Democracy, Governance, and Economic Performance: Theory and Evidence.

Ahrens, Joachim

Democracy, Governance, and Economic Performance: Theory and Evidence Yi Feng MIT Press: Cambridge, MA and London, England, 2003, pp. xvii + 383.

Comparative Economic Studies (2005) 47, 235-238. doi:10.1057/palgrave.ces.8100076

In the last 15 years, economists have rediscovered the importance of institutions such as private property rights, the rule of law, and social capital for long-run economic performance. Institutions are the rules of the game which provide the incentive structure for individual behaviour. Formal and informal institutions are interdependent and play essential roles in determining the development of an individual country. In combination with the emerging research agenda on good governance, it is particularly political institutions whose impact on economic growth and development has found increasing emphasis in recent works by economists, political scientists, and sociologists, notably in studies sponsored by international organisations such as the World Bank. Nevertheless, theoretical and empirical research findings on the relationship between political institutions and economic growth have not been clearcut.

The basic puzzle of why economic growth follows different regional patterns has remained unsolved. Growth has been uneven and volatile in Latin America and sub-Saharan Africa, fast in much of East Asia, and steady and sustainable in Europe, and North America. The overall objective of Yi Feng's book 'is to examine political factors that differentiate a country's growth history from the patterns of other countries' (p. 9).

To explain the different regional patterns, the author focuses on political freedom, political stability, and policy certainty. These variables 'constitute the political foundation of economic management and affect not only economic growth, but also the economic determinants of growth, such as inflation, investment, human capital, income inequality, property rights, and population growth' (p. 1).

Based on a theoretical political-economic model of growth, Yi Feng operationalises the key political variables and then tests the derived hypotheses empirically. The study comprises 12 chapters, most of which can be read as independent essays focusing on specific inter-relations between political institutions and various economic performance indicators. His analytical structure is based on Douglass North's definitions of institutions and organisations, and his focus is on general rules of a political system, not particular actors or policies. Next, the author discusses the basic political environment for long-term economic growth. He offers a simple, but elegant and sound, theoretical foundation formalising the effects of political institutions on growth. This analysis yields three testable propositions: (1) the survival probability of the political regime and the degree of political stability are positively correlated with economic growth; (2) the polarisation of policy positions within a country and the level of policy uncertainty are negatively correlated with growth; and (3) the higher the degree of political freedom, the faster is economic growth.

The third chapter critically examines definitions and concepts of democracy used in the literature and operationalises the three political variables that Yi Feng thinks are key to understanding growth processes. Descriptive statistics presented show how his three political variables are instrumental in accounting for differential patterns of economic growth in the G-7 countries, in Asian-Pacific nations, in Latin America, and sub-Saharan Africa over the period 1960-95.

In the fourth chapter, the author tests the impact of the political determinants on long-term growth in a multivariate setting for a sample of more than 130 countries. Controlling for familiar variables, such as the initial levels of development and education, investment share in GDP, inflation, crude birth rates, and economic freedom, Yi Feng investigates the relation between economic performance and political institutions. The latter are assumed to be exogenous--an assumption loosened in subsequent chapters. The analysis finds that the variable 'policy certainty' represents the major defining characteristic of growth. In addition, the indicator of political stability is also shown to have a positive impact. Political freedom appears to have an indirect effect--promoting growth through its effect upon education, investment, economic freedom, birth rates, income distribution, as well as political stability. Yi Feng concludes that a single political variable is neither necessary nor sufficient condition for economic development. Only certain combinations of all three variables will show distinct effects on growth.

In the remaining chapters, the three political variables are endogenously determined and particular emphasis is given to the indirect effects of democracy (ie, political freedom) on economic growth. In this context, the author stresses the joint effects of political freedom, political stability, and economic growth on the one hand, and the impact of political institutions on inflation, investment, human-capital formation, income distribution, economic freedom, and population growth, on the other hand.

Yi Feng concludes his major findings by drawing policy implications, and sketches the lines of future research. His major conclusion is that political institutions actually matter for economic performance. 'Democracy indirectly promotes growth by inducing major regular government change and by inhibiting irregular government change' (p. 296). Furthermore, 'while both economic freedom and political freedom are important to economic development, democratic institutions are instrumental in creating and deepening economic freedom, thus promoting economic growth' (p. 298). Finally, democratic reform entails economic liberalisation as well as privatisation and hence fosters economic development.

Although the state can be an obstacle to economic development, it can also overcome institutional weaknesses and underdevelopment. The polity can provide unalterable prerequisites for sustained development--namely, those rules constituting a liberal democracy. 'A truly democratic government' he writes, can use private investment, the rule of law, human-capital formation, income equality, and reductions in birth 'to increase growth' (p. 303).

Yi Feng ends by posing a multitude of unresolved questions. According to the author, the most important open question is the following: 'suppose that we all agree that democracy is a good, rather than a bad. ... How can we help manufacture this political product?' (p. 307). To that question Yi Feng's book cannot provide an answer.

This study represents interdisciplinary research at its best. It combines insights of economists, political scientists, and sociologists in a fruitful manner and thereby tends to circumvent shortcomings of single-discipline analyses. The book makes a valuable contribution to enhance readers' understanding of how institutions affect economic performance. The author takes the reader step-by-step through his complex analysis and explains in great detail his theoretical assumptions, the data selection process as well as the empirical methodology. In particular, the study provides convincing empirical evidence of the theoretically derived hypotheses, and it deserves special merits for revealing the indirect effects of political institutions on long-run economic performance.

The book is accessible to readers with different backgrounds, it is a useful read for graduate students as well as scholars in the fields of economics, political science, and sociology. Understanding the highly complex analysis is substantially facilitated in each chapter through country-specific case studies which complement the empirical analysis, derivation of policy implications, and summaries.

Some readers, however, may be disappointed. While Yi Feng explicitly defines and explains the terms democracy and economic performance and analyses the inter-relations between them, he neglects to make any conceptual, theoretical, or empirical reference to the term 'governance', though this term appears in the book's title. Governance is not used as a distinct concept or approach to analyse the interplay of political and economic factors, but simply as a general phrase. Large parts of the new literature on good governance have been disregarded as well as recent empirical studies on the relationship between various governance indicators and economic growth as well as other performance variables.

An explicit discussion of how Yi Feng's three key political variables relate to concepts of governance or existing governance indicators would have proved to be fruitful for a thorough understanding of how political institutions affect economic performance. Political stability and policy certainty are not exclusive characteristics of Western-style democracies. As East Asian experiences show, relatively high degrees of political stability and policy certainty may also exist in non-democratic settings. While liberal democracies may show these characteristics that foster economic growth, non-democratic polities may do so as well. In order truly to understand the impact of political institutions on growth beyond the broad dimensions of democracy and autocracy, one needs to dig even deeper into the institutional fabric of a society. An explicit governance-related analysis could have been useful in doing exactly that.

Despite this shortcoming, the book is to be recommended highly. That institutions matter is no news. Of greater interest is which institutions matter and how they influence economic performance. This is where the book has its merits. Concisely written, it is a splendid addition to the controversial debate in academia and in policy-making circles on the relationship between democracy and economic development. It is high degrees of political freedom, political stability, and policy certainty that foster growth. Through an appropriate combination of theory, statistical analyses, and country-specific case studies, Yi Feng has discovered several multifaceted and differentiated insights. Sophisticated econometric work identified possible general effects of political institutions, but it was his country case studies that enriched the statistical work and provided even deeper insights.

Joachim Ahrens

European Business School International University, Oestrich Winkel, Germany