Democracy and Income (Distribution)

Democracy and Income (Distribution) Jess Benhabib NYU May 1, 2013 Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 1 / 46

Democracy and Income The questions will be: Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 2 / 46

Democracy and Income The questions will be: 1 Why is democracy more sustainable at high levels of income but not at low levels? Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 2 / 46

Democracy and Income The questions will be: 1 Why is democracy more sustainable at high levels of income but not at low levels? 2 Are growth, and democracy, driven by good institutions (property rights, rule of law, constraints on executive) or are they endogenous, primarily a function of wealth or income? First: a sketch of some theory, an overview of the recent work, and then the empirics of Democracy and Income. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 2 / 46

Democracy and Income The questions will be: 1 Why is democracy more sustainable at high levels of income but not at low levels? 2 Are growth, and democracy, driven by good institutions (property rights, rule of law, constraints on executive) or are they endogenous, primarily a function of wealth or income? First: a sketch of some theory, an overview of the recent work, and then the empirics of Democracy and Income. (Let s postpone the definition of Democracy to later.) Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 2 / 46

Inequality, Growth and Democracy Let me start however, with Democracy and Inequality. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 3 / 46

Inequality, Growth and Democracy Let me start however, with Democracy and Inequality. The most obvious hypothesis is that excessive and persistent inequality leads to social conflict and coups, and is incompatible with democracy. In the absence of redistribution that mediates and ameliorates inequality, democracy cannot survive. But this may be too simplistic: the goverment may redistribute only to the point which avoids revolt by the poor (left), or stop short of the level of redistribution that would trigger a coup by the rich (right). Here specifics of the distribution of power, the costs of collective action, the degree of repression and the potential use of force all matter. (For example recently new social media may have reduced collective action costs.) Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 3 / 46

Inequality, Growth and Democracy Let me start however, with Democracy and Inequality. The most obvious hypothesis is that excessive and persistent inequality leads to social conflict and coups, and is incompatible with democracy. In the absence of redistribution that mediates and ameliorates inequality, democracy cannot survive. But this may be too simplistic: the goverment may redistribute only to the point which avoids revolt by the poor (left), or stop short of the level of redistribution that would trigger a coup by the rich (right). Here specifics of the distribution of power, the costs of collective action, the degree of repression and the potential use of force all matter. (For example recently new social media may have reduced collective action costs.) So political economy is diffi cult. Empirically, what do we know from some classic papers? Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 3 / 46

"We are specifically interested in two questions: I. Does income inequality increase political instability? 2. Does political instability reduce investment? According to our findings, the answer to both questions is yes. First, more unequal societies are more politically unstable: in particular, our results suggest that political stability is enhanced by the presence of a wealthy middle class. Second, political instability has an adverse effect on investment and, therefore, on growth. Furthermore, these two effects (from inequality to instability, and from instability to investment) are not only statistically significant, but also economically significant." A. Alesina and R. Perotti "Income distribution, political instability, and investment" EER, 1996. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 4 / 46

"More equal societies have lower fertility rates and higher rates of investment in education. Both are reflected in higher rates of growth. Also, very unequal societies tend to be politically and socially unstable, which is reflected in lower rates of investment and therefore growth. Finally, the data do not support the idea that more equal societies, particularly those with democratic institutions, grow faster because they generate fewer demands for redistribution and therefore fewer distortions." R. Perotti, "Growth, Income Distribution, and Democracy: What the Data Say," Journal of Economic Growth, (1996) Here we also have hints of inequality retarding growth through credit market imperfections and social instability. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 5 / 46

"More equal societies have lower fertility rates and higher rates of investment in education. Both are reflected in higher rates of growth. Also, very unequal societies tend to be politically and socially unstable, which is reflected in lower rates of investment and therefore growth. Finally, the data do not support the idea that more equal societies, particularly those with democratic institutions, grow faster because they generate fewer demands for redistribution and therefore fewer distortions." R. Perotti, "Growth, Income Distribution, and Democracy: What the Data Say," Journal of Economic Growth, (1996) Here we also have hints of inequality retarding growth through credit market imperfections and social instability. The point in bold: In more equal countries with democratic institutions, typically richer countries, there may be more redistribution, rather than less. Redistribution is mediated by the government and a welfare state. Maybe because the stakes are higher? Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 5 / 46

"Evidence from a broad panel of countries shows little overall relation between income inequality and rates of growth and investment. For growth, higher inequality tends to retard growth in poor countries and encourage growth in richer places." R. Barro, "Inequality and Growth in a Panel of Countries," JOEG, (2000). Note the differential impact of inequality between rich and poor. Can richer countries tolerate more inequality with less social disruption and adverse effects on growth? Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 6 / 46

Income, Growth and Democracy Property Rights? So let s move to explore the relationship of income, rather than income distribution, on growth and democracy. A key concept, often measured and included in econometric specifications, is the "security of property rights." The following sketch of model, though problematic and too abstract, can set some tentative initial ideas. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 7 / 46

Income, Growth and Democracy Property Rights? So let s move to explore the relationship of income, rather than income distribution, on growth and democracy. A key concept, often measured and included in econometric specifications, is the "security of property rights." The following sketch of model, though problematic and too abstract, can set some tentative initial ideas. What if "property rights / institutions" are endogenous, a function of more basic fundamentals, like wealth or income? Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 7 / 46

Expropriation, Appropriation, Tragedy of the Commons Expropriative redistributive activities can result from nationalizations, confiscations, required bribes to offi cials, arbitrary taxes, coups... Appropriative redistributive activities can have legitimate, clientelist forms: subsidies, regulations, wage and price controls, taxes targeted to specific groups, an overvalued currency to favor urban vs rural areas producing exportables (agricultural and mineral goods), restrictions on mineral and agricultural exports to be channeled through govenment marketing boards, govenment fertilizer monopolies, allocation of civil service jobs... (whether the government is elected or not.) To simplify, the absence of well-defined property rights over the long-horizon may give rise to a dynamic "Tragedy of the Commons". (Benhabib and Radner, 1992, Benhabib and Rustichini, 1996). Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 8 / 46

Expropriation, Appropriation, Tragedy of the Commons Expropriative redistributive activities can result from nationalizations, confiscations, required bribes to offi cials, arbitrary taxes, coups... Appropriative redistributive activities can have legitimate, clientelist forms: subsidies, regulations, wage and price controls, taxes targeted to specific groups, an overvalued currency to favor urban vs rural areas producing exportables (agricultural and mineral goods), restrictions on mineral and agricultural exports to be channeled through govenment marketing boards, govenment fertilizer monopolies, allocation of civil service jobs... (whether the government is elected or not.) To simplify, the absence of well-defined property rights over the long-horizon may give rise to a dynamic "Tragedy of the Commons". (Benhabib and Radner, 1992, Benhabib and Rustichini, 1996). With various interest groups engaging of appropriation/expropriation (even with pre or post fisc equality) expected returns on productive activities are reduced, and growth can slow down, or get trapped. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 8 / 46

Questions With actors or interest groups having long term, forward-looking objectives, this problem can get complicated. Does it pay for the various interest groups to adhere to institutional constrains and refrain from short-term expropriation in order to sustain higher growth and future well-being? Can you sustain cooperation because the high short-term payoff of revolt and too high expropriation is just not worth it in the long run? Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 9 / 46

Questions With actors or interest groups having long term, forward-looking objectives, this problem can get complicated. Does it pay for the various interest groups to adhere to institutional constrains and refrain from short-term expropriation in order to sustain higher growth and future well-being? Can you sustain cooperation because the high short-term payoff of revolt and too high expropriation is just not worth it in the long run? The twist we are looking for is whether cooperative actions are sustainable from income/wealth levels above a treshold, but not below it (for a given discount rate). Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 9 / 46

Sustainable Growth: A Model Too Abstract Suppose groups voluntarily agree not to expropriate, or revolt because the one time gain is not worth trigerring a bad (high appropriation) equilibrium with low and uncertain effective returns for the longer run. Suppose a first-best cooperative outcome with growth is self-sustaining as an equilibrium from high income levels. But it may not be at lower income levels: The marginal utility of one time expropriation is smaller at high levels of income, and the loss associated with reversion to a bad equilibrium too big... Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 10 / 46

Sustainable Growth: A Model Too Abstract Suppose groups voluntarily agree not to expropriate, or revolt because the one time gain is not worth trigerring a bad (high appropriation) equilibrium with low and uncertain effective returns for the longer run. Suppose a first-best cooperative outcome with growth is self-sustaining as an equilibrium from high income levels. But it may not be at lower income levels: The marginal utility of one time expropriation is smaller at high levels of income, and the loss associated with reversion to a bad equilibrium too big... The same is not true at low wealth and income levels: marginal utilities are high and the benefits of slow accumulation are distant... Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 10 / 46

Sustainable Growth: A Model Too Abstract Suppose groups voluntarily agree not to expropriate, or revolt because the one time gain is not worth trigerring a bad (high appropriation) equilibrium with low and uncertain effective returns for the longer run. Suppose a first-best cooperative outcome with growth is self-sustaining as an equilibrium from high income levels. But it may not be at lower income levels: The marginal utility of one time expropriation is smaller at high levels of income, and the loss associated with reversion to a bad equilibrium too big... The same is not true at low wealth and income levels: marginal utilities are high and the benefits of slow accumulation are distant... Rocking the boat is not worth it if you are rich, only if you are poor.. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 10 / 46

Second Best? The second-best sustainable equilibrium may entail slower growth and accumulation until a treshold wealth level is crossed, or in the extreme, we could get a poverty trap. (all for a given discount rate). Redistributive pressures arising from inequality, or conflicts over the distribution of income and wealth may be mediated through political and democratic processes, but may in certain cases lead to social instability, coups or repression in poorer countries. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 11 / 46

Second Best? The second-best sustainable equilibrium may entail slower growth and accumulation until a treshold wealth level is crossed, or in the extreme, we could get a poverty trap. (all for a given discount rate). Redistributive pressures arising from inequality, or conflicts over the distribution of income and wealth may be mediated through political and democratic processes, but may in certain cases lead to social instability, coups or repression in poorer countries. So we may observe expropriative activities and coups more frequently at lower income/wealth levels. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 11 / 46

In a Picture Think of "a" as repression" Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 12 / 46

Now the basis for the priority of liberty is roughly as follows: as the conditions of civilization improve, the marginal significance for our good of further economic and social advantages diminishes relative to the interests of liberty, which become stronger as the conditions for the exercise of the equal freedoms are more fully realized. Beyond some point it becomes and then remains irrational from the standpoint of the original position to acknowledge a lesser liberty for the sake of greater material means and amenities of offi ce... First of all as the general level of well-being rises ( as indicated by the index of primary goods the less favored can expect) only the less urgent wants remain to be met by further advances, at least insofar as men s wants are not largely created by institutions and social forms. At the same time the obstacles to the exercise of equal liberties decline and a growing insistence upon the right to pursue our spiritual and cultural interests asserts itself... To be sure, it is not the case that when the priority of liberty holds, all material wants are satisfied. Rather these desires are not so compelling as to make it rational for the persons in the original position to agree to satisfy them by accepting a less than equal freedom. John Rawls, Theory of Justice, p. 543 Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 13 / 46

Digression: Homotheticity A technical digression about homogeneity: Why should enforcability of cooperation depend on wealth if production and preferences are homothetic? Even if if production and preferences are homothetic, but there is a fixed factor, you can get this result: (there may be a maximum time endowment to be allocated between labor and leisure for example. ) Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 14 / 46

Role of Institutions? We can already signal a basic question to be addressed later: Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 15 / 46

Role of Institutions? We can already signal a basic question to be addressed later: Can good institutions (property rights, rule of law, constraints on the executive, etc) secure cooperation and good behavior, or are institutions endogenous, so that they evolve to reflect (or their implementation reflects) self interested computations by various groups? Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 15 / 46

Role of Institutions? We can already signal a basic question to be addressed later: Can good institutions (property rights, rule of law, constraints on the executive, etc) secure cooperation and good behavior, or are institutions endogenous, so that they evolve to reflect (or their implementation reflects) self interested computations by various groups? We ll get to this. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 15 / 46

Some problems with the model : First, a significant source of growth is TFP, not investment. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 16 / 46

Some problems with the model : First, a significant source of growth is TFP, not investment. Second, TFP growth diffuses from technology leaders and can (irresistibly) drive growth, despite the political regimes and expropriations. Distance to the leader and educational levels may drive technology adoption and the diffusion rate. Parente and Prescott (1993, 2002) reintroduce politics to explain TFP diffusion across countries. They make the point that technology adoption can be blocked or retarded by vested interests through various political barriers. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 16 / 46

Some problems with the model : First, a significant source of growth is TFP, not investment. Second, TFP growth diffuses from technology leaders and can (irresistibly) drive growth, despite the political regimes and expropriations. Distance to the leader and educational levels may drive technology adoption and the diffusion rate. Parente and Prescott (1993, 2002) reintroduce politics to explain TFP diffusion across countries. They make the point that technology adoption can be blocked or retarded by vested interests through various political barriers. Nevertheless so far the analysis, while it is dynamic and allows forward looking agents, is too abstract and too much of a black box. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 16 / 46

A model of sustainable democracy (Benhabib-Przeworski, ET (2006)) Now we switch from sustainability of high growth rates to sustainability of democracy. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 17 / 46

A model of sustainable democracy (Benhabib-Przeworski, ET (2006)) Now we switch from sustainability of high growth rates to sustainability of democracy. Democracy here is the median voter setting taxes and redistributions (Note: we show the median voter thm holds in our context even with the infinite sequence of taxes) Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 17 / 46

A model of sustainable democracy (Benhabib-Przeworski, ET (2006)) Now we switch from sustainability of high growth rates to sustainability of democracy. Democracy here is the median voter setting taxes and redistributions (Note: we show the median voter thm holds in our context even with the infinite sequence of taxes) Agents are long-lived, and heterogeneous in initial wealth. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 17 / 46

The upper x% and the lower y% of the wealth tail may attempt a coup if they find the redistribution excessive or insuffi cient, that is their long-term expected utility is higher under the coup for everyone in that tail. If the left or the right revolts there is a probabilistic outcome of a left or right dictatorship. Under a right dictatorship taxes and redistrubutions are zero, under a left dictatorship rediredistribution equalizes wealth immediately (with zero taxes afterwards. An interesting tangential issue here: will inequality nevertheless re-emerge in some form? Remember Pareto.) Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 18 / 46

The upper x% and the lower y% of the wealth tail may attempt a coup if they find the redistribution excessive or insuffi cient, that is their long-term expected utility is higher under the coup for everyone in that tail. If the left or the right revolts there is a probabilistic outcome of a left or right dictatorship. Under a right dictatorship taxes and redistrubutions are zero, under a left dictatorship rediredistribution equalizes wealth immediately (with zero taxes afterwards. An interesting tangential issue here: will inequality nevertheless re-emerge in some form? Remember Pareto.) All else equal, everyone prefers democracy. There is a fixed cost under dictatorship (which can differ for the right and left, depending who is in power.). Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 18 / 46

RESULTS We ask what redistributions of income and assets are feasible in a democracy, given the initial assets and their distribution. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 19 / 46

RESULTS We ask what redistributions of income and assets are feasible in a democracy, given the initial assets and their distribution. The question is motivated by the possibility that if redistribution is insuffi cient for the poor or excessive for the rich, they may turn against democracy. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 19 / 46

RESULTS We ask what redistributions of income and assets are feasible in a democracy, given the initial assets and their distribution. The question is motivated by the possibility that if redistribution is insuffi cient for the poor or excessive for the rich, they may turn against democracy. In turn, if no redistribution simultaneously satisfies the poor and the wealthy, democracy cannot be sustained. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 19 / 46

RESULTS CONT D Hence, the corollary question concerns the conditions under which democracy is sustainable. We find that democracies survive in wealthy societies. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 20 / 46

RESULTS CONT D Hence, the corollary question concerns the conditions under which democracy is sustainable. We find that democracies survive in wealthy societies. Conditional on the initial income distribution, each country has a threshold of capital stock above which democracy survives. This threshold is lower when the distribution of initial endowments is more equal and when the revolutionary prowess of right or left groups in the tails are lower. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 20 / 46

RESULTS CONT D Hence, the corollary question concerns the conditions under which democracy is sustainable. We find that democracies survive in wealthy societies. Conditional on the initial income distribution, each country has a threshold of capital stock above which democracy survives. This threshold is lower when the distribution of initial endowments is more equal and when the revolutionary prowess of right or left groups in the tails are lower. Yet in poor unequal countries there exist no redistribution scheme which would be accepted both by the poor and the wealthy.hence, democracy cannot survive. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 20 / 46

RESULTS CONT D As endowments increase, redistribution schemes that satisfy both the poor and the wealthy emerge. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 21 / 46

RESULTS CONT D As endowments increase, redistribution schemes that satisfy both the poor and the wealthy emerge. Moreover, as capital stock grows the wealthy tolerate more and the poor less redistribution, so that the set of feasible redistributions becomes larger. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 21 / 46

RESULTS CONT D As endowments increase, redistribution schemes that satisfy both the poor and the wealthy emerge. Moreover, as capital stock grows the wealthy tolerate more and the poor less redistribution, so that the set of feasible redistributions becomes larger. Since the median voter prefers one such scheme to the dictatorship of either group, democracy survives. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 21 / 46

EMPIRICS (based on Przeworski et al, 2000) Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 22 / 46

Modernization Theory "The general income level of a nation also affects its receptivity to democratic norms. If there is enough wealth in the country so that it does make too much difference whether some redistribution takes place, it is easier to accept the idea that it does not matter greatly which side is in power. But if loss of offi ce means serious losses for major groups, they will seek to retain offi ce by any means available." Lipset, S.M.: Political man: the social bases of politics. Garden City: Doubleday 1960. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 23 / 46

What is democracy? Robert A Dahl (1971): Electoral Competition and Participation Przeworski et al (2000): Countries are democratic if the following all hold: 1 The chief executive is elected 2 The legislature is elected 3 There is more than one party competing in the elections 4 An alternation in power under identical electoral rules has taken place Otherwise, countries are coded as dictatorships. This is a binary measure. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 24 / 46

Polity IV The Polity measure of democracy is the difference of two scores. 1 Democracy score 2 Autocracy score The Polity IV measure is based on attributes: 1 competitiveness of executive recruitment 2 openness of executive recruitment 3 constraints that exist on the executive 4 regulation of political participation 5 competitiveness of political participation This is a continuous measure from aggegating the above, ranging from -10 to 10. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 25 / 46

Freedom House Freedom House s annual measure has two dimensions that produce a continuous measure: 1 Political rights dimension 2 Civil rights dimension Raters score 10 questions, from 0 to 4, summed to produce a score from 0 to 40. The 0-40 score is converted into a 1 to 7 scale. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 26 / 46

Freedom House Cont d Example questions used to develop the political rights dimension: 1 Is the head of state elected in free and fair elections? 2 Is there pervasive corruption? 3 Is the government open, accountable, and transparent between elections? 4 Is there a competitive opposition? Example questions used to develop the civil rights dimension: 1 Are the media free and independent? 2 Is there an independent judiciary? 3 Is there equal treatment under the law? 4 Is there equality of opportunity? 5 Do citizens have the right to own property? Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 27 / 46

Vanhannen Scores are generated from multiplying two attributes and dividing by 100: Competition: 1 % of votes to the largest party Participation: % of total population voting Note: The democracy indices are highly correlated. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 28 / 46

Institutions and Critical Junctures in History "We favor another explanation for this pattern. Even in the absence of a simple causal link from income to democracy, political and economic development paths are interlinked and are jointly affected by various factors. Societies may embark on divergent political-economic development paths, some leading to relative prosperity and democracy, others to relative poverty and dictatorship. Our hypothesis is that the positive cross-sectional relationship and the 500-year correlation between changes in income and democracy are caused by the fact that countries have embarked on divergent development paths at some critical junctures during the past 500 years." Acemoglu, Johnson, Robinson, Yared, "Income and Democracy" (AER, 2008) Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 29 / 46

Using Settler Mortality as Instrument for Institutions "We provide support for this hypothesis by documenting that the positive association between changes in income and democracy over the past 500 years is largely accounted for by a range of historical variables. For the whole world sample, the positive association is considerably weakened when we control for date of independence, early constraints on the executive, and religion. We then turn to the sample of former European colonies, where we have better proxies for factors that have influenced the development paths of nations. AJR(2001, 2002) and Engerman and Sokoloff (1997) argue that differences in European colonization strategies have been a major determinant of the divergent development paths of colonial societies. This suggests that the critical juncture for most societies corresponds to their experience under European colonization." Acemoglu, Johnson, Robinson, Yared, "Income and Democracy" (AER, 2008) Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 30 / 46

"Furthermore, AJR(2002) show that the density of indigenous populations at the time of colonization has been a particularly important variable in shaping colonization strategies, and provide estimates of population densities in the year 1500 (before colonization). When we use information on population density, as well as on independence year and early constraints on the executive, the 500-year relationship between changes in income and democracy in the former colonies sample disappears. This is consistent with the hypothesis that the positive cross-sectional relationship between income and democracy today is the result of societies embarking on divergent development paths at certain critical junctures during the past 500 years" AJRY (2008) Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 31 / 46

Using Fixed Effects for Divergent Paths at Colonization Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 32 / 46

Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 33 / 46

Do Institutions Persist? "Following AJR, statistical studies of the impact of institutions adopt the following procedure: 1) Regress current incomes for a recent date (or an average of recent dates) on recent institutions and some control variables; 2) Instrument recent institutions by instrumenting institutions at some time immemorial. Yet this assumption is patently false. Here is a crosstab of institutional quality as measured by the variable used by AJR ( constraints on the chief executive ), of exit-year institutions (when countries ceased to exist or information is last available) by entry-year institutions (the year of independence or soon after) for all countries that appear in the PolityIV data set (including those that were never colonies)." A. Przeworski, "The Last Instance: Are Institutions the Primary Causeof Economic Development?", Arch.europ.sociol.,(2004). Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 34 / 46

Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 35 / 46

Another Hypothesis on Settlers "The correlation between AJR s proposed instruments and their preferred measures of institutions is very high indeed. For example, the logarithm of settler mortality is correlated at -.54 with average executive constraints, and -.51 with average expropriation risk, while the logarithm of population density in 1500s is correlated at -.35 and -.40 with the same measures of institutions. Edward L. Glaeser, Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer, "Do Institutions Cause Growth?" Journal of Economic Growth, 2004" Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 36 / 46

Settlers and Human Capital, Income and Growth "...Still, both settler mortality and 1500 population density are strongly correlated with today s per capita income. Why might this be so?... We have seen that human capital is an important determinant of economic growth. The importance of malaria in determining current income points in the same direction. Could the influence of AJR s proposed instruments on today s development work through human capital? Put differently, perhaps when colonizers settled, they brought with them their know-how rather than constraints on the executive." Glaeser et al, JOEG, 2004. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 37 / 46

Settlers, Human Capital, Growth, Income and Democracy "Our evidence suggests in contrast that the Lipset-Przeworski-Barro view of the world is more accurate: countries that emerge from poverty accumulate human and physical capital under dictatorships, and then, once they become richer, are increasingly likely to improve their institutions." Glaeser et al, JOEG, 2004. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 38 / 46

Benhabib, Corvalan, Spiegel, 2011 on Fixed Effect Regressions Our analysis confronts two primary issues: First, more and better-measured data on both income and democracy has become available since the publication of AJRY (2008). This development is crucial because the inclusion of country fixed effects reduces inference to that based on within-country variation in the data. However, as we show below, the initial Penn World Tables 6.1 (PWT 6.1) sample has data for shorter time spans than those available in either the newer Penn World Tables 6.3 data set [Heston, et al, (2009)] (PWT 6.3), or the alternative Maddison (2003) data set. There is reason to believe that these new panels will be more informative, as the (within country) coeffi cients of variation in all of the democracy measures considered increases when one goes from the original PWT 6.1 data set to either the PWT 6.3 or Maddison alternatives. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 39 / 46

Second, the measures of democracy used in AJRY are discrete (Przeworski et al), or censored (Freedom House, Polity (two-sided), Vanhanen (one-sided)) violating the maintained assumptions under OLS. We respond to this issue by using either a two-sided Tobit specification or the double-censoring specification of Alan, Honoré, and Leth-Petersen (2008) and we use conditional and unconditional Logit specifications to obtain estimates for the binary Przeworski measure. Additionally, for the four measures of democracy Freedom House, Polity, Index of Democratization and DD we also use the Wooldridge (2005) estimator (WE). This estimator generalizes the Chamberlain (1980) estimator used by AJRY (2009) and parameterizes the fixed effects as well as the initial conditions in a dynamic panel. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 40 / 46

Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 41 / 46

***p<0.001, **p<0.05, *p<0.1. Country, time fixed effects suppressed. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 42 / 46

Point estimates indicate that substantial movements in income can have notable implications for measured democracy levels. Income spurts are exceptional, but they do occur. In the balanced panel of 88 emerging market economies for which we have complete income data between 1960 and 2000, 18 countries, or 20.5% of the panel, experienced a growth spurt where income doubled within a 20 year period. To interpret the impact of such a growth spurt, consider that the mean coeffi cient for lagged income in all our specifications is 0.07. As lagged democracy is 0.5, the long run effect of income is 0.14. This effect implies that doubling income would result in an increase in measured democracy of about 0.10. Using the most recent 2008 Polity data, one could go from the democracy level found in Malaysia to those the one found in Belgium. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 43 / 46

TABLE 2: Results with binary democracy/dictatorship measure of democracy Estimates for Chamberlain and Wooldridge correspond to marginal effects. *** indicates statistical significance at 1% confidence level, ** at 5% confidence level, and *** at 10% confidence level. Country and time fixed effect estimates suppressed. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 44 / 46

Our estimated coeffi cients indicate that the presence or absence of democracy is extremely sensitive to income: a two standard deviation increase in income would lead to 52% and 30% increases in the probability of democracy using the Chamberlain-adjusted probit estimator, and by 55% and 32% respectively using the Wooldridge estimator. For a country with average income, our Wooldridge estimation point estimates indicate that doubling income would result in a 15% increase in the probability of being a democracy using the PWT 7.0 data, and an 11% increase in the probability of being a democracy using the Maddison data. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 45 / 46

Conclusion Why is Democracy more sustainable at high levels of income but not at low levels? Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 46 / 46

Conclusion Why is Democracy more sustainable at high levels of income but not at low levels? 1 Current wealth and current democracy are both the result of early and persistent institutions that secure property and constrain the executive. 2 Democracies survive in wealthy societies. The general income level of a nation affects its receptivity to democratic norms: "Higher incomes reduce the intensity of conflict over the distribution of income, and thereby give way to democratic institutions that discourage expropriation and support redistributive fiscal policies under the rule of law." (Benhabib, Corvalan, Spiegel, 2011). Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 46 / 46

Conclusion Why is Democracy more sustainable at high levels of income but not at low levels? 1 Current wealth and current democracy are both the result of early and persistent institutions that secure property and constrain the executive. 2 Democracies survive in wealthy societies. The general income level of a nation affects its receptivity to democratic norms: "Higher incomes reduce the intensity of conflict over the distribution of income, and thereby give way to democratic institutions that discourage expropriation and support redistributive fiscal policies under the rule of law." (Benhabib, Corvalan, Spiegel, 2011). We think the second explanation is more likely. Jess Benhabib (NYU) Democracy and Income (Distribution) May 1, 2013 46 / 46