IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this article or follow this journal

Political instability: Effects on financial development, roots in the severity of economic inequality

  • Roe, Mark J.
  • Siegel, Jordan I.

We here bring forward strong evidence that political instability impedes financial development, with its variation a primary determinant of differences in financial development around the world. As such, it needs to be added to the short list of major determinants of financial development. First, structural conditions first postulated by Engerman and Sokoloff (2002) as generating long-term inequality are shown here to have strong empirical support as exogenous determinants of political instability. Second, that exogenously-determined political instability in turn holds back financial development, even when we control for factors prominent in the last decade's cross-country studies of financial development. The findings indicate that inequality-perpetuating conditions that result in political instability and weak democracy are fundamental roadblocks for international organizations like the World Bank that seek to promote financial development. The evidence here includes country fixed effect regressions and an instrumental model inspired by Engerman and Sokoloff's (2002) work, which to our knowledge has not yet been used in finance and which is consistent with current tests as valid instruments. Four conventional measures of national political instability – Alesina and Perotti's (1996) well-known index of instability, a subsequent index derived from Banks' (2005) work, and two indices of managerial perceptions of nation-by-nation political instability – persistently predict a wide range of national financial development outcomes. Political instability's significance is time consistent in cross-sectional regressions back to the 1960s, the period when the key data becomes available, robust in both country fixed effects and instrumental variable regressions, and consistent across multiple measures of instability and of financial development. Overall, the results indicate the existence of an important channel running from structural inequality to political instability, principally in nondemocratic settings, and then to financial backwardness. The robust significance of that channel extends existing work demonstrating the importance of political economy explanations for financial development and financial backwardness. It should help to better understand which policies will work for financial development, because political instability has causes, cures, and effects quite distinct from those of many of the key institutions most studied in the past decade as explaining financial backwardness.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.sciencedirect.com/science/article/pii/S014759671100014X
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Article provided by Elsevier in its journal Journal of Comparative Economics.

Volume (Year): 39 (2011)
Issue (Month): 3 (September)
Pages: 279-309

as
in new window

Handle: RePEc:eee:jcecon:v:39:y:2011:i:3:p:279-309
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622864

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Rajan, Raghuram G & Zingales, Luigi, 1998. "Financial Dependence and Growth," American Economic Review, American Economic Association, vol. 88(3), pages 559-86, June.
  2. Raghuram Rajan & Luigi Zingales, 2003. "The Emergence of Strong Property Rights: Speculation from history," NBER Working Papers 9478, National Bureau of Economic Research, Inc.
  3. Persson, T. & Tabellini, G., 1993. "Is Inequality Harmful for Growth," Papers 537, Stockholm - International Economic Studies.
  4. King, Robert G. & Levine, Ross, 1993. "Finance and growth : Schumpeter might be right," Policy Research Working Paper Series 1083, The World Bank.
  5. King, Robert G. & Levine, Ross, 1993. "Finance and growth : Schumpeter might be right," Policy Research Working Paper Series 1083, The World Bank.
  6. Marco Pagano & Paolo Volpin, 1999. "The Political Economy of Corporate Governance," CSEF Working Papers 29, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 01 Jul 2005.
  7. Easterly, W & Levine, R, 1996. "Africa's Growth Tragedy : Policies and Ethnic Divisions," Papers 536, Harvard - Institute for International Development.
  8. Acemoglu, Daron & Johnson, Simon & Robinson, James & Thaicharoen, Yunyong, 2003. "Institutional causes, macroeconomic symptoms: volatility, crises and growth," Journal of Monetary Economics, Elsevier, vol. 50(1), pages 49-123, January.
  9. Enrico C. Perotti & Ernst-Ludwig von Thadden, 2006. "The Political Economy of Corporate Control and Labor Rents," Journal of Political Economy, University of Chicago Press, vol. 114(1), pages 145-174, February.
  10. Rafael La Porta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, 1998. "Law and Finance," Journal of Political Economy, University of Chicago Press, vol. 106(6), pages 1113-1155, December.
  11. Edward L. Glaeser & Andrei Shleifer, 2002. "The Injustice of Inequality," NBER Working Papers 9150, National Bureau of Economic Research, Inc.
  12. Daron Acemoglu & Simon Johnson & James A. Robinson, 2000. "The Colonial Origins of Comparative Development: An Empirical Investigation," NBER Working Papers 7771, National Bureau of Economic Research, Inc.
  13. William O. Brown & Richard C. K. Burdekin & Marc D. Weidenmier, 2005. "Volatility in an Era of Reduced Uncertainty: Lessons from Pax Britannica," NBER Working Papers 11319, National Bureau of Economic Research, Inc.
  14. Simeon Djankov & Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer, 2005. "The Law and Economics of Self-Dealing," NBER Working Papers 11883, National Bureau of Economic Research, Inc.
  15. repec:dgr:rugggd:gd-81 is not listed on IDEAS
  16. Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer, . "What Works in Securities Laws?," Working Paper 19491, Harvard University OpenScholar.
  17. Andrei Shleifer & Florencio Lopez-de-Silanes & Rafael La Porta, 2008. "The Economic Consequences of Legal Origins," Journal of Economic Literature, American Economic Association, vol. 46(2), pages 285-332, June.
  18. Mark Gradstein, 2007. "Inequality, democracy and the protection of property rights," Economic Journal, Royal Economic Society, vol. 117(516), pages 252-269, 01.
  19. Rafael La Porta & Florencio Lopez-de-Silane & Andrei Shleifer & Robert W. Vishny, 1997. "Legal Determinants of External Finance," NBER Working Papers 5879, National Bureau of Economic Research, Inc.
  20. Colin Mayer & Julian Franks, 2003. "Ownership: Evolution and Regulation," Economics Series Working Papers 2003-FE-14, University of Oxford, Department of Economics.
  21. Alberto Alesina & Enrico Spolaore, 1995. "On the Number and Size of Nations," NBER Working Papers 5050, National Bureau of Economic Research, Inc.
  22. Alberto Alesina & Dani Rodrik, 1991. "Distributive Politics and Economic Growth," NBER Working Papers 3668, National Bureau of Economic Research, Inc.
  23. Perotti, Roberto & Alesina, Alberto, 1996. "Income Distribution, Political Instability, and Investment," Scholarly Articles 4553018, Harvard University Department of Economics.
  24. Enrico Perotti & Armin Schwienbacher, 2007. "The Political Origin of Pension Funding," Tinbergen Institute Discussion Papers 07-004/2, Tinbergen Institute, revised 30 Oct 2008.
  25. Craig J. Richardson, 2005. "The Loss Of Property Rights And The Collapse Of Zimbabwe," Cato Journal, Cato Journal, Cato Institute, vol. 25(3), pages 541-565, Fall.
  26. Djankov, Simeon & McLiesh, Caralee & Shleifer, Andrei, 2007. "Private credit in 129 countries," Journal of Financial Economics, Elsevier, vol. 84(2), pages 299-329, May.
  27. Wacziarg, Romain & Alesina, Alberto & Devleeschauwer, Arnaud & Easterly, William & Kurlat, Sergio, 2002. "Fractionalization," Research Papers 1744, Stanford University, Graduate School of Business.
  28. Pushan Dutt & Devashish Mitra, 2008. "Inequality and the Instability of Polity and Policy," Economic Journal, Royal Economic Society, vol. 118(531), pages 1285-1314, 08.
  29. J. François OUTREVILLE, 1999. "Financial Development, Human Capital And Political Stability," UNCTAD Discussion Papers 142, United Nations Conference on Trade and Development.
  30. L Angeles, 2005. "Income Inequality and Colonialism," Centre for Growth and Business Cycle Research Discussion Paper Series 66, Economics, The Univeristy of Manchester.
  31. Franklin Allen & Jun Qian & Meijun Qian, 2002. "Law, Finance, and Economic Growth in China," Center for Financial Institutions Working Papers 02-44, Wharton School Center for Financial Institutions, University of Pennsylvania.
  32. Rene M. Stulz & Rohan Williamson, 2001. "Culture, Openness, and Finance," NBER Working Papers 8222, National Bureau of Economic Research, Inc.
  33. Thorsten Beck & Asli Demirgüç-Kunt & Ross Levine, 2007. "Finance, inequality and the poor," Journal of Economic Growth, Springer, vol. 12(1), pages 27-49, March.
  34. Alesina, Alberto & Perotti, Roberto, 1996. "Income distribution, political instability, and investment," European Economic Review, Elsevier, vol. 40(6), pages 1203-1228, June.
  35. repec:cup:cbooks:9780521855266 is not listed on IDEAS
  36. Levine, Ross, 1996. "Financial development and economic growth : views and agenda," Policy Research Working Paper Series 1678, The World Bank.
  37. Ayyagari, Meghana & Demirguc-Kunt, Asli & Maksimovic, Vojislav, 2005. "How well do institutional theories explain firms'perceptions of property rights?," Policy Research Working Paper Series 3709, The World Bank.
  38. Rajan, Raghuram G. & Zingales, Luigi, 2003. "The great reversals: the politics of financial development in the twentieth century," Journal of Financial Economics, Elsevier, vol. 69(1), pages 5-50, July.
  39. Stanley L. Engerman & Kenneth Lee Sokoloff, 2002. "Factor Endowments, Inequality, and Paths of Development among New World Economies," ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION, ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION.
  40. David H. Romer & Jeffrey A. Frankel, 1999. "Does Trade Cause Growth?," American Economic Review, American Economic Association, vol. 89(3), pages 379-399, June.
  41. Stanley L. Engerman & Stephen H. Haber & Kenneth L. Sokoloff, 2000. "Inequality, institution and differential paths of growth among New World economies," Chapters, in: Institutions, Contracts and Organizations, chapter 11 Edward Elgar.
  42. Colin Mayer, 2008. "Trust in Financial Markets," European Financial Management, European Financial Management Association, vol. 14(4), pages 617-632.
  43. Treisman, Daniel, 2000. "The causes of corruption: a cross-national study," Journal of Public Economics, Elsevier, vol. 76(3), pages 399-457, June.
  44. Claessens, Stijn & Perotti, Enrico, 2007. "Finance and inequality: Channels and evidence," Journal of Comparative Economics, Elsevier, vol. 35(4), pages 748-773, December.
  45. Svensson, Jakob, 1998. "Investment, property rights and political instability: Theory and evidence," European Economic Review, Elsevier, vol. 42(7), pages 1317-1341, July.
  46. Perotti, Roberto, 1996. " Growth, Income Distribution, and Democracy: What the Data Say," Journal of Economic Growth, Springer, vol. 1(2), pages 149-87, June.
  47. Easterly, William, 2007. "Inequality does cause underdevelopment: Insights from a new instrument," Journal of Development Economics, Elsevier, vol. 84(2), pages 755-776, November.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:eee:jcecon:v:39:y:2011:i:3:p:279-309. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.