Democracy, Diversification, and Growth Reversals

49 Pages Posted: 8 Oct 2008

See all articles by David Cuberes

David Cuberes

University of Sheffield

Michal Jerzmanowski

Clemson University - John E. Walker Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: September 17, 2008

Abstract

Several studies have documented a negative relationship between democracy and volatility. The latter is usually measured at high frequency - as the standard deviation of annual GDP growth rates. On the other hand, growth researchers have recently focused on the medium term and documented frequent shifts in the trend-growth process within countries. In this paper we aim to connect these two strands of the literature: we ask whether trend-volatility is also lower in more democratic countries. We find evidence of a common pattern in less democratic countries - there appear to be frequent medium term reversals of growth, i.e. episodes when a period of exceptionally high growth is followed by a period of exceptionally low or even negative growth, and vice versa. When compared with factors commonly associated with volatility such as measures of quality of institutions, macroeconomic policies and financial development, we find that democracy is the most robust predictor of a country's propensity for growth reversals. Motivated by this evidence we construct a model in which non-democracies have high barriers of entry for new firms. This leads to less sectoral diversification: fewer sectors are operated but more resources are channeled to each. In an uncertain environment this leads to infrequent but large growth accelerations when one of the few sectors operated is successful. However, these accelerations are followed by large declines when fortunes change in favor of the missing sectors. We present empirical evidence that confirms the positive relationship between democracy and industrial diversification.

Keywords: medium term growth, growth volatility, democracy, diversification

JEL Classification: O11

Suggested Citation

Cuberes, David and Jerzmanowski, Michal, Democracy, Diversification, and Growth Reversals (September 17, 2008). Economic Journal, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1280965

David Cuberes

University of Sheffield ( email )

9 Mappin Street
Sheffield, S1 4DT
UNITED KINGDOM

HOME PAGE: http://merlin.fae.ua.es/cuberes/

Michal Jerzmanowski (Contact Author)

Clemson University - John E. Walker Department of Economics ( email )

Clemson, SC 29634
United States

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