Responsible researcher: Eduarda Miller de Figueiredo
Authors: Daron Acemoglu, Simon Johnson, James A. Robinson and Pierre Yared
Intervention Location: All countries
Sample Size: --
Sector: Political Economy
Variable of Main Interest: Lagged value of the log of per capita income
Type of Intervention: Democracy
Methodology: Instrumental Variables
Summary
The literature prior to this study had demonstrated a positive relationship between income and democracy, but without taking into account the issue of causality. Because of this, the authors revisited this relationship, analyzing the issue of causality. To do this, the authors used data on measures of democracy and autocracy, assembling an annual and five-, ten- and twenty-year data panel. OLS, difference-in-differences and instrumental variables estimates were made. The results demonstrated that there is no evidence of a causal effect of income on democracy.
Studies had been demonstrating a positive relationship between income and democracy in the 1990s. Most countries were not democratic before the modern growth process, so the democratization process occurred along with growth. As Barro (1999) states: “increases in various measures of living standards predict a gradual increase in democracy. In contrast, democracies that emerge from prior economic development... tend not to last.”[1].
The authors state that previous studies did not establish causality. Therefore, when revisiting the relationship between per capita income and democracy, they analyze the issue of reverse causality and the potential omitted variable bias, since some other factor can determine both the nature of the political regime and the potential for economic growth. In which reverse causality would be caused by the fact that democracy generates income and not the other way around.
The literature argues that differences in European colonization strategies were one of the main determinants of the divergent development paths of colonial societies (Acemoglu, Johnson, and Robinson, 2001, 2002; Engerman and Sokoloff, 1997). This suggests that, in the sample studied, the critical moment for most societies corresponds to their experience under European colonization.
The main measure of democracy used by the authors is the Freedom House Political Rights Index . In this index, the country receives a higher score as political rights come closer to the ideals suggested by a checklist of questions, which include the existence of free and fair elections, whether elected officials govern, whether there are other political groups, whether the opposition plays an important role and has real power and whether minority groups participate in government.
Data from all independent countries from 1800 onwards from Polity IV Polity Index composition , which is the difference between the indices of democracy and autocracy (Marshall and Jaggers, 2004), were also used. Thus, a panel was assembled for five, ten, twenty years, in addition to an annual data panel.
The authors used two strategies to investigate the causal effect of income on democracy.
The first was by controlling for country-specific factors that affect both income and democracy, including country fixed effects. The main source of potential bias in a regression of democracy on per capita income are country-specific historical factors that influence political and economic development. If these omitted characteristics are time-invariant, the inclusion of fixed effects will remove this source of bias.
A second strategy by the authors was to use the instrumental variables method to estimate the impact of income on democracy. To achieve this, the authors used two instruments: (i) previous savings rates; and (ii) changes in the incomes of trading partners.
The econometric model developed by the authors for this study has as its dependent variable the democracy score of country i in period t. Furthermore, variables with lagged values were added to capture the persistence of democracy and the main variable of interest was the lagged value of the log of per capita income. Thus, a parameter was also added to measure the causal effect of per capita income on democracy, a set of binary variables for countries and a set of time effects to capture common shocks for democracies.
From this model, the authors ran regressions for OLS, the Difference-in-Differences Method and the Instrumental Variables Method.
The first instrument is the savings rate. According to the authors, it is natural for the savings rate to influence income in the future and it is plausible to expect that changes in the savings rate, over periods of 5 to 10 years, do not have a direct effect on the culture of democracy, structure of political institutions or the nature of political conflict within society. However, there are several channels through which the savings rate can be correlated with the error term of the econometric model, such as the fact that it can be influenced by the current political regime or it can also be correlated with changes in the distribution of income or the composition of assets – which could have a direct effect on political balances.
The second instrument explores commercial links between countries. In that the transmission of economic cycles from one country to another through trade, implies that one can think of a statistical model for a country's income that includes a parameter z that measures the effect of world income weighted by trade on income of each country. To do this, the authors use as an instrument a weighted sum of world income for each country.
The results for OLS regressions using the five-year sample suggest that democracy lag is highly significant and indicates that there is a considerable degree of persistence in democracy. The log of per capita income was also significant and, according to the authors, this illustrates the positive relationship between income and democracy. And, although statistically significant, the income effect is quantitatively small. However, the positive relationship between per capita income and various measures of democracy disappeared when fixed effects were introduced. Therefore, there is no relationship between changes in per capita income and changes in democracy. In other words, per capita income is not an important determinant in democracy.
Using the instrumental variables method, the results showed a strong relationship between income and the savings rate in the first stage. The authors found a result that demonstrated that a global democracy index, constructed by them through commercial actions, has no effect. Therefore, the two IV strategies presented by the authors demonstrated consistent results that indicate no evidence for a strong causal effect of income on democracy.
The authors conclude, after presenting the results that corroborate the findings, that although the results did not provide evidence of a causal effect of income on democracy, such an effect may be present, but acting at much lower frequencies or this causal effect may be conditioned to some other features. It is also highlighted that the results found do not imply that democracy has no effect on economic growth, since the fixed effects in the regressions and the presence of divergent development trajectories create a trend, but there are other factors influencing the path of democracy in the countries .
When answering the question “ why are rich countries democratic today?” ”, the authors state that, although there is no relationship between changes in income and democracy over the last 100 years, there is a positive association over the last 500 years. Most societies were not democratic 500 years ago and had similar income levels, where the positive cross-sectional relationship reflects the fact that those who have become more democratic over this period are also those who have grown faster. Where the authors' hypothesis is that the positive cross-sectional relationship, over the 500-year period, between changes in income and democracy are caused by the fact that countries embarked on divergent development paths.
References
Barro, RJ1999. “Determinants of Democracy”. Journal of Political Economy , 107(6): S158-83.
Marshall, MG; Jaggers, K. “Political Regime Characteristics and Transitions, 1800-2002.” College Park, MD: Polity IV Project, University of Maryland
[1] Own translation. Original quote: “ Increases in various measures of the standard of living forecast a gradual rise in democracy. In contrast, democracies that arise without prior economic development… tend not to last ” (Barro, 1999).
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