Confusions about democracy and prosperity

Spoiler: in a previous post, I claimed that there was a positive relationship between prosperity and high quality institutions. Some people go further and argue that democracy leads to growth and prosperity as this influential study argues. Other people think that the causality is reversed. The effects of democracy on growth and prosperity occur through better conditions for people to engage in entrepreneurial activities, to save, and invest in both physical and human capital. These conditions are determined by the quality of institutions.

Property rights, rule and law and control of corruption are regarded as key institutions for growth. But not everyone is convinced which you can see here. Critics of instutions' role for growth and prosperity see the devleopments of traditional growth theory variables as independent of institutional changes.

In this post I will have a look at some countries where it seems that institutions don’t matter (much) or that growth precedes democracy and high-quality institutions. And maybe you can have high quality institutions that are good for growth without democracy. You can also find examples of countries where the regimes don't seem to care a lot of growth, on the contrary, they fear growth as it may serve to undermine them.

If you’re not confused now, don’t worry. You will be.

What causes democratisation and growth? What comes first? Some people argue that economic development in countries create middle classes whose population begin to demand political reforms. Others argue that the causality is reversed. Political reforms that make countries democratic also improve the conditions for savings, investments, and growth.

While richer countries tend to be more democratic, many academics question the causality from growth to democracy. Here is an overview of the discussions of this topic. There are also critics of both causality directions. They argue that the relationship between democracy and prosperity is merely a correlation. Rich democratic countries tend to be more politically stable than poor countries. History has shown that while poor democracies can be overturned and transformed to autocracies, this seldom occur in rich countries. Developments in Hungary, Poland and what may happen in the USA if Trump wins the 2024 Presidential Election, may make the latter transformation more frequent.

High-quality institutions in autocracies

Whatever causality relationship, countries which have become democratic have often reformed and designed institutions that strengthen Rule of Law and weaken Corruption. While the quality of such institutions in general are higher in democracies, they can also be found in prosperous autocracies. Conditions of Rule of Law a Control of Corruption are related with prosperity as shown in the top panel below. In only one High-Income country are both Rule of Law and (control of) Regime Corruption <0.5.

The bottom panel shows that these conditions are mostly found in democracies. Only in three autocratic countries are conditions of Rule of Law and Control of Corruption very strong (>0.75). Two of those countries are South-East Asian High-Income countries, Hong Kong and Singapore, while the third is an African Low-Income country; Benin, c.f. Figure 1

Figure 1. Rule of law vs Corruption in countries of different income groups (top) and in autocracies or democracies (bottom).

Source: Regime Corruption, Rule of Law and type of Regime: Varieties of Democracy, https://www.v-dem.net/en/. Rule of Law Index. The index ranges from 0 to 1 and aims to assess to what extent laws are transparently, independently, predictably, impartially, and equally enforced, and to what extent do the actions of government officials comply with the law? Regime Corruption. The index ranges from 0 to 1 and aims to assess to what extent politicians use their offices for private and/or political gain. The V-Dem index is reversed in the figure above to show conditions in the same way as the Rule of Law index does: the higher the value, the better are conditions in the country. Type of Regime. Assesses the political regimes considering the competitiveness of access to power as well as liberal principles. Income group: TheWorld Bank. https://datahelpdesk.worldbank.org/knowledgebase/articles/906519-world-bank-country-and-lending-groups.

High quality institutions are not only found in democracies. In autocracies where such are found, firms and households have incentives to save and invest and engage in long-term contractual relationships that are often necessary for commercial activities.

An island where institutions don’t matter (much)

But sometimes, growth takes place anyway. An interesting example of where institutions don’t seem to matter is given by the Dominican Republic and Haiti. The two countries are located on the same island. Neither Haiti nor the Dominican Republic have a history of high-quality institutions. Somehow GDP per capita in the Dominican Republic has grown by on average 3.1 percent per year while it has decreased in Haiti, c.f. Figure 2.

Figure 2. GDP per capita and economic and political institutions in Haiti and the Dominican Republic.

The difference does not appear to be due to differences in levels of democracy or economic freedom. Nor can any large differences in Rule of Law of Corruption explain the difference. Jaramillo and Sancak dig deeper to find explanations behind the difference. They find that traditional growth theory variables matter. Differences in policies for supporting investments in human capital and physical capital in combination with differences in political stability between the two countries, are the main explanations. The Haitian dictators have been crueller which is why the OAS sanctioned the country 1991 and the UN imposed an oil-embargo. Absence of trade held back growth. While Haiti has a history of many coup d’états, the dictators in the Dominican Republic were better at controlling their opposition and pursued policies to increase investments.

Growth before democracy or growth without democracy

Also countries in South-East Asia offer developments that question the supposed causal relationship between democracy and growth. Most countries in that region have seen the GDPs per capita doubled or more since 1990. GDP per capita in Myanmar has increased by a factor of eight since 1990. Like Myanmar, most of the countries are autocracies.

This applies for Hong Kong where Communist China now have stepped in to crush the people’s human rights as well as Singapore. Hong Kong and Singapore are interesting. Both countries have long had high quality institutions. Rule of law and control of corruption are strong which is good for investments and entrepreneurial activities which require impartial institutions, see here for an elaboration. Rule of law and control of corruption were strong before growth took off in Hong Kong and Singapore.

Two other countries have however experienced not only growth but also transformations from autocracies to democracies. South Korea and Taiwan used to be brutal dictatorships but are now liberal democracies. Rule of law and control of corruption became strong as the countries became democracies. For these countries, the reforms of the institutions were probably parts of the democratisation processes.  Growth preceded democracy in both countries, c.f. Figure 3.

Figure 3. Developments of GDP per capita, Democracy and Rule of Law in Hong Kong, Singapore, South Korea and Taiwan.

Source: GDP per capita. Penn World Tables, version 10. https://www.rug.nl/ggdc/productivity/pwt/?lang=en  GDP is Real GDP at constant 2017 national prices (in mil. 2017US$). Democracy Index. Varieties of Democracy, https://www.v-dem.net/en/ The index ranges from 0 to 1 and aims to assess constitutionally protected civil liberties, strong rule of law, an independent judiciary, and effective checks and balances that, together, limit the exercise of executive power in countries. The index also takes the level of electoral democracy into account. Rule of Law Index. The index ranges from 0 to 1 and aims to assess to what extent laws are transparently, independently, predictably, impartially, and equally enforced, and to what extent do the actions of government officials comply with the law?

There are also examples where democratisation precedes reforms of the institutions. This is arguably what happened in the Baltic countries and Eastern Europe some thirty years ago. Free and fair elections were held in all countries relatively soon after the communist reigns ended. Aiming for EU memberships gave the countries’ governments incentives to introduce reforms that would pass the conditions detailed in different chapters here. As I showed here, the former communist countries that have joined the EU have not only enjoyed more freedom than the countries that did not, but also higher living standards.

Autocracies are bad.

Even though it may be difficult to establish the causal relationship between democracy and growth, it is not difficult to find examples of how bad autocracies are for growth and prosperity. Africa, and Latin America are full of such examples as Chile and Venezuela show. Contrary to what many claim, growth during the Pinochet regime was not stronger than before he made his coup. It might even be that some of the increase in GDP per capita is due to the number of people that his butchers slaughtered or fled or was deported.

Despite having a lot of oil, different Venezuelan governments never managed to create sustainable growth. Neither governments during periods of democracy nor governments during autocracy. Increasing oil prices worked in Chavez’s favour but his and Maduro’s miserable economic policies led to a growth disaster with an impoverished population, c.f. Figure 4.

Figure 4. Developments of GDP per capita, in Chile and Venezuela.

Source: GDP per capita. Penn World Tables, version 10. https://www.rug.nl/ggdc/productivity/pwt/?lang=en  GDP is Real GDP at constant 2017 national prices (in mil. 2017US$).

Some people argue that the Venezuelan disaster is due to American sanctions. Even though, Trump’s sanctions did not help, this is just not true. The disaster is home made as I show here.

Maybe some regimes don’t want or dare their countries to grow

Achieving growth is not rocket science. Many countries have grown out of poverty by utilising their comparative advantages and investing in infrastructure, education, carrying out land reforms and more. So why doesn’t this happen in all countries? To answer that question requires at least a post of its own.

And there is probably not a simple answer to the question. The regime in North Korea is preoccupied by remaining in power and therefore oppresses its people by any means. Kim Jong-Un is not interested in having a resourceful middle-class demanding civil rights and democracy. Besides, he has nuclear missiles, so he doesn’t need economic growth to create a strong army to defend himself.

Political instability is not good for growth as not only Haiti but also Pakistan and many African countries show. If you don’t know the rules of the game tomorrow, you don’t dare to invest, you spend your income right away. The inherent instability could also be the reason for lack of public investments in health, and infrastructure. Governments in countries where governments are frequently overthrown, have weaker incentives to make public investments, i.e., postpone consumption. Less public investments mean more consumption to keep your people happy and less prone to overthrow you.

Autocratic regimes that fear uprisings have incentives not to invest in infrastructure. More and better roads and railways make it easier to assembly and transport rebel troops and weapons to be used against the regimes.