Democracy and Globalization

Democracy and Globalization

Barry EichengreenDavid Leblang

Many assume that democracy and globalization go together

• So say those impressed with changes in– Eastern Europe post 1989– Latin America post 1978

• Rationale– Since free international transactions should benefit

society as a whole, democracy renders leaders more accountable and thus they should remove restrictions

– The exchange of goods and services is a conduit for the exchange of ideas, and a more diverse stock of ideas enhances political competition.

Aggregate data also point in this direction

• Between 1975 and 2002, there was a quadrupling in the number of democratic countries.

• Over the same period, global trade as a share of GDP, a standard measure of trade openness, rose from 7.7 to 19.5 per cent.

• The share of countries open to international capital flows, as measured by the International Monetary Fund, rose from 25 to 38 per cent.

Of course, every causal statement just made could be wrong

• Some studies not only reject the hypothesis that democratization leads to openness but concludes in favor of the opposite– Authors rationalize their findings by observing that

concentrated interests may be better able to secure the imposition of protectionist policies in democracies

– Other base their arguments on Stolper-Samuelson logic: in countries where labor is the scarce factor of production democratic reforms increase labor’s voice which encourages protectionism

Modern work is inconclusive

• Most studies look only at one of the two causal connections– Since they are not concerned with two-way causality,

and sometimes they do not even acknowledge the existence of an endogeneity problem, much less develop an appropriate instrumental variables strategy.

• Few studies acknowledge different dimensions of globalization

• Few studies take advantage of the fact that there have been prior waves of globalization and democratization.

Identification• Instruments for trade openness

– Gravity based: geographic size, economic size, average distance from other markets

• Instruments for financial openness– Based on large literatures on capital mobility and

capital crises– Country size, inflation, budget deficit, # of other

countries with controls, systemic crises

• Instruments for democracy– Based on Przeworski, et al and Boix & Stokes– Prior transitions, constitutional age, colonial heritage,

natural resource endowments, urbanization, population density, geographic controls.

Sample, Data

• Between 14 & 156 countries over the period 1870-2000

• Trade: (imports+exports)/GDP: Mitchell, Banks• GDP: real gdp per capital PPP: Maddison• Capital Controls: IMF & Bordo-Eichengreen• Democracy:Dichotomous measure

– Przeworski, et al 1950-present– Boix and Rosato 1870-1950– Tested robustness using POLITY (both dichotomous

and continuous measure)

Statistical methods• IV models estimated via GMM with Newey-

West standard errors– Provides efficient estimates when residuals are

heteroscedastic– Can adjust bandwidth to deal with serial correlation

• Note: this means that we estimate linear probability models when the dependent variable is dichotomous.

Procedure

• Kitchen sink approach?– Would produce relevant instruments but would likely

result in overidentification

• We proceed as follows:– Use relevant instruments– Perform tests for overidentification and relevance– Refine instrument list based on these tests– Repeat

• Appropriate process because of the different processes operating at different times

Effect of Democracy on Trade Openness 1870-2000: Dichotomous Measure of Democracy

Full Sample

Gold Standard

Interwar Period

Bretton Woods

Post Bretton Woods

Democracy(t-1) 4.106*** 1.616*** 2.095*** 3.929*** 4.021*** (0.633) (0.283) (0.239) (0.459) (0.601) Log(Total GDP PPP(t-1)) -0.919*** -0.758*** -0.791*** -0.963*** -0.853*** (0.086) (0.068) (0.054) (0.065) (0.079) Log(Distance(t-1)) -0.783*** -0.025 1.244*** -1.364*** -1.022*** (0.245) (0.290) (0.340) (0.230) (0.321) Log(Country Size(t-1)) 0.002 -0.188*** -0.240*** 0.064 0.013 (0.035) (0.049) (0.047) (0.044) (0.031) Log(Total Population(t-1)) 0.486*** 0.294*** 0.706*** 0.457*** 0.452*** (0.078) (0.081) (0.091) (0.055) (0.076) Interwar Period -0.258 (0.223) Bretton Woods Period 0.893*** (0.202) Post Bretton Woods Period 2.781*** (0.267) Constant 5.527*** 1.898 -12.251*** 11.599*** 9.988*** (1.963) (2.596) (3.104) (1.881) (2.533) Observations 7362 763 712 2079 3792 F 62.705 59.612 103.816 107.769 80.816 p-value 0.000 0.000 0.000 0.000 0.000 First Stage F 22.14 79.97 113.41 32.03 30.52 p-value 0.000 0.000 0.000 0.000 0.000 Cragg-Donald Under-ID Test 331.746 171.794 290.379 129.479 182.062 p-value 0.000 0.000 0.000 0.000 0.000 Hansen J Statistic 5.926 0.026 2.088 0.004 8.166 p-value 0.052 0.873 0.352 0.952 0.017 Instruments Tot Dem

Pop Den Brit Col

Tot Dem

Brit Col

Tot Dem Urban Pop

Brit Col

Pop Den Brit Col

Tot Dem Pop Den Brit Col

Effect of Democracy on Capital Controls 1870-2000: Dichotomous Measure of Democracy

Full Sample

Interwar Period

Bretton Woods

Post Bretton Woods

Democracy(t-1) -0.768*** -0.782*** 0.505*** -0.730*** (0.204) (0.300) (0.166) (0.148) Interwar Period 0.455*** (0.066) Bretton Woods Period 0.917*** (0.053) Post Bretton Woods Period 0.638*** (0.057) Log(Total GDP PPP(t-1)) 0.004 -0.085*** 0.004 0.013** (0.007) (0.023) (0.010) (0.006) Log(GDP Per Capita PPP(t-1)) 0.053 0.544** -0.353*** 0.005 (0.054) (0.241) (0.082) (0.035) Systemic Crises(t-1) 0.004* 0.069*** -0.018 0.003 (0.002) (0.010) (0.012) (0.002) Inflation(t-1) 0.000*** 0.003 -0.006*** 0.000*** (0.000) (0.002) (0.002) (0.000) Government Balance(t-1) -0.006*** -0.009 0.001 -0.006*** (0.002) (0.006) (0.002) (0.002) Constant -0.064 -2.949* 3.501*** 0.868*** (0.320) (1.616) (0.563) (0.229) Observations 5440 316 650 3919 F 78.858 14.891 6.276 49.884 p-value 0.000 0.000 0.000 0.000 First Stage F 19.35 8.38 18.21 35.57 p-value 0.000 0.000 0.000 0.000 Cragg-Donald 160.432 19.223 77.295 139.355 p-value 0.000 0.000 0.000 0.000 Hansen J Statistic 0.025 0.430 10.394 0.392 p-value 0.875 0.512 0.015 0.531 Instruments Tot Dem

Brit Col Const Age

Brit Col Tot Dem Pop Den Urban

Const Age

Tot Dem Brit Col

Effect of Tra de on Democracy 1870-2000: Dichotomous Measure of Democracy

Full Sample

Gold Standard

Interwar Period

Bretton Woods

Post Bretton Woods

Log(Trade Openness(t-1)) 0.174*** 0.404*** 0.208*** 0.127** 0.189*** (0.059) (0.070) (0.044) (0.055) (0.066) Prior Transitions To Dictatorship(t-1) 0.127*** 0.191*** 0.022 0.135*** 0.114*** (0.014) (0.057) (0.038) (0.018) (0.014) Log(Constitutional Age(t-1)) -0.039** -0.211*** 0.036** -0.003 -0.051*** (0.017) (0.056) (0.017) (0.018) (0.016) # of Democracies in System(t-1) 0.001 0.008 -0.002 -0.018*** 0.001 (0.001) (0.010) (0.006) (0.004) (0.001) British Colonial Heritage 0.166*** 0.831*** -0.170** 0.147*** 0.109*** (0.036) (0.132) (0.076) (0.044) (0.034) French Colonial Heritage 0.058 -0.024 0.074* (0.039) (0.051) (0.039) Spanish Colonial Heritage 0.028 -0.240*** 0.070 -0.029 0.092* (0.040) (0.090) (0.067) (0.048) (0.048) Log(GDP Per Capita PPP(t-1)) 0.156*** 0.228*** 0.156*** 0.135*** 0.161*** (0.035) (0.027) (0.028) (0.035) (0.042) Growth Rate(t-1) 0.035 -0.228 0.019 -0.117 0.044 (0.104) (0.486) (0.165) (0.179) (0.134) Urban Population (t-1) -0.081 0.901** 0.985*** 0.106 -0.213** (0.109) (0.458) (0.254) (0.151) (0.089) Population Density (t-1) -0.000 -0.000 -0.002*** 0.000 0.000 (0.000) (0.001) (0.001) (0.000) (0.000) Constant -0.025 0.250 0.178 0.518*** -0.354* (0.059) (0.263) (0.179) (0.123) (0.196) Observations 6837 741 727 2010 3371 F 79.606 38.408 297.287 110.162 120.391 p-value 0.000 0.000 0.000 0.000 0.000 First Stage F 17.63 23.07 27.73 13.04 23.07 p-value 0.000 0.000 0.000 0.000 0.000 Cragg-Donald Under-ID Test 63.927 19.440 10.576 23.739 32.829 p-value 0.000 0.000 0.001 0.000 0.000 Hansen J Statistic p-value

Exactly identified

Exactly identified

Exactly identified

Exactly identified

Exactly identified

Instruments Dist Dist Dist Dist Dist

Summary of other results

• Similar story– Using different measures of democracy– Using different datasets (POLITY, Sachs-Warner)– Putting trade and capital controls on the right hand

side

• Markov Transition Model– Trade increases the probability that a democracy

(dictatorship) will remain a democracy (dictatorship) but has no impact on the probability of a transition (in either direction)

– Capital openness increases the probability that a dictatorship will become a democracy.

Extension: trade theory• Trade theory suggests that the impact of

democratization on openness is contingent upon a country’s factor endowment– Workers/voters prefer trade in labor abundant

countries.– We interact democracy with the land/labor ratio.– We obtain a positive effect of democracy and a

negative effect from the interaction.– We find this pattern using the entire sample, a

sample from 1870-1913, and a sample from 1960-2000, but not for the interwar years.

• We find similar results when capital controls is the dependent variable.

Conclusion

• What do the dynamics of a democratization-globalization system look like?– Unstable Case: shocks to trade and democracy could

send both in a positive or negative direction--without limit (e.g., experience of the 1930s)

– Stable Case: shocks to trade and democracy could send both in a positive or negative direction--within limits (e.g., ‘third wave’ of democracy since the 70s)

• Our results show support for the stable case: increases in democracy lead to increases in globalization and vice versa…but each successive increase is smaller than the one prior.