Summary of JOIE article (First View, 1 June 2020) by Nauro Campos, University College London, ETH Zurich and IZA-Bonn, Menelaos Karanasos, Brunel University London, Panagiotis Koutroumpis, Queen Mary University London and Zihui Zhang, Brunel University London. The full article is available on the JOIE website
How does institutional change affect economic growth? This paper explores a new hand-collected dataset and within country variation over extremely long-time horizons using an uncommon econometric framework to assess the effect of political instability on the growth rate of gross domestic product (GDP). We focus on both direct changes in formal political institutions and on potential indirect changes through political instability.
The Brazilian case is particularly interesting to study the relationship between the instability of political institutions and economic performance. Brazil is relevant because of its size (both in terms of populations and output), its hegemonic role in South America and its relatively important role globally. It is also important because despite the reputation of having a relatively peaceful history, this is a country that exhibits a rich variety of types of instability of political institutions (indeed of all the formal and informal types one can find in large cross-sections of countries) under considerable variation of contexts (empire and republic as well as over varying degrees of democracy and autocracy), over the very long time window we consider.
An important issue regards the channels through which political instability is expected to influence growth. It might be expected that instability will make property rights less secure and transaction costs too high, the rule of law weak and state capacity too thin to support sustained growth episodes. Furthermore, political instability is likely to affect the behaviour of both voters as well as monetary and fiscal authorities thus influencing economic decisions and output.
The intricate relationship between institutions and political instability has been examined in detail by many authors. In a seminal paper, using a cross section framework, Barro (1991) finds that assassinations, number of coups and revolutions have negative effects on economic growth. Campos and Nugent (2002) confirm this result by using panel data analysis but find that this negative impact (on growth) is mostly driven by sub-Saharan African countries. Easterly and Rebelo (1993) suggest that assassinations and war casualties have no significant effect on growth, while Benhabib-Spiegel (1997) and Sala-i-Martin (1997) empirically support this argument. Knack and Keefer (1995) compared more direct measures of institutional environment (such as the security of property rights and the Gastil indicators of political freedoms and civil liberties) with instability proxies utilized by Barro (1991). Asteriou and Price (2001) examine the influence of political instability on UK economic growth and find that political instability affects growth negatively whereas it has a positive impact on its uncertainty. Spruk (2016) examined the impact of de jure and de facto political institutions on the long-run economic growth for a large panel of countries. The empirical evidence suggests that societies with more extractive political institutions in Latin America experienced slower long-run economic growth and failed to converge with the West.
Within a power-ARCH (PARCH) framework and using annual time series data for Brazil covering the period from 1870 to 2003, the aim of this paper is to put forward answers to the following questions. What is the relationship between the instability of a country’s key political institutions, economic growth and volatility? Are the effects of these changes in institutions direct (on economic growth) or indirect (via the conditional volatility of growth)? Does the intensity and sign of these impacts vary over time? Does the intensity of these effects vary with respect to short- versus long-run considerations? Is the intensity of these effects constant across the different eras or phases of Brazilian economic history (in other words, are they independent from the main structural breaks we estimate)?
Our main results can be organised in terms of different types of effects. We discuss direct (on mean economic growth), indirect (via volatility), dynamic (short and long-run) and structural break effects. As for the direct effects of institutional change on economic growth, we find evidence for negative direct influences on real GDP growth from both the informal political instabilities (i.e., assassinations, coups and revolutions) and formal political instabilities (i.e., legislative effectiveness and number of cabinet changes). Equally importantly, we find that almost all of our political instability indicators have strong negative impacts on the output growth in the short-run. As for indirect (via volatility) effects, we find strong volatility-decreasing effects from both formal and informal political instability indicators.
The investigation of the dynamic effects shows important differences in terms of the short and long-run behaviour of our key variables: almost all political factors affect growth negatively in the short-run but the evidence for the long-run is much weaker. Importantly, however, the negative impact of assassinations, coups, revolutions together with legislative effectiveness and cabinet changes remains strong in the long-run. Finally, we tried to adjust all the above results to the possibility of the presence of structural breaks. This is an important exercise given the long-term nature of our data. We find that our basic results are confirmed once we take structural breaks into account.
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