimes is due to differences in the
security of property rights, and they find strong evidence that countries
governed by absolutist regimes grew more slowly than those governed by
strong constitutions or by merchants. They conclude (p. 700),
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European historians have often written to celebrate the firm establishment of

princely authority….But from the perspective of the welfare of the people alive
at the time, or of the long-term growth of the economy, princely success is eco-
nomic failure….The rise of an absolutist government and the establishment of
princely authority are, from a perspective that values economic growth, events
to be mourned and not celebrated.

In addition to a better understanding of the overall relationship between

democracy and economic growth, economists are interested in the chan-
nels through which democracy affects growth. While democracy may have
some direct effects on growth, it is also possible that a country’s level of
democracy may affect its growth performance indirectly. This could occur
in two ways. Democracy may affect variables (such as education or invest-
ment) that in turn influence growth rates. For example, democracies are
frequently assumed to have more egalitarian educational policies than au-
thoritarian regimes, since mass political participation translates into more
people voting for better education for their children (see Acemoglu and
Robinson [2000]).
Alternatively, countries with different levels of democracy may utilize
the factors of production available to them differently. More technically,
the aggregate production function relating these inputs to output may dif-
fer across levels of democracy. To see this intuitively, consider two coun-
tries that receive identical amounts of foreign aid or investment. In the
totalitarian regime, the dictator allocates the new funds to the building of
a third presidential palace, while in the democracy, the government chan-
nels the funds toward investment in infrastructure. (Of course, the oppo-
site is also plausible—the dictator may be able to direct funds to primary
education, while the democracy feels obligated to reward supporters or
court potential votes with nonproductive assistance.)
Helliwell (1994) is the best-known investigation of the first type of indi-
rect effects, testing for both direct and indirect (through the channels of
education and investment) effects of democracy on growth. He uses a sys-
tem of simultaneous equations to control for dual causality between de-
mocracy and income. He estimates a negative but not statistically significant
effect of democracy on economic growth, controlling for other factors, but
finds that this effect is offset by the increased levels of education and in-
vestment that occur in democracies. (As in most empirical and theoretical
studies, levels of education and investment are both positively correlated
with economic growth.) After controlling for these simultaneous effects,
he concludes that there is little difference in growth rates between demo-
cratic and non-democratic countries.
The second type of indirect effects—that democracies and non-democ-
racies differ in how effectively they use given amounts of inputs—is the
focus of Minier (1998). She uses a statistical technique known as a regres-
sion tree to endogenously split a sample of 96 countries into groups of
countries considered “most similar” with respect to estimated aggregate
production functions. The advantage of this technique is that it selects the
90 Knowledge, Technology, & Policy / Winter 2001

level on which to split the data: the researcher does not have to arbitrarily
decide to split on the median level of some variable, for example. This is
particularly valuable in the case of democracy: although the theoretical split
into “democracies” and “non-democracies” is straightforward, many coun-
tries fall somewhere in between (for example, a country may offer full suf-
frage but require governmental approval of all candidates). Additionally,
splits can be considered on any number of potential split variables: in Minier
(1998), the splits on democracy that occur are judged “better” splits of the
data than splits based on literacy or GDP per capita. The alternative of no
splits of the data is also considered.5
After isolating the poor and low literacy countries, the remaining
subsample of 47 non-poor, high literacy countries is split based on the level
of democracy, suggesting that democracy does in fact affect how efficiently
countries use the inputs available to them. Among this group, the low de-
mocracy countries have a much stronger estimated correlation between
investment in physical capital and economic growth; the high democracy
countries have a stronger correlation between education and economic
growth. As potential explanations, Minier suggests that governments of
less democratic countries may be able to direct investment into more pro-
ductive activities, because they are not required to make concessions to
special interests and lobbying groups. She also suggests that the higher
correlation between education and economic growth in democracies may
be due to the existence of more opportunities for citizens of democracies,
increasing the returns to education.
In a related study, Rodrik (1999) finds that wages in manufacturing sec-
tors are higher in democracies. This relationship appears to hold even after
controlling for other political factors, such as the rule of law, political sta-
bility and civil liberties. Rodrik hypothesizes that this relationship may be
due to opportunities for more efficient bargaining between employers and
employees in democracies, and/or that the benefits of democracy, such as
more secure property rights and higher levels of political stability, offset
the cost of high wages to employers.

The effects of income levels and growth on democracy

Much of the research concerned specifically with the effect of economic

growth (as opposed to levels of income) on democracy is based on anec-
dotal evidence. For example, Huntington (1991) cites the role of rapid eco-
nomic growth in the moves toward democracy of countries such as Greece,
Spain, Brazil, South Korea, and Taiwan.
Barro (1996, 1999) regresses observed levels of democracy (based on the
Freedom House index) on a range of variables, including income levels,
previous levels of democracy, measures of educational attainment, urban-
ization, and population. Controlling for these variables, he finds a positive
and statistically significant correlation between democracy levels and in-
come. He concludes that, “improvements in the standard of
living…substantially raise the probability that political institutions will
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become more democratic over time. Hence, political freedom emerges as a

sort of luxury good.” (Barro does not include recent economic growth as a
potential predictor of democracy levels.) Helliwell (1994) also finds a ro-
bust and positive effect of income levels on democracy.
Many papers interpret these predictions of the level of democracy as
studies of the determinants of the “demand” for democracy. Minier (2001)
tests the relationship between economic growth or income levels and the
demand for democracy more directly. She created a data set of democratic
movements, and uses it to indicate the presence of a widespread demand
for democracy. Using logit analysis, she finds that the probability of a demo-
cratic movement occurring is increasing in levels of GDP per capita up to
approximately $5,000; the probability of a democratic movement occurring
falls with income at higher income levels. There is no relationship between
economic growth over the preceding five-year period and the probability
of a democratic movement occurring, controlling for other variables.

Policy Implications

Perhaps the most important policy implication that could be drawn from
this literature is whether it is optimal for developed countries and interna-
tional organizations to encourage democracy in authoritarian developing
countries, where economic growth is likely to be a concern. Many have
argued—anecdotes of India, Costa Rica, and Botswana aside—that democ-
racy is incompatible with lower levels of development. Minier (1998) tests
this implication more directly, by comparing countries that became demo-
cratic to a priori similar countries that did not. She identifies 13 countries
that experienced substantial increases in democracy and 22 countries that
experienced large decreases in democracy during the period 1965-87. For
each country that experienced a change, she forms a “control group” of
countries that, prior to the change in democracy, were similar in terms of
income per capita and democracy levels to the countries that underwent
changes in democracy.
Over five-year periods, per capita income in countries that had just be-
come democratic increased by 2 percent, on average, while a priori similar
countries averaged a decrease of 1 percent. Countries that experienced de-
creases in democracy grew by approximately 8 percent over the subsequent
five-year period, while the control group average was nearly 15 percent.
The differences are magnified over periods of ten and fifteen years: coun-
tries that increased democracy experienced economic growth of 32 per-
cent, on average, over the fifteen years following the change, relative to an
average of 6 percent among the control groups, while countries that expe-
rienced a decrease in democracy grew by 8 percent relative to a control
group average of 35 percent. Furthermore, there is no evidence that the
democratic transitions were more successful in increasing growth rates
among higher income countries.
Although not all of these differences are statistically significant, it is
important to note that they provide no evidence that countries that be-
92 Knowledge, Technology, & Policy / Winter 2001

came democratic grew more slowly than if they had remained authoritar-
ian. There are clearly many reasons to encourage democracy for its own
sake; although there is not much evidence to support encouraging democ-
racy for economic reasons, there seems to be little reason to discourage de-
mocracy for fear of adverse growth consequences.

Notes
1. Rueschemeyer et al. (1992) approaches the issue from the political science perspective,
while Acemoglu and Robinson (2000) and Moore (1996) address it as economists.
2. See Feng and Zak (1999, 2000) and Zak and Feng (1998).
3. More information is available online (http://www.freedomhouse.org), including recent
and historical values of the index for all countries rated.
4. Bollen (1993) discusses some of the criticisms against the Gastil index and compares
it to similar rankings.
5. See Minier (1998) for a more complete description of the regression tree procedure.

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