Democracy and Policy Stability
55 Pages Posted: 18 Oct 2007
Date Written: September 2007
The strong negative link between democracy and output volatility documented by Rodrik (2000) and others stands in sharp contrast to the lack of consensus on the democracy-growth relationship. To explain stable growth performance in democracies we characterize political systems in terms of the distribution of political power across groups, and show that in a world where the qualities of available policy alternatives are uncertain, greater democracy (i.e. decentralization of decision-making authority) leads to more stable policy choices. We design an empirical test of this mechanism by creating measures of the inter-temporal variability in fiscal and trade policies for a panel dataset of 92 countries. In an array of specifications (cross-sectional and panel OLS, fixed effects, random effects, instrumental variables), under 5 different measures of democracy and using sharp episodes of democratizations in a difference in difference, we show that policy choices are significantly more stable over time in democracies. This mechanism explains a large part of the negative link between democracy and output volatility.
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