Democracy, Growth and Doing Business

My previous blog talked about some research I am doing with Mohammad Amin on the link between democracy and Doing Business reforms. One reason to be excited about the project is that it may settle a big debate in the previous literature: does growth cause democracy or does democracy cause growth?

Various economists have weighed in on this. The discussion goes back to Montesquieu and Aristotle. The former thought that constraining the government through some sort of a democratic process is essential for prosperity (very un-French of him). Aristotle, in contrast, argued that growth in income and education will lead to better political institutions. These views are supported by voluminous work: the new institutional economists spurred by Douglas North have shown various evidence in favor of Montesquieu; Lipset and Barro have shown support for the Aristotle theory.

The paper most specific to this debate is Do Institutions Cause Growth? by Andrei Shleifer and co-authors. Their general finding is that countries that emerge from poverty accumulate human and physical capital under dictatorships, and then, once they become richer, are increasingly likely to embrace democracy. The comparison between North and South Korea is given as an example. They started with the same level of income and education, both under dictatorships. The North opted for socialism, the South for capitalism; growth picked up in the South and by the late 1980s the country was moving towards democracy.

The paper is worth reading to see how the alternative hypothesis, democracy to growth, is tested and rejected.

How is the Doing Business reform data useful for this debate? Because it is so specific to particular legal and administrative changes and has wide variations across countries. The literature to-date depends on subjective measures of institutions that cause growth: several measures of rule of law are most often used. These move slowly over time (as does democracy) and hence are subject to the criticism that they don't explain democracy; they simply move with it. In other words, there is no causal relationship. Simply put, good things move together.

As the Doing Business data is so finely focused even within a country, it is by definition not subject to this criticism. In other words, it is wildly implausible that a reform that made business entry faster precipitates a country's move to democracy. So if one finds evidence that democracies reform more, and one couples this evidence with already available research that Doing Business reforms increase growth, the puzzle is solved.

There would be exceptions: Singapore is the top-ranked country on the ease of doing business. Nay-sayers always point to it. But they conveniently forget to look at the other end, where the likes of Congo Democratic Republic, the Central African Republic, Venezuela and Zimbabwe reside.

What Doing Business data do not yet explain is this: how do you get democracy? The Shleifer paper has a proposition: through education.