Private Investment and Democracy in the Developing World

By Pastor, Manuel, Jr.; Sung, Jae Ho | Journal of Economic Issues, March 1995 | Go to article overview

Private Investment and Democracy in the Developing World


Pastor, Manuel, Jr., Sung, Jae Ho, Journal of Economic Issues


The relationship between domestic politics and economic performance in developing countries has been the subject of a new wave of research by both economists and political scientists [Alesina and Rodrik 1991; Alesina et al. 1991; Frieden 1991; Haggard and Kaufman 1989; Maxfield 1990; Remmer 1991; Rodrik 1991]. While much of this research is concerned with the politics of adjustment programs, delayed stabilizations, and other such matters, there has also been a return to the grander themes of democracy and development [Huber, Rueschemeyer, and Stephens 1993]. Unfortunately, statistical studies of the democracy-growth relationship are often methodologically flawed and, taken all together, inconclusive [Przeworski and Limongi 1993].

This paper builds on previous research [Pastor and Hilt 1993] and attempts to address some of the methodological problems noted by Przeworski and Limongi. Specifically, we forego the usual correlation method and instead "nest" our empirical assessment of democracy's effect in a fuller model that can independently explain the economic variable in question: private investment. The focus on private investment arises for two reasons: (1) much of the democracy-development debate focuses on whether a more closed political regime is necessary to shield private capital (and hence investment decisions) from the redistributive demands of popular classes; and (2) much of the current policy stress in developing countries is on the recuperation and expansion of the private sector, partly because research supports economists' general presupposition that private investment is especially important for developing countries' economic growth [Khan and Reinhart 1990].

In this paper, we begin by sketching out the reasons why some view democracy as a negative environment for private investors; as we will see, the argument hinges on the supposed capacity of authoritarian regimes to restrain consumption and insulate policymakers. We take the opposite view, suggesting that a potentially positive relationship between democracy and investment may exist precisely because more open political systems allow policymakers to better "read" and respond to distributive pressures and thereby reduce social conflict; we also suggest that democracy is likely to allow private capitalists (as well as other citizens) institutional access to policymakers. While the causal chain of our argument is not directly testable, we do specify and then test an investment function that includes a measure of democracy as well as other "political" variables. As it turns out, the democracy measure is significant and positive, a result in line with our own view. The paper concludes by discussing the limits to our work and suggesting possible avenues for future research.

Democracy and Economic Performance

That democracy might constitute a drag on capitalist development was, as Przeworski [1990] points out, a concern of classical political thinkers. After all, democracy supplements the "one dollar, one vote" rule of the market place with the "one person, one vote" rule of the polling booth. Since the median voter - the one who casts the deciding ballot in a majority rule system - is not likely to not be a capitalist owner, there seems a great risk that democracy could overturn capitalism (or at least greatly alter the profile of income generated by a skewed distribution of income-generating property). Given this, it is not surprising that Marx argued that democracy "unchains the class struggle" [Marx 1952, 6, as quoted in Przeworski and Limongi 1993, 52] and that elites in the United States and elsewhere initially tried to limit the franchise to property owners. This argument that "person rights" threaten property rights still resonates, especially with modern-day radical economists: Samuel Bowles and Herbert Gintis [1986], for example, argue strenuously that capitalism and democracy have come to a parting of the ways, at least in the advanced capitalist countries. …

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