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Inequality, Growth, and Democracy

Published online by Cambridge University Press:  13 June 2011

Dimitri Landa  and
Ethan B. Kapstein
Dimitri Landa
Affiliation:
University of Minnesota
Ethan B. Kapstein
Affiliation:
University of Minnesota
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Abstract

The analysis of the relationship between inequality and economic growth in distinct politi-coeconomic environments has been one of the central preoccupations of the extensive theoretical and empirical work on growth in the last decade. The authors argue that the empirical evidence available to date strongly indicates the relevance of this work for understanding the elusive causal connection between economic development and democracy. The state of the literature suggests considerable sophistication in conceptualizing the direct economic effects of inequality and contains critical insights into politically unconstrained policy-making aimed at the alleviation of their negative economic impact. However, the political feasibility of the recommended policy measures and the politically mediated effects of inequality and redistributive policy on growth and on the strength and stability of democratic regimes are understood less well. The authors discuss the critical factors influencing these effects and sketch several approaches to creating a comprehensive politicoeconomic account of the interaction between inequality, redistributive policy-making, and political regimes.

Type
Review Articles
Information
World Politics , Volume 53 , Issue 2 , January 2001 , pp. 264 - 296
Copyright
Copyright © Trustees of Princeton University 2001

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References

1 These features include the security of property rights (e.g., Svensson, Jacob, “Investment Property Rights and Political Instability: Theory and Evidence,” European Economic Review 42 [July 1998]CrossRefGoogle Scholar; Catherine Hafer, “The Political Economy of Emerging Property Rights” [Manuscript, Department of Political Science, University of Rochester, May 2000]), income and wealth redistribution (Persson, Torsten and Tabellini, Guido, “Is Inequality Harmful for Growth?” American Economic Review 84 [June 1994]Google Scholar; Alesina, Alberto and Rodrik, Dani, “Redistributive Politics and Economic Growth,” Quarterly Journal of Economics 109 [May 1994]CrossRefGoogle Scholar; Perotti, Roberto, “Political Equilibrium, Income Distribution and Growth,” Review of Economic Studies 60 [October 1993]CrossRefGoogle Scholar; Benabou, Roland, “Inequality and Growth,” in Bernanke, Ben and Rotemberg, Julio, eds., NBER Macroeconomics Annual 1996 [Cambridge: MIT Press, 1996])Google Scholar, and the size of government (e.g., Rodrik, Dani, “Why Do More Open Economies Have Bigger Governments,” Journal of Political Economy 106 [October 1998])CrossRefGoogle Scholar.

2 See, for example, Ethan Kapstein and Branko Milanovic, “Dividing the Spoils: Pensions, Privatization, and Reform in Russia's Transition,” World Bank Research Paper no. 292 (March 2000).

3 For an account of institutional choice that focuses on the relative appeal of particular distributive consequences of institutions, see Knight, Jack, Institutions and Social Conflict (Cambridge: Cambridge University Press, 1992)CrossRefGoogle Scholar.

4 For a review, see Huntington, Samuel P., The Third Wave: Democratization in the Late Twentieth Century (Norman: University of Oklahoma Press, 1991), 59–72Google Scholar.

5 See Raymond D. Gastil, ed., Freedom in the World (Westport, Conn.: Greenwood Press, 1983 and other years). For 1960–65, Gastil's variable is supplemented with the data from Bollen, Kenneth A., “Political Democracy: Conceptual and Measurement Traps,” Studies in Comparative International Development 25 (Spring 1990)CrossRefGoogle Scholar.

6 This finding is, of course, one of the best established empirical generalizations in political science and sociology; for a recent reformulation, see Przeworski, Adam and Limongi, Fernando, “Modernization: Theories and Facts,” World Politics 49 (January 1997)CrossRefGoogle Scholar.

7 See, for example, Riker, William H., “Implications from the Disequilibrium of Majority Rule for the Study of Institutions” American Political Science Review 74 (June 1980)CrossRefGoogle Scholar.

8 Przewoiski and Limongi (fn. 6), 158.

9 Lipset, Semour Martin, “Some Social Requisites of Democracy: Economic Development and Political Legitimacy,” American Political Science Review 53 (March 1959), 84CrossRefGoogle Scholar.

10 Barro, “Democracy and Growth,” Journal of Economic Growth (March 1996), 23—24, emphasis added.

11 A similar argument is put forth in Richard Posner, “Equality, Wealth and Political Stability,” Journal of Law, Economics and Organization 13 (Spring 1997).

12 See, for example, Sen, Amartya, “Development: Which Way Now?” Economic Journal 93 (December 1983)CrossRefGoogle Scholar.

13 Note that this claim and Sen's argument are distinct from the assertion that democracy always promotes economic growth. We leave the latter assertion without consideration in this review. For an influential review of the empirical evidence, see Przeworski, Adam and Limongi, Fernando, “Political Regimes and Economic Growth,” Journal of Economic Perspectives 7 (Summer 1993)CrossRefGoogle Scholar.

14 Lipset (fn. 9); and Putnam, Robert D. with Leonardi, Robert and Nanetti, Raffaella Y., Making Democracy Work: Civic Traditions in Modern Italy (Princeton: Princeton University Press, 1993)Google Scholar. See also Bollen, Kenneth A., “Political Democracy and the Timing of Development,” American Sociological Review 44 (August 1979)CrossRefGoogle Scholar.

15 See Rueschemeyer, Dietrich, Stephens, Evelyne H., and Stephens, John D., Capitalist Development and Democracy (Chicago: University of Chicago Press, 1992)Google Scholar.

16 Barro mentions both of these arguments (pp. 51—52) in passing without further analysis.

17 These findings are at odds with the results in Muller, Edward, “Economic Determinants of Democracy,” in Midlarsky, Manus I., ed., Inequality, Democracy and Economic Development (Cambridge: Cambridge University Press, 1997)Google Scholar. Barro's results are more convincing, however, because of his more sophisticated estimation technique and the use of the second inequality indicator, which bolsters the plausibility of this result in the face of objections concerning the quality of data and the crudeness of the monetary measures of inequality. His results are confirmed by Posner (fn. 11), who uses a country sample that is larger than Midler's.

18 The benchmark studies in the literature on the relationship between inequality and growth include Alesina and Rodrik (fn. 1) and Persson and Tabellini (fn. 1). Roberto Perotti, “Growth, Income Distribution, and Democracy: What the Data Say” Journal of Economic Growth 1 (June 1996) and Benabou (fn. 1) present comprehensive discussions of the available cross-country regressions. More recent work indicates that the relationship between inequality and growth tends to be more negative for the poor countries than for the rich ones: see, e.g., Barro, Robert, “Inequality and Growth in a Panel of Countries,” Journal of Economic Growth 5 (March 2000)CrossRefGoogle Scholar.

19 E.g., Paukert, Felix, “Income Distribution at Different Levels of Development: A Survey of Evidence,” International Labor Review 108 (1973)Google Scholar; Ahluwalia, Montek S., “Income Distribution and Development: Some Stylized Facts,” American EconomicReview Papers and Proceedings 66 (1976)Google Scholar; Muller, Edward N., “Democracy, Economic Development, and Income Inequality,” American Sociological Review 53 (February 1988)CrossRefGoogle Scholar.

20 These results are obtained using an improved data set on inequality, introduced in Deininger, Klaus and Squire, Lyn, “A New Data Set for Measuring Income Inequality” World Bank Economic Review 10 (September 1996)CrossRefGoogle Scholar.

21 We return to this possibility in the penultimate section of the review.

22 For a useful review of this literature, see Riezman, Raymond and Wilson, John, “Politics and Trade Policy,” in Banks, Jeffrey and Hanushek, Eric, eds., Modern Political Economy (New York: Cambridge University Press, 1995)Google Scholar.

23 See Williamson, John, “In Search of a Manual for Technopols,” in Williamson, John, ed., The Political Economy of Policy Reform (Washington, D.C.: Institute for International Economics, 1994)Google Scholar; and Sachs, Jeffrey and Warner, Andrew, “Economic Reform and the Process of Global Integration,” in Brainard, William and Perry, George, eds., Brookings Papers on Economic Activity 1 (1995)Google Scholar. Sachs and Warner argue empirically that both because of its direct stimulation of the economy and because of its indirect inducement of a responsible economic policy by governments, openness to trade comes close to being sufficient to guarantee above-average growth in poorer countries. Dani Rodrik, whose other work is often seen as defining of the minority position of the vocal trade skeptics (e.g., Francisco Rodriguez and Dani Rodrik, “Trade Policy and Economic Growth: A Skeptic's Guide to the Cross-National Evidence” [Manuscript, Harvard University, May 2000]; and Rodrik, Dani, Has Globalization Gone Too Fart [Washington, D.C.: Institute for International Economics, 1997]Google Scholar) takes a more positive stance in The New GlobalEconomy, one suggestive of caution (in its emphasis on the critical importance of institutional mechanisms for the countries' abilities to benefit from trade), rather than skepticism.

24 For a classic statement of the utilitarian position with respect to trade theory, see Meade, James E., The Theory of International Economic Policy (London: Oxford University Press, 1951), 5Google Scholar.

25 Nobel-prize winning economist John Hicks quoted in Hausman, Daniel M. and McPherson, Michael S., Economic Analysis and Moral Philosophy (Cambridge: Cambridge University Press, 1996), 95–96Google Scholar.

26 For a useful review of the literature, see Cline, William, Trade and Income Distribution (Washington, D.C.: Institute for International Economics, 1997)Google Scholar; for a review essay on the recent work on this topic, see Kapstein, Ethan B., “Winners and Losers in the Global Economy,” International Organization 54 (Spring 2000)CrossRefGoogle Scholar.

27 Cline (fn.), 40–41.

28 In fact, Aghion's explanation predicts precisely opposite effect in these countries—the shrinking skill differentials.

29 Donald Robbins, Evidence of Trade and Wages in the Developing World, OECD Development Center Technical Papers, no. 119 (December 1996). See also Inter-American Development Bank, Facing Up to Inequality in Latin America (Washington, D.C.: IADB, 1998), 46Google Scholar.

30 See Adrian Wood and C. Ridao-Cano, “Skill, Trade and International Inequality,” Working Paper 47 (Institute of Development Studies, University of Sussex, 1996).

31 Barro (fn. 18) adopts this interpretation in presenting his regression results, which show a robust and significant positive relationship between openness and inequality. They contradict those in Bourguignon, François and Morrisson, Christian, “Income Distribution, Development and Foreign Trade: A Cross-Sectional Analysis,” European Economic Review 34 (September 1990)CrossRefGoogle Scholar; using older and lower quality data, Bourguignon and Morrisson find that increase in degree of protection increases income inequality.

32 For an elaboration of this point, see Kapstein, Ethan, Sharing the Wealth: Workers and the World Economy (New York: W. W. Norton, 1999)Google Scholar.

33 Examples would include the tariff escalation in the North, which inhibits investment in value-added export industries in the South.

34 Similar statements can be found in Aghion (see, in particular, pp. 7,11) and Tanzi and Chu (see, for example, the introduction and the chapter by Michel Camdessus).

35 Indeed, even at the height of its prominence, the view that there is a necessary “conflict between equality and growth” was a mischaracterization of the theorized relationship between redistribution and growth.

36 See Persson and Tabellini (fn. 1); and Alesina and Rodrik (fn. 1).

37 Among the exceptions is Posner (fn. 11), who argues that the variation in the average income fully accounts for the effects of the distribution of income on growth.

38 There are, of course, other mechanisms in the literature as well, but the four we discuss in this section have been the focal points of the literature in the past decade and are of particular consequence for the works under review.

39 The somewhat distinct versions of this model were introduced in the papers by Persson and Tabellini (fn. 1) and Alesina and Rodrik (fn. 1). The papers that pioneered the median-voter approach to redistribution are Roberts, Kevin W. S., “Voting over Income Tax Schedules,” Journal of Public Economics 8 (December 1977)CrossRefGoogle Scholar; and Meltzer, Arthur H. and Richard, Scott F., “A Rational Theory of the Size of Government,” Journal of Political Economy 89 (October 1981)CrossRefGoogle Scholar.

40 The differences between the methodological approach of this model and its forerunners in the analysis of the effects of inequality is well described by the following quote from Joseph Stiglitz's contribution to Tanzi and Chu: “[EJarlier literature emphasizing the role of government in redistribution took the pretax distribution of income as given. The new emphasis is on how government can change the pretax distribution of income” (p. 36).

41 See, most prominently, Alesina, Alberto and Perotti, Roberto, “Income Distribution, Political In1stability, and Investment,” European Economic Review 40 (June 1996)CrossRefGoogle Scholar. See also Venieris, Yannis and Gupta, Dipak, “Income Distribution and Sociopolitical Instability as Determinants of Savings: A Cross-Sectional Model,” Journal of Political Economy 94 (August 1986)CrossRefGoogle Scholar; and Muller, Edward N. and Seligson, Mitchell A., “Inequality and Insurgency,” American Political Science Review 81 (June 1987)CrossRefGoogle Scholar.

42 It would leave other inequality-based threats to growth unaddressed, as well, as we discuss below.

43 As we note in the next section, there may also be a way of creating positive growth effects without decreasing the welfare of the net taxpayers, but its plausibility as a general and comprehensive measure seems doubtful.

44 The critical conditioning role of capital markets is also emphasized in Bruno, Ravallion, and Squire's chapter in Tanzi and Chu (see, in particular, p. 133). As our discussion of the distributive consequence of trade in the previous section indicates, this role is particularly ominous in the light of the effects of underdeveloped capital markets on deepening the distributive gaps created by the SET transfers.

45 For the counterfactual—the evidence in support of what might be termed the “redistribution effect” of the median-voter arguments (that redistribution does occur in response to inequality) in essentially the same data set—see Branko Milanovic, “Do More Unequal Countries Redistribute More? Does the Median-Voter Hypothesis Hold?” World Bank Working Paper (November 30, 1999). Barro (fn. 18) confirms the differences in the strength of the relationship between inequality and growth between the more and the less developed countries. It is important to note that the implied criticism is not of the median-voter model but of the dominance of the decreasing savings effect over other (positive) effects of redistribution.

46 Aghion, Philippe and Bolton, Patrick, “A Trickle-Down Theory of Growth and Development with Debt Overhang,” Review of Economic Studies 64 (April 1997)CrossRefGoogle Scholar.

47 Some caution, though, should be maintained: the expectation of a redistribution may induce negative intertemporal incentives for the transfer recipients.

48 Unfortunately for the coherence of their arguments, however, the empirical tests of these two models have been interpreted as at once a wholesale refutation of one and a vindication of the other; see, for example, Perotti (fn. 18).

49 This fact distinguishes the developing countries from the advanced industrial democracies, where public access to capital markets is significantly more open, offering better prospects for social mobility and, in turn, greater political stability. Significantly, as Roland Benabou and Efe Ok show in a recent paper, a lower degree of social mobility also leads to higher demands for redistribution, closing a vicious circle of the political effects of inequality in LDCs. See Benabou and Ok, “Social Mobility and the Demand for Redistribution: The POUM Hypothesis,” NBER Working Paper no. 6795 (November 1998).

50 These effects correspond, respectively, to the “exogenous” and the “endogenous” prosperity-hence-democracy arguments; see Przeworski and Limongi (fn. 6).

51 For evidence of the little support for the positive relationship between the degree of inequality and marginal tax rates, see, notably, Perotti (fn. 18). A chapter by Enrique Iglesias in Tanzi and Chu cites Argentina, Brazil, and Peru in the 1980s and Chile in the early 1970s as examples of the negative effects of populist economic policies (p. 15), but as the author himself notes, the real issue in these countries was the deficit financing of populist reforms, which led to stagflation. The cross-country evidence of the relationship between inequality and sociopolitical instability is reviewed in Alberto Alesina's contribution to Tanzi and Chu (and, more extensively, in Aghion, Philippe and Howitt, Peter, Endogenous Growth Theory (Cambridge: MIT Press, 1998), chap. 9Google Scholar.

52 For a recent elaboration, see Knight (fn. 3).

53 This point distinguishes democracies from nondemocracies in degree, at best; most societies that score relatively high in the standard measures of political and civil rights have a highly means-sensitive political process.

54 Of the two remaining countries—Indonesia (with 1988 Gini of 0.336) and Thailand (with 1988 Gini of 0.474)—whose responses to the Asian crisis are a focus of Rodrik's institutional analysis, Indonesia had what is now known to be an extraordinarily high degree of decades-long institutionalized corruption at the highest ranks of government and the military, ex ante making the adoption of the institutions of conflict management an unlikely prospect.

55 Alesina's chapter in Tanzi and Chu displays acute awareness of the vagaries of political feasibility and of what he calls “redistribution to the vocal” rather than to the needy, but aside from listing cases in which the desirable kind of redistribution occurred, he does not offer an examination of the conditions that made it possible.

56 For some examples of works emphasizing this causality in the cases of the 1964 coup in Brazil, 1952 in Guatemala, and 1973 in Chile, see Wallerstein, Michael, “The Collapse of Democracy in Brazil: Its Economic Determinants,” Latin American Research Review 15, no. 3 (1980)Google Scholar; Trudeau, Robert, Guatemalan Politics: The Popular Strugglefor Democracy (Boulder, Colo.: Lynne Rienner, 1993)Google Scholar; and Valenzuela, Arturo, “Chile: Origins, Consolidation and Breakdown of a Democratic Regime,” in Diamond, Larry, Linz, Juan J., and Lipset, Seymour M., eds., Democracy in Developing Countries: Latin America (Boulder, Colo.: Lynne Rienner, 1989)Google Scholar.

57 Even where some results are already available, the key aim of our sketch is to suggest directions for further research in relation to possibilities they uncover.

58 The exception is some of the recent work on the political economy of transitions. We discuss an important representative of this work below.

59 Similar dynamics characterizes the justification of redistributive programs as insurance mechanisms: the greater the gap between the rich and the poor, the less plausible is the possibility that the rich's welfare can drop substantially enough to make it worthwhile to bring up the welfare of the poor as a protection for the rainy day.

60 In an influential review of the literature, Benabou (fn. 1) extends the endogenous fiscal policy analysis of redistribution and growth by endogenizing the possibility of the voting distribution being truncated at the bottom or at the top, and thereby producing political institutions with, correspondingly, “positive or negative wealth bias.” But Benabou's results (positive wealth bias implies lesser and negative greater danger to growth) contain a bias of their own by failing to treat the “excluded” portions of the population as political agents, whose responses to such an exclusion should be expected to affect the resulting policy or the nature of the political regime. At least with respect to the truncation at the top, it is difficult to see how the outcome could constitute a plausible political equilibrium of a larger background interaction.

61 Acemoglu and Robinson, “A Theory of Political Transitions” (Manuscript, Department of Economics, MIT, 1999).

62 Somewhat surprisingly in the context of the median-voter arguments (but fairly intuitive, once the possibility of power capture by the rich is introduced), Acemoglu and Robinson (fn. 61) also show that when the cost of taxation function is sufficiently convex, the higher the degree of inequality in the democracy, the lower is the average tax rate. This follows because higher inequality (and hence greater redistribution) makes coups more appealing to the rich—an effect that, in the interests of preventing the coups, must be offset by lowering the extent of redistribution.

63 For the empirical discussions motivating Acemoglu and Robinson's arguments, see Weyland, Kurt G., Democracy without Equity: Failures of Reform in Brazil (Pittsburgh, Pa: University of Pittsburgh Press, 1996)Google Scholar; and Leonard Wantchekon, “Strategic Voting in Conditions of Political Instability: The 1994 Elections in El Salvador,” Comparative Political Studies (forthcoming).

64 See Londregan, John B. and Poole, Keith T., “Poverty, the Coup Trap, and th e Seizure of Executive Power,” World Politics 42 (January 1990)CrossRefGoogle Scholar; and idem, “The Seizure of Executive Power and Economic Growth: Some Additional Evidence,” in Cukierman, Alex, Hercowitz, Zvi, and Leiderman, Leonardo, eds., Political Economy, Growth, and Business Cycles (Cambridge: MIT Press, 1992)Google Scholar.

65 Another level of complexity is introduced with the ubiquitous “voting with the feet,” which is assumed away in the competing interests models discussed in this section, but which is, of course, increasingly relevant in the globalizing economy.

66 Frye, Tim, “Presidents, Parliaments, and Democracy: Insights from the Post-Communist World,” in Reynolds, Andrew, ed., Constitutional Design: Institutional Design, Conflict Management, and Democracy in the Late Twentieth Century (Oxford: Oxford University Press, 2000)Google Scholar; and idem, “Cashing In: The Dynamics of Post-Communist Presidential Power” (Manuscript, Department of Political Science, Ohio State University, 2000). In the most dramatic case—Russia—a 75 percent increase in the value of a Gini coefficient corresponds to a 150 percent increase in the presidential power (based on a version of a scale of presidential powers developed in Shugart, Matthew and Carey, John, Presidents and Assemblies: Constitutional Design and Electoral Dynamics [Cambridge: Cambridge University Press, 1992])CrossRefGoogle Scholar.

67 In the Acemoglu-Robinson model (fn. 61) the economic environment does not include production decisions by the agents.

68 Recall that diminishing-returns production technology is one of the driving forces behind the growth convergence results.

69 Dimitri Landa, “Income Redistribution and Democratization” (Manuscript, Department of Political Science, University of Minnesota, 2000).