Democracy and Growth Volatility: Exploring the Links
AbstractWe study the volatility of growth rates and find that it differs systematically across countries. Our empirical investigation reveals that there is a high correlation between disparity in political regimes across countries and differences in volatility. This is not the case for some of the commonly cited reasons like initial income, inequality or instability of regimes. We find that less democratic countries are more volatile. To explain this observation we use a dynamic model in which democracy is parameterized by the fraction of people who benefit from being in power. The government in this model maximizes the utility of the group in power using a redistributive tax scheme - setting uniform income taxes but transferring lump sum amounts and providing goods and services to the favored group only. When there is a bad shock in this economy, the marginal utility of consumption of agents in power is high. When the transfer is divided among a few, gains from increased transfer outweigh distortionary costs of higher tax. Thus, the optimal tax policy in non-democratic countries, in contrast to that in democratic countries, is such that tax rates are high when there is a bad shock and low when there is a good shock (we refer to this as procyclical tax policy). Further, we show that procyclical tax rates will lead to higher volatility of growth rates than under alternative tax policies. Thus, our model is successful in explaining why tax policies are pro-cyclical in some countries, a commonly observed phenomenon, in addition to providing reasons for differences in volatility of growth rates across countries. The modelâ€™s predictions are borne out by data in a number of other dimensions also
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Bibliographic InfoPaper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 515.
Date of creation: 03 Dec 2006
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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Web page: http://www.EconomicDynamics.org/society.htm
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volatility; optimal fiscal policy; transfer; democracy;
Other versions of this item:
- Malik Shukayev & Partha Chatterjee, 2006. "Democracy and Growth Volatility: exploring the links," Computing in Economics and Finance 2006 231, Society for Computational Economics.
- Partha Chatterjee & Malik Shukayev, 2011. "Democracy and Growth Volatility: Exploring the Links," Working Papers 13, Development and Policies Research Center (DEPOCEN), Vietnam.
- E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
- H2 - Public Economics - - Taxation, Subsidies, and Revenue
- O1 - Economic Development, Technological Change, and Growth - - Economic Development
- P16 - Economic Systems - - Capitalist Systems - - - Political Economy of Capitalism
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