Saturday, March 17, 2007

Should Democracy or Economic Growth come first?

Catching up on reading blogs over the weekend, Greg Mankiw points to an interesting debate from WSJ's Econoblog that asks "Is Democracy the Best Setting for Strong Economic Growth?"

I tend to agree with Daron Acemoglu's concluding remarks:

Democracy doesn't strongly predict economic growth, at least not in the short run. [...] Sustained economic growth requires secure property rights and a level playing field for generating new technologies and entry by new firms. Democracy is the best guarantor for such sustained economic growth. Economic growth generates various vested interests, ranging from landed elites to businessmen in declining industries to privileged workers. These vested interests will try to block the introduction of new technologies and stop the entry of new firms. Democracy is not perfect, but with its more egalitarian distribution of political power, it will have greater resistance against vested interests than autocracy.
What democracy brings can be replicated through benevolent autocracies/dictatorships. Markets are more efficient for driving innovation because it's made up of millions of little experiments jockeying to best reap the rewards of what the future might bring in what Joseph Schumpeter has termed "creative destruction". Autocracies often create barriers to new experiments favoring dominent or entrenched firms. As a form of government then, democracy tends to force change promoting a better meritocracy.

China inevitably comes up in this conversation. While the current regime ought to be applauded for making communism more pliable than Marx ever considered, they're still only making up for lost time. China remains a mere fraction of the economic force they were only a few hundred years ago. As far as China has come, there still exists a huge question mark on what's happened to all those state sanctioned, underperforming and crony loans that will never be repaid - an amount that could top $1 trillion dollars. Now imagine the scenario if depositors (and Chinese people tend to be savers) lost confidence in their financial system (it's one of those reasons why I think it's rather foolish for outsiders to press for fast and dramatic currency regime reform given that it could spark a run on domestic institutions).

Democracy tends to promote the spread of new ideas. While only a few years ago, blogger seemed to be behind the great firewall of China, wikipedia continues to be. Only a year ago, I wasn't even able to access my (paid) yahoo account through pop3. When I called Yahoo! on this, they told me it was because these accounts were blocked from within China. That said, the fact I seem to be now able to access my account is promising but may not bode well in keeping a populace unhappy with political machinations of the day at bay.

Another reason that representative democracies tend to produce more sustained growth is that they provide greater stability with a political outlet for dissent (not always the case obviously) and political succession tends not to be a bloody mess.

This isn't to say that in democracies bad loans and loans to cronies can't happen (ref: 1980s S&L crisis) or that you can't have instability (ref: Iraq), it just tends to be better other forms of government.

For some observers, China is a powder keg waiting to ignite. It bears considering that the argument for market reforms wasn't so much that China's government wanted them but rather didn't have a choice. From what I've seen locally and from what others have observed, your average joe might not have extraterritorial ambitions, but they can be fiercely nationalistic and can be ruthless about dealing with internal matters - under which they consider both Taiwan and Tibet to be.

But back to the question of which comes first - democracy or economic growth. I personally don't question that the two are two sides of the same coin, but given the difficulties of achieving the former, it would seem to me that the latter tends to need to come first. Further, I also have little doubt that the latter builds pressure for the former. China is indeed in for interesting times if this proves to be the case.

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