Is the Democracy Good for the Economy of the Country - Essay Example

Democracy and Economic growth Introduction: A democracy may be summed up as a Government “for the people, by the people and of the people”. Many countries are in the process of democratising their economies. But does the degree of democratisation of the country affect economic growth proportionately? Savings, capital accumulation and technological development are the ultimate determinants of growth, but a discrepancy may be noted between economic growth in developing and developed countries. Does democracy facilitate economic growth or hinder it? Some factors affecting economic growth: There are several factors that determine economic growth, of which the nature of credit institutions and facilities is one. For example, in developing countries like India, Sri Lanka and other African nations, existing credit institutions are not properly regulated [Piketty 1997]. Government regulation in such countries is poor [Ghatak 2002] and these nations have a history of corruption and nepotism in all spheres of life. Institutions in a particular country matter and history plays an important role, because in order for an economy to perform well, it should have started off well [Sokoloff et al 2000]. A country with a history of poverty is likely to remain poor. A worker who is on a low subsistence wages is likely to be struggling to gather his basic necessities and to simply survive. Therefore he cannot function as an entrepreneur. He is caught in the vicious cycle of grinding poverty and is unable to accumulate enough money to invest in any business enterprise or even earn interest from savings. Further, such an individual will not be considered a good risk by credit institutions and he will not be able to secure loans either, in order to invest in capital and other start up costs to fund any enterprise [Ghatak 2002]. Therefore the extensions of credit facilities and loans of money is restricted to rich entrepreneurs, who become a select few who cannot accelerate the growth of the per capita income of the majority, and thereby also accelerate economic growth. As opposed to this, United States and Canada, for example, started off working on land that was not rich in crop and was difficult to cultivate. Hence, there was more scope for individuals to thrive and adopt the role of entrepreneur as they took up the challenge of land cultivation. This resulted in a more egalitarian society where wage differences were not really so high. Therefore these nations started off with a predominantly higher per capita income, and this improved and advantageous economic situation continues even today. Credit institutions in these nations are strictly monitored by Government and interest rates are controlled. Due to the safety net of Government regulations and control and a historically corruption free environment, more people are able to qualify to receive and repay loans {Piketty 1997] thereby increasing economic activity by investments and consequently improving economic growth. European settlers had two policies towards the lands they colonized (a) a grab and run policy, such as those in West African countries where the focus was on extorting as much as possible from the colonies and moving on, since they faced a hostile atmosphere [Acemoglu et al, 2001] and (b) the endeavour to create “new Europes” in colonies such as Australia and the U.S. where they faced less hostility and therefore set up institutions favorable to economic growth [Acemoglu et al, 2001] . According to a study done by historian Philip Curtin for 64 countries [Curtin, 1989], the mortality rate of the early colonizing settlers more than 100 years ago has been shown to be inversely proportional to the current GDP per capita - it was the nature of the early institutions and their business and economic practices which are continuing into the present and account for the current economic growth or lack of it in countries today. The effect of early institutions and their influence on the present may also be seen in Latin America where monopolies and regulations set up by Spanish – a small group of the elite – remained until modern times and has created economic imbalances which still persist today. In several African countries, long term rule by one leader has produced dictatorial tendencies in them, which in turn has ushered in large scale corruption and suppression of human rights. In the year 2000, Cote d’Ivoire minister of planning and economic developed Tijdjame Thimae said “ Africa has paid too little attention to political modernization. Too many African governments pay only lip service to democracy, which is often limited to simply holding elections.”[Williams, 2000]. . Despotic tendencies of African leaders tend to hamper progress by discouraging investors and consequently affects the economic growth in these countries. Certain nations have demonstrated a history of corruption and nepotism in the highest circles of Government which has had a detrimental effect on the overall economic growth of a nation. In such countries, funds that are set aside for disbursement to the poor via Government programs, etc are pocketed by corrupt elements, thereby ensuring that the benefits of economic development do not reach the majority poor. Practices such as black-marketing by corrupt elements is rampant and widespread. Monies allocated for development of infrastructure and poverty alleviation programs are misappropriated by corrupt elements and this only results in individual accumulation of wealth and proves detrimental to the overall economic growth of the nation. In economically developed nations on the other hand, a relatively corruption free history exists. Dictatorships demonstrating economic growth: Democracy is touted as the route to economic growth. But several countries are disproving this statement, since authoritarian styles of Government are producing economic growth. The most notable example of a dictatorship producing economic growth is Germany. In the 1920s, Germany after the Versailles Treaty, was in shambles. With the onset of the Great depression, its financial affairs were a mess, the pride and dignity of its people had been ground into the dust and its economy was floundering [Trivanovich, 1937]. Industrial production had declined by 40%, exports and imports had collapsed and there were 8.5 million unemployed people. Adolf Hitler, the dictator took over in 1933 and in the space of a few years, turned the economy around – in 1936, industrial production increased by 60%, GNP by 40% and unemployment had fallen to 1.5 million. No one can dispute that Adolf Hitler’s practices were barbaric and inhuman, however the fact remains that he was responsible for raising Germany’s economic status. Singapore provides another example of a quasi dictatorship successfully implementing economic growth. In the 1950s Singapore was a poor country. But after Lee Kuan Yew took over in 1963, he introduced a series of tough reforms and trade incentives and tightened up the economy. Freedom was curtailed considerably and even today, people are fined and subjected to the humiliation of public flogging for small offences. But this has given Singapore the reputation of a corruption free environment that is attractive to investors. Singapore’s economy has dramatically turned around and shows significant economic growth due to expanding trade and public investment in human capital. Long term economic growth has been about 8.2 per cent since 1968 to 1989. Current GNP per capita is 10. In the year 2000, GDP per capital was more than $30,000 (Houseman, 2000) and the country’s economic growth over the past decade have exceeded 7 percent and have been as high as 9 percent. (Asia Week, weekly statistics). The African nation of Malawi was under the dictatorship of Kamuzu Banda for 101 long years and Malawi’s economy did not remain stagnant during this time. In the period since 1960, Malawi’s economy grew rapidly at a rate of around 6 percent per annum, from 1980 onwards the economic downturn began. The efficiency of the civil services under this dictator have been shown to be a factor in this decline [Chipeta et al, 2002]. Similarly, countries that are not democracies but are Socialist countries instead, such as China and Vietnam have demonstrated remarkable economic progress in the last two decades, in spite of remaining Socialist (Rodrik 2004 p 17-18). The significant factors as identified by Summers (2003) to achieve economic growth are (a) ability to integrate with world economy (b) capability to sustain Government finance and sound money and (c) ability to create good legal institutions for enforcement of contracts. The history of certain nations reveals the existence of vast amounts of unused capital. In his book, “ The History of Capital: Why Capitalism thrives in the West and fails everywhere else”, the author draws attention to the real estate owned by poor people in Latin American countries [DeSoto, 2000]. The history of land ownership and property rights in these countries is such that individuals owning the properties are unable to raise loans against their equity. Liberalization has not proved to be as productive as was previously envisaged, as demonstrated by Williamson and Kuczynski (2003). Many Latin American countries introduced all necessary democratic measures to improve economic growth but it has progressed slowly and "Latin Americans are entitled to feel disappointed that the past decade did not live up to the hopes that were kindled at the start of the 1990s" (p. 2). The onset of democracy in Latin American countries has almost been synomous with increased foreign direct investment. Armijo (2001) proposes a hypothesis that appears to be plausible, as demonstrated in a case study of Mexico conducted by Mayer Serra. Mexico has an authrotitarian but liberalizing political regime and capital sources were portfolio investments with the Government and foreign direct investment. According to the Armijo (2001) theory this should have generated a pressure on the Government for neoliberal reform (p 28) which in turn would have resulted in a strengthening of the regime rather than a transition to democracy. However, in view of the fact that democracy was pressed upon Mexico, no balancing element could work and this has produced disappointing economic outcomes in Mexico (p 137-138). In the case study of Brazil done by Peter R Kingstone (Arminjo 2003), democracy has not aided the coutnry in achieving economic growth, in spite of input of foreign capital, which plays a pivotal role in the economic status of the country (p 152). This finding was supported by Rodrik (2004 ) who states that the economy of the country is bumping up against financial constraints that are conditioned by external constraints (p 11). Economic reforms of the 1980s and 1990s that include trade liberalization and other progressive measures, have not produced the desired results (Rodrik, 2004) In his study of democracy and economic growth, Yi Feng(2003) arrives at the conclusion that political instability adversely affects economic growth by creating an economic climate that makes investors reluctant to invest. Rodrik (2004) concludes that democratic reforms are not necessarily a precursor for economic growth. According to Barro (1994) there is a connection between wealth and democracy and it is only after the attainment of certain levels of wealth that a country can begin to enjoy democracy. A country’s economic growth is measured by the real capital GDP which depends upon factors such as infant mortality rate, primary school attainment and other such factors which indicate the probability that political institutions become democratic in due course of time (Barro 1994 p 23-24). Therefore democracy is seen as the after effect of wealth, not the precursor which may explain why some developing countries are unable to achieve economic growth in spite of the introduction of democracy. According to Kaplan, the introduction of democracy in developing countries could be dangerous in some cases: “If a society is not in reasonable health, democracy can be not only risky but dangerous.” (Kaplan 2000, p 62). In reference to African countries, Zakaria (2003) states: “although democracy has in many ways opened up African politics and brought people liberty, it has also produced a degree of chaos and instability that has actually made corruption and lawlessness worse in many countries.” (Zakaria, 2003, 98) Cases where democracy has been successful in producing economic growth: The example of Chile may be cited here. The bloody coup in Chile installed a military Government which is not strictly a democracy but is attempting to move towards one. This Government set into motion a series of laws [Larrain 2000] that incorporated more freedoms to corporations and opened up the economy to foreign investment. The focus was on exports and a series of decrees were introduced to subsidize the forestry, fishery and agricultural sectors, which resulted in a jump in the export of natural resources and an impressive economic growth of 6 to 7 percent annually during the last 13 years. Chile has been referred to as the “Latin American tiger” and is the most notable example of economic growth among the Latin American nations. As compared to its average annual growth 10 years before democratisation which was just 1.589, the growth rate 10 years after democratisation is 5.797 (Rodrik, 2005 :Table 3) Other examples of successful democracies that may be cited are Mauritius and Botswana which are African countries but which nevertheless are enjoying economic growth.(Rodrik 2005). Uruguay has also shown a noticeable jump in economic growth 10 years after democratisation as compared to its state before democratisation. Perhaps the best example to support the contention that a democracy does show better economic growth as compared to a dictatorship is that of Korea. Both these nations were exceptionally poor in 1950. The period between 1950 to 1980 symbolized the Korean war and dictatorial regimes. Yet, it may be noted that by 1980, South Korea had posted a per capita income of $1589 while that of North Korea was only $768. [Gleaser et al, 2004]. Economic growth was higher in South Korea in terms of factors such as GDP, as opposed to North Korea, which has been lagging behind. The one important difference between the two countries was that by 1980, South Korea had begun the process of democratising, while North Korea remained, and still remains, a dictatorship. Analysis: Is it then possible to state, based on the case of Korea cited above, that democracy does indeed have a positive effect on economic growth? The examples of the United States and the European countries may be taken into consideration here. These countries reflect a consistently high GDP and per capita income and are classified as developed nations, as compared to the developing nations, most of whom cannot be classified as pure democracies. However, one cannot ignore the case of India, which is purported to be the largest democracy in the world – but does not enjoy exceptional economic growth. After its independence, this country was predominantly socialistic until 1991, when it introduced economic reforms to encourage foreign investment. Since then, the real GDP rate has been growing between 4 to 8 percent. However, this economic growth is not as significant or as sustained as it is in the western countries. Reasons cited for this slow rate of economic growth are (a) lack of infrastructure (b) large population which means that per capita income remains low (c) high interest rates and (d) bureaucracy. China was also predominantly Communist, under Mao Tse Tung and is only slowly opening up its tight fisted hold on its economy, to let in foreign investors and to export its services to the more advanced nations. Stringent measures to control population appear to have yielded the recent economic benefits to this country which cannot still be labelled a true democracy. The Tienneman Square massacre is all too fresh an event in history. The country continues to remain Socialist, even as it enjoys the fruits of permitting certain freedoms and inflow/outflows from the country in the form of economic growth. Although some elemental basics of democracy have been introduced into the country, it is only as an overlay of already existing controls which therefore do not render it a true democracy, yet it is enjoying economic growth. However, a general assumption may be drawn from the examples cited above that the introduction of democracy does produce a positive effect. In the study undertaken by Rodrik and Wacziarg (2005), the authors concluded that “Democratization surely yields benefits – in terms of their individual freedom and empowerment that are valued independently of their consequences for material wealth.” By introducing some measure of freedom to the masses, changes do trickle into the system, slowly. However, the negative aspects of a democracy have been pointed by Barro(2000), who notes that a highly democratic society experiences “the pressure to enact redistribution of income from the rich to the poor.” A democracy incorporates the free market and free trade and economic activity is conditioned primarily by the laws of demand and supply and the motive of making profits. However, under such conditions, there is an inevitable divide created between the rich and the poor and the maxim “the rich get richer, the poor become poorer” would hold good as a democracy progresses. Barro studied data assimilated on growth rate of real per capita GDP in over a hundred countries and he stated after his analysis of the data that “one cannot conclude from this evidence that more or less democracy is a critical element for economic growth”. However, his findings do suggest that increase in political rights do initially increase growth, but tend to retard growth once a moderate level of growth has been attained. Yi Feng however combines theory and country specific studies [Feng 2003] which demonstrate that political institutions and conditions do affect economic growth and that economic growth helps to promote democracy. Walter Williams, in an article on Africa’s economic problems as a function of democracy, concludes that democracy isn’t necessarily a good thing [Williams 2000]. In their Paper on democracy and mass killings [Easterly et al 2004], the authors state that economic development is a two edged sword for mass killings. On the one hand, economic development leads to enhanced education and social organization which promotes tolerance for others and is democratic in nature. On the other hand, dictators can use these very features to kill civilians en masse. Daron Acemoglu and James Robinson [2002] emphasized the importance of the economic aspects in the democratisation of countries. Dictatorships tend to exist predominantly in countries where there is a high incidence of poverty and over population and ineffective legal enforcement systems. The effect of the existing institutions in the country also cannot be ignored when considering economic growth. It has been shown that the nature of the institutions that have historically existed in a country will determine the degree of effectiveness with which a democratic framework can be installed. [Acemogulu, 2002]. The most important aspect of the progress of democracy and its impact on economic growth is that of the widening income gap that occurs between the rich and the poor. This poses a problem because it generates a potential break down in the law and order situation and an increase in crime, as the poor attempt to breach the gap between rich and poor. When there is a break down in law and order, economic activity will be affected negatively and will lead to an economic slowdown. Barro’s cross country empirical study showed that the “overall relation between economic growth and the democracy is statistically weak.” Therefore, some countries purporting to be democracies show low economic growth, while others that are dictatorships show a surprisingly high rate of economic growth. But the significant factor is that there is a suggestion of a non linear relation – which would be graphically represented as an upside down “U” – wherein it may be noted that the introduction of democracy has an initially beneficial effect but after a point when democracy has been moderately established, the economic growth shows a decline. The initial upswing may be explained by the increase in growth with the conferring of electoral rights, which necessarily goes hand in hand with a limitation on Government power. However, further increase in electoral rights tends to hinder growth and development. This may be explained by the upsurge in predominantly social concerns once democracy has been established. The focus shifts to income redistribution via government sponsored incentives and social programs for the poor, in order to effect a more equitable distribution of income. Conclusion: It may therefore be concluded that the political institutions in existence in a country do have some bearing on its economic development. On an overall basis, it may be generally concluded that democratic countries fare better on the economic front than do dictatorships. However, this is by no means a hard and fast rule and individual variations do exist. One important conclusion that may be drawn is that the introduction of democracy is beneficial in terms of human freedoms - however, this only produces rise in economic growth up to a point, and this levels out as social concerns are brought to the forefront, when economic growth tends to decline as income redistribution takes place. Therefore, it cannot be stated definitively that democracy always produces economic growth – there are various other factors that come into play and determine the degree of economic growth. But the effect of democratization is generally positive. Bibliography Acemoglu, Daron and Robinson, James A. (2002) : Political origins of democracy and Dictatorship: < http://econ-www.mit.edu/faculty/?prof_id=acemoglu > Armijo, Leslie Elliott, 2001 ed. Financial Globalization and Democracy in Emerging Markets. New York: Palgrave Macmillan Barro, Robert J.(1997): Determinants of Economic Growth: A Cross-Country Empirical Study. Cambridge, MA: MIT Press, 1997. Barro, Robert, J. (2000): Rule of Law, Democracy and Economic Performance: Lands of Liberty 2000 report, Index of Economic Reform Barro, Robert J, 1994. “Democracy and Growth” National Bureau of Economic research. Curtin, Philip D. (1989): Death by migration: Europe’s encounter with the Tropical World in the 19th Century. New York: Cambridge University Press, Daron Acemoglu, Simon Johnson, and James A. Robinson (2002): "The Colonial Origins of Comparative Development: An Empirical Investigation", American Economic Review. Chipeta, C.; Mkandawire, M. (2002): Internal political systems and external economic forces have disrupted growth rates in Malawi. 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The Coming Anarchy: Shattering the Dreams of the Post Cold War. New York : Random House. Larrain, Sara. (2000): Views from the South: The effects of globalization and the ETO on the Third World. First food Books with the International Forum on Globalization, Fall 2005 * Piketty, T. (1997) : "The Dynamics of Wealth Distribution and the Interest Rate with Credit Rationing", Review of Economic Studies, 64. Rodrik, Dani and Wacziarg Romain, 2005. “Do Democratic transitions produce bad economic outcomes?” American Economic review, May 2005. [Online] Available at: http://www.stanford.edu/~wacziarg/downloads/democratictransitions.pdf Rodrik, Dani, 2004. “Rethinking growth policies in the developing World.” [Online] Available at: http://ksghome.harvard.edu/~drodrik/Luca_d_Agliano_Lecture_Oct_2004.pdf Sokoloff Kenneth and Engerman, Stanley (2000): "Institutions, Factor Endowments, and Paths of Development in the New World" Journal of Economic Perspectives.Economic Review. 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