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Relationship between the democracy and economic growth

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Summary:

To examine the relationship between the democracy and economic growth in the people's Republic of China over the last three decades. Actually, China represents an interesting case in the debate over the relationship between the democracy and growth.

Methods:

Using the short and long run effect of democracy on the china within a production function framework by following the methods of error correction mechanism, and Granger Causality tests-testing between the labour and capital, and most studies by economist have tested for correlation between democracy and economic growth and have failed to adequately address the issue of causation, and using the Granger causality tests to explore the effects of shocks of democracy and economic growth beyond the sample period through the use of variance decomposition analysis and impulse response functions.

Effect of democracy on Growth:

Sirowy and Inkeless (1990) suggest that there are three major views on the effects of democracy on growth with they label the "conflict", and the compatibility" and the "skeptical". The conflict thesis suggests that democracy and economic growth are incompatible because elected officals longing for popular approval make shortsighted decisions designed to maximize whose objective is to divert resources from productive activities in favor of immediate consumption. Related arguments are that democracy is less conducive to long term stability (world Bank, 1991, pp. 132-133) or long term development ( Barro, 1996) because of the tendency in majority voting systems to enact rich to poor redistribution of income including land reforms.

On the other hand, the compatibility thesis proffers that democratic features such as political pluralism, institutional checks and balances and freedom of the press provide safeguards against system abuse or predatory behavior often associated with authoritarian regimes. Friedman (1962) was one of the first to suggest that economic and political freedoms are mutually reinforcing. He postulated that an expansion in political freedom fosters economic freedoms such as secure property rights and certainty of contract, which, in turn, underpin higher rates of economic growth. As Barro( 1996) argues, of course there is nothing in principle preventing non-democratic governments from promoting economics freedoms. Examples of autocracies which have increased economic freedom include the Pinochet regime in chile and the Fujimora government in Peru. The point, though, made by advocates of the compatibility thesis is democracy is more likely to be conducive to promoting economic freedoms than authoritarianism because the political legitimacy and therefore long term survival of a democracy depends on maintaining economic rights.

The third perspective, which is the skeptical view, suggests there is no systematic relationship between democracy and economic growth. While it might generally be true that there is more economic freedom under a democracy than an autocracy, there is no guarantee it will be at an optimum ( Esposto and Zaleski. 1999). Even in a democracy there will be those whose aims is to challenges the private property status quo if it is in their best interests, and because of the very nature of a democracy they will have more opportunities to do so( Przewoki and Limongi, 1993).

However, the empirical evidence on the three perspectives in not clear-cut. Sirowry and inkeles( 1990) review thirteen studies; of which, six supported the skeptical view, four suggested qualified or conditional relationships, and three provided unconditional support for the conflict perspective. In a later survey, Brunetti ( 1997) reviewed 17 empirical studies of the democracy-growth relationship. He found ( at p. 167) "nine studies report no relationship, one study a positive, one study a negative, three studies a fragile negative relationship and three studies a fragile positive relationship between democracy and economic growth". Helliwell (1994), Barro (1996) and Tavares and Waczing (2001) found that democracy has either a non-significant or moderately weak negative effect on growth once other growth-determining variables are held constant. On the basis of the mixed findings in the literature, a reasonable conclusion is that: " We do not know whether democracy fosters or hinders growth" (Przewoki and Limongi, 1993, P.64). However, as a provision to this, the balance of empirical evidence is with the conflict and skeptical views rather than the compatibility view.

Effect of growth on Democracy:

Political scientists have examined the effect of the economic growth on democracy. Most studies have found that economic growth generates demands for political right ( Lipset, 1959; Bollen, 1979; Bollen and Jackman, 1985; Burkhart and Lewis-Beck, 1994). At one level, casual empiricism seems to also support the view that economic growth promotes democracy. As Gupta et al. ( 1998, pp. 589-590) note, " all of the developed, industrialized nations have a democratic political system. In contrast, most of the nations in the poorest segment of the world community operate under various forms of non-democratic political system". However, This is not ture in a blanket sense. Casual observation also suggests that economic growth does not necessarily bring about a demand for democracy. There are examples of authoritarian regimes in Southeast Asia and the Middle East where citizens are willing to forego demand for political liberalization provided their economic needs are being met.

In these instance there is a good argument that it is only when the authoritarians government stops delivering on the economic front that there are calls for more political rights. An example is the fall of the Suharto regime in Indonesia following the Asian financial crisis when spiraling inflation and unemployment prevented Suharto from delivering in the economic sphere. Glasure et al. ( 1999) obtain results that are consistent with this view. Their finding suggest that in developing countries and newly industrializing countries economic development has a significant effect on democratic performance, but contrary to Lipest( 1959) economic development leads to lower levels of democracy. Glasure et al. ( 1999, p. 475) conclude: " The sign reversal may stem from the possibility that as nations strive for economic development, the nations tend to trade off democracy for economic development"

Methods:

Durlauf and Quah, 1999, Romer, 2001, and Gounder, 1999, 2001, 2002 take the model as the following form: Yt= a + BKt+xL+WDt+Et where D stand for the democracy and other factors are the output like Y stand for real GDP, Real capital stock K, index of human capital L. Weakness cannot define how those factors related to each other, and the result of this equation seem to show only the positive effects while ignoring the bad effects.

Conclusion or finding:

Lack of democracy in China has had a statisfically significant negative effect on real income. However, democracy in the short run has had a satisfically insignificant effect on economic growth. The Granger causality results suggest that in the long run growth in capital, labour and democracy granger cause economic growth, while in the short run there is bi-directional Granger causality between democracy and economic growth in China.

Our finding from the variance decomposition analysis suggest that democracy is more important than either capital stock or human capital in explaining shocks to income. The findings from the impulse response analysis suggest that shocks in democracy have a negative impact on income for the first five years. The results suggest that China's lack of democracy have curtailed economic growth. While it is true that China has had one of the most phenomenal growth performance over the last two decades, an interesting finding from our empirical study is that China's economic growth could have been even higher if there had been more political freedom.

Paresh Kumar Narayan, and Russell Smyth. (2007). Does democracy facilitate economic growth or does economic growth facilitate democracy? An empirical study of Sub-Saharan afica. Monash University. Examine the relationship between the democracy and economic growth in 30 Sub-Saharan African counties, support the Lipset hypothesis, use the real GDP Granger to explore the cause of democracy and an increase in GDP results in an improvement in democracy. In the long run democracy Granger causes real income and an increase in democracy has a positive effect on real income, which is found for Bostwana with the freedome house data and for Madagascare, Rwanda, South Africa, and Swaziland.

Similar Studies:

Several studies have considered the effect of political variables on economic growth in SSA (

Ghura, 1995; Ojo and Oshikoyo, 1995; Easterly and Levine, 1997; Guillaumont et al., 1999). Other studies have examine the effect of political instability on savings ( Gyimah-Brempong and Traynor, 1996) or investment ( Gyimah-Brempong and Traynor, 1999) in SSA. Poltical instability, in particular, has been found to be an important reason for the observed low growth of SSA ( Guillaumont et al., 1999). However, a problem with most existed studies that have tested for a correlation between democracy and economic growth, including those on the democracy-growth relationship in SSA, is that they fail to adequately address the issue of causation, and this limitation of past research is important given that the direction of causation is in dispute. The concept of Granger causality provide a useful too with which to examine the democracy-growth nexus and simultaneously test the economic and political science hypotheses. Granger Causality has been widely used in other contexts; however, with a few exceptions ( Burkhart and LewisBeck, 1994; Glasure et al., 1999; Campos and Nugent, 1999), it has not been used to examine the causal relationship between democracy and economic growth.

Competing Hypotheses on the democracy-Growth Nexus:

There are three major these concerning the effects of democracy on growth that have been dubbed the "conflict", the "Compatibility" and the "skeptical" hypotheses ( Sirowy and Inkeless, 1990). The conflict hypothesis propose that democracy and economic growth are incompatible. One reason suggested for this incompatibility is that elected officials will make myopic decisions designed to maximize their electoral success ( Comeau, 2003). This behavior make officals vulnerable to the overtures of rentseeking interest groups ( Krueger, 1974) and special interet politics ( Olson, 1982), such as the labour unions whose demands will cut into entrepreneurs' profits and slow the rate of economic growth ( Gupta et al., 1998). In contrast, the conflict hypothesis proposes that authoritarian regimes are insulated from redistributive politics, which allows them to enact policies conducive to long term growth ( Comeau, 2003). Moreover, as the residual claimants of their countries' wealth, dictators have an interest in furthering growth to increase their share of national income ( McGuire and Olson, 1996).

A second argument made by advocates of the conflict hypothesis is that democracy is less conducive to long term stability ( World bank, 1991, pp.131-132) or to long-term development ( Barro, 1996) given the proclivity of majority voting system to legislate for redistribution of income, including land reforms, from the rich to the poor. Cheung ( 1998) put forward a third argument that corruption is more likely to flourish under democracy than dictatorship. The rational for Cheung's position is that in an authoritarian regime, " people on top want to maintain their hold on power and corruption is one thing that will most likely destroy this. Cheung's view, however, overlooks subtleties between regime types. Corruption can exist in both democracies and dictatorships. In addition, there is no consensus about the effects of corruption on economic growth. Some studies have found that corruption reduce growth ( Mauro, 1995; Mo, 2011). However, other studies conclude that corruption has desirable properties for growth ( Acemoglu and verdier, 1998). The latter perspective suggests that corruption can act as a lubricant that reduce transaction costs and therefore increase the efficiency of the democracy.

The compatibility hypothesis provides that opposite view to the conflict hypothesis. First, it suggests that political pluralism and institutional check and balances are necessary to protect against systemic abuse or predatory behavior, which are often associated with authoritarian regime. According to North ( 1993), "well specified and enforced property rights, a necessary condition for economic growth, are only secure when political and civil rights are secure; otherwise arbitrary confiscation is always a threat". Second, in contrast with the argument made for the conflict hypothesis, it is suggested that democratization might limit rent seeking due to its system of checks and balance ( De Haan an Sturn, 2003). This view builds on Rodrik's ( 2000) argument that democratic institutions can be viewed as the ultimate institutions for conflict management as they allow for differences among social groups to be resolved in a predictable, inclusive and participatory manner. The compatibility hypothesis is consistent with the view that economic and political freedoms are mutually reinforcing ( Friedman, 1962). While there is nothing in principle preventing non-democratic governments for promoting economic freedom ( Barro, 1996), the compatibility hypothesis suggest that democracy is more conducive to promoting economic freedom and growth than authoritarianism because the political legitimacy of a democracy depends on maintain economic rights.

The intermediate position is the skeptical hypothesis which proffers that there is no systematic relationship between democracy and economic growth. What really matters is the effectiveness of policies implemented and the stability of the regime, rather than its type ( comeau, 2003). Clague et al. ( 1996) suggested that there can be growth enhancing democracies and growth enhancing dictatorships and that the quality of economic policies depends on the time horizon of the dictator in autocracies and whether the democratic system is durable in democracies. Their empirical findings suggest that autocrats who have been in power for some time provide better contractual and property rights than autocrats who have been in power a shorter period.

Advocates of the skeptical hypothesis argue that while it might generally be true that there is more economic freedom under a democracy than under authoritarianism, there is no guarantee that there will be an optimal outcome ( Esposto and Zaleski, 1999). Democracies contain those whose aim is to challenges the private property status quo where it is in their best interests. Cheung ( 1998, p.247) suggest: " if you look at the things people in the so-called democratic countries are voting on, in the absence of a well-defined constitution, the core issues generally involve infringement of property rights, which in turn undermine the system of private enterprise". Moreover, the very nature of a democracy, which its emphasis on political freedom, creates more opportunities for such challenges to property rights ( Przewoki and Limongi, 1993).

There is mixed empirical support for each of the hypotheses. This led Przewoki and Limongi ( 1993, p.64) to conclude: " we do not know whether democracy fosters or hinders growth". There is some evidence to suggest that political freedom has facilitated economic liberalization in central and Eastern Europe ( De Melo et al. 1996, 1997; Dethier et al., 1997). The balance of empirical evidence, however, seems to be with the conflict and skeptical views rather than the compatibility view. This is interesting in light of the fact that the literature on the political economy of SSA seems to have developed a consensus that rejects the conflict hypothesis, even if there is no clear support for the compatibility hypothesis. Sirowy and Inkelss ( 1990) surveys thirteen studies of the democracy-growth nexus, six of which supported the skeptical view, four of which suggested qualified or conditional relationships, and there of which provided unconditional support for the conflict perspective. Borner et al. ( 1995) reported that of 16 empirical studies, three suggest a positive relationship and three a negative relationship between democracy and economic growth, and the other 10 are inconclusive. Brunetti (1997) examine 17 studies and found " nice studies report no relationship, one study a positive, one study a negative, three studies a fragile negative relationship and three studies a fragile positive relationship between democracy and economic growth".

While economists have been primarily concerned with the effect of democracy on economic growth, political scientists have focused on the implication of economic growth for increased levels of political freedom. Most studies have found that economic growth results in more demands for political freedom ( Lipset, 1959; Bollen, 1979; Bollen and Jackman, 1985; Burkhart and Lewis-Beck, 1994; Barro, 1996). Barro (1996) has termed this Lipset hypothesis. Glasure et al. (1999) also found that in developing countries and newly industrializing countries, economic development has a significant effect on democratic performance, but contrary to Lipset et al ( 1959), economic development leads to lower levels of democracy. Glasure et al. ( 1999, p. 475) concluded: " the sign reversal may stem from the possibility that as nations strive for economic development, the nations tend to trade-off democracy for economic development".

Discussion of the results:

In the result using the Freedom House dataset, Botswana stands out as the one country where there is support for both the compatibility and Lipset hypothese, i.e. there is Granger causality between democracy and real GDP in the long run, and democracy and real GDP have a positive effect on each other. The results using the Beck et al. ( 2001) dataset confirm long-run Granger causality running from GDP to democracy and the GDP has positive effect on democracy. The democracy growth is well established in Botswana. The OECD (1999, p.29) posited: " Political stability has result from…favorable economic conditions". While this is true, Botswana's economic success has also been built on democratic tradition in which there are no narrow ethnic-based interest groups with distinct means of expression, which has avoided infighting over diamonds and other political issue ( Wiseman, 1990).

Of course, Botswana has been described as an African success story( Acemoglu et al., 2001) with the highest growth rate of any country in the world between 1960 and 1999. From 1965 to 1973 Bostswana's annual rate of growth of GDP was 14.8% which was the highest in the world except for the high income oil rich Oman ( 21.9%). From 1973 to 1984 Botswana's annual growth rate was 10.7% which was the highest in the world, outstripping Asian Tigers, Hong Kong ( 9.1%) and Singapore( 8.2%) ( World Bank, 1986). Between 1980 and 1990 Botswana grew at 11%, also the highest in the world over this period, with China second at 10.3% per annum. From 1990 to 2003 Botswana's growth slowed to 5.2% but was still in the top dozen countries in the world Bank world Development indicators list of countries over this period ( World Bank, 2005). Botswana is one of only a few African countries with a democratic tradition ( Wiseman, 1990). It has had continuous democracy since obtaining independence in 1996. The discovery of diamond mines has facilitated economic growth, but there is more to Botswana's success than simply having abundant natural resources. There is universal agreement that the Botswana government has used the revenue from diamonds to pursue good policies ( See e.g Acemoglu et al., 2001).


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