Does Democracy Drive Growth? - Greater Pacific, London and Mumbai

  

Greater Pacific, Londres e Mumbai – 7.7.2022

Does Democracy Drive Growth? Can China Succeed Without it and India Prosper Under it?

 

The 20th Century has undoubtedly been the century of democracy. The past 100 years have seen democratic government move from being an anomaly for modern states to being the rule, with the number of democratic countries in the world increasing from under 10 in 1900 to over 120 in 2007, covering nearly 60% of the world’s population. The fall of Communism late in the 20th century was seen as the final triumph for liberal democracy and the capitalist economic system it supported. However, in the minds of many, China’s economic rise over the past 30 years cast doubt over the superiority of democratic government, at least with regards to creating economic growth and prosperity, its own brand of state capitalism having delivered decades of double digit GDP growth. India in contrast stood as a developing country that failed to demonstrate the economic growth from its democracy. Today, developing countries appear to have the choice to reject liberal democracy without rejecting economic growth, by following China’s authoritarian-based development model. However, the question of democracy and the role of freedom in economic growth has resurfaced as China sees its own growth slowing and struggles to once again re-invent its economy while preserving its authoritarian political institutions. In contrast, India’s growth has started to increase under its new leadership. Understanding freedom’s impact on economic development appears to once again be critical for both the likely economic trajectory of major economies such as China and India and indeed for the continued growth of democracy in the world, which at least in Western minds, is not just an economic growth enabler but also a fundamental human right.

 

Do Democracy and Freedom Drive Economic Growth?

 

This seemingly straightforward question has sparked much debate and analysis, which has typically sought to separate the impacts of democracy (defined as "a system of government in which all the people…are involved in making decisions about its affairs” ) from that of freedom. In terms of the former, strong arguments have been voiced both in favour of and against democracy’s impact on growth. Its supporters point to the developed world and the OECD in particular, arguing that only democracies have to date created post-industrial economies and societies. Its detractors point to China, who under authoritarian leadership has embarked on one of history’s most amazing development feats, and to countries such as India, which despite (or because of, they argue) its democracy has suffered from low growth for much of its modern history. Logical arguments about democracy’s impact or lack thereof on growth support both sides of the debate. Supporters of democracy point to the accountability it creates for leaders and the checks and balances on their power that it instils in addition to democracy’s broader promotion of fundamental human rights and the dignity of the individual, which are (more or less) universally recognised as worthy goals in and of themselves. Democracy’s detractors on the other hand point to the distorting effects that elections give rise to, ranging from a skewed focus on short-term priorities over long term needs to the undemocratic impact of special interest groups shaping government policy.

While it is clear that democracies (and politically free) states are on average richer than authoritarian and unfree states, studies that have tried to statistically quantify democracy’s impact on economic growth, have been inconclusive. This is should be no surprise given the complexity in separating cause and effect in topics related to social science and impact of variables other than freedom impacting economic growth. In broad-based studies, authoritarian states include the majority of the world’s high growth oil states, while the democratic states include among others African states at the time of their independence, then lacking the basic institutions required to ensure security, stability and development.

More straightforward however, is the question of economic freedom on economic (GDP) growth, which has been clearly demonstrated. The key transmission mechanisms whereby economic freedom drives growth include the creation of strong institutions (including property rights, the rule of law and free markets), a focus on creating and unlocking value from human capital and the reduced importance of government consumption in the economy. Some combination of these factors, if not all of them, have been critical components to the successful economic development of every major economy in the world during the past 50 years. Importantly, these growth promoting economic freedoms are not necessarily accompanied by political freedoms or democratic government: Chile and South Korea (not to mention China), for example in the early phases of their development implemented economic freedoms under authoritarian regimes and still grew successfully as a result. Further, as the events of the Global Financial Crisis has shown, economic freedom, particularly an excess of freedom in the form of a fundamental lack of regulation, can have high economic costs, enabling extreme cycles, market bubbles and subsequent crashes. However, despite big swings, these freedoms also create systems of enterprise that are self-balancing and end up putting the country and its people back on an upward trajectory of growth, which explains their enduring success (and the corresponding failure of communist economic planning).

While democracy’s statistical impact on economic growth may remain uncertain, economic growth’s impact on democracy is clear, and strongly positive. The increased standards of living that result from growth (which are a result of economic freedoms) invariably drive demands for political rights too, and only a few countries have been able to resist the demands of its citizens for political reforms over the long term. What is less clear is what happens to growth once these political reforms and freedoms are implemented and whether democratic transitions on balance hurt or help further economic growth, especially in the short term.

Understanding this relationship is critical to understanding the economic value of democracy, (its fundamental value as a fundamental human right aside). Is democracy a “luxury good” that, while valuable for its own sake, can only be afforded past a given level of national wealth or is it a required cost in ensuring sustainable growth above a certain level of development that virtually all countries need to make? The answer to this question likely depends not only on what happened to GDP growth after democratisation but also on at what levels of GDP the transition itself took place at. History has shown that democratisation in the absence of strong institutions and a base of economic performance has led to serious economic and political disruptions and even regime failure in some cases (e.g. post-colonial Africa and certain former members of the USSR). What is more, the process of democratisation by revolution and mass uprising can destabilise existing institutions, thereby depressing economic development and undermining the political reform process itself, as the lessons of the Arab Spring in countries such as Egypt demonstrate. This is by no means to say that the choice of people to rise up en masse is not a legitimate part of the process of social-political change; it is to recognize that it can lead to economic and political setbacks and unintended consequences. The key questions to ask therefore are (i) where along the development curve does the pressure to democratise sustainably build up, (ii) whether democratising at this stage drives or restricts further GDP growth and (iii) how long do the adjustment pains last after which one can expect the trajectory to continue to be an upward one.

These questions are highly relevant to both India and China: India has (many believe) paid a high price in the past for being a democracy, and the key questions for it are whether and where along its own development curve the hoped for “democratic dividend” will kick in. China on the other hand has for a long time enjoyed economic success from having implemented many of the economic policies and (to a lesser extent) freedoms that help growth while continuing to run an authoritarian political regime. Given the dramatic shift down of China’s economy, markets and currency, for China observers (if not China itself), the question of the value of democracy to continued prosperity and when the demand for democracy is likely to be at critical or irresistible point is critical, given that successive leaderships have appeared to be committed to maintaining the political status quo indefinitely, regardless of economic development levels and growth considerations.

 

When Do States Democratise?

 

What is undeniably true is that there are only a few examples of developed and at least moderately wealthy countries that are not democratic and politically free. The table below captures all of the countries with GDP/capita levels above US$7,500, and compares economic prosperity with political freedom. While this does not provide an indication of when and how countries have democratised during their development, it does show that the pressure towards political liberalisation has been resisted by only a small number of well to do countries.

A closer look at the undemocratic outliers above reveals their being in one of two groups, either resource rich states (e.g. the Gulf States and other oil producers) or countries that have delivered consistent and a few nations with long-term high economic growth (e.g. China, Turkey, and to a lesser degree Singapore).Resource-rich states of course either directly own the natural resources in question or generate the majority of their tax income from them, making them less dependent on, and receptive to its citizens’ wishes, impacting the balance of power between state and society. However, the Arab Spring has demonstrated that this cannot be taken for granted indefinitely, particularly in states with large young and increasingly well connected populations with access to information. High growth states, on the other hand, have a powerful currency in the form of increasing household wealth that they can offer its citizens in exchange for continuing to forfeit increasing political freedom. The former of these models is of course dependent on the continued production of natural resources, while the latter model is dependent on delivering consistent and on-going growth. The table on the right captures the long-term growth rates and effective resource dependency of the outliers, indicating their grouping in one or the other of these categories.

 

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