Democracy and Globalization Barry Eichengreen David Leblang

Many assume that democracy and globalization go together So say those impressed with changes in –Eastern Europe post 1989 –Latin America post 1978 Rationale – Since free international transactions should benefit society as a whole, democracy renders leaders more accountable and thus they should remove restrictions –The exchange of goods and services is a conduit for the exchange of ideas, and a more diverse stock of ideas enhances political competition.

Aggregate data also point in this direction Between 1975 and 2002, there was a quadrupling in the number of democratic countries. Over the same period, global trade as a share of GDP, a standard measure of trade openness, rose from 7.7 to 19.5 per cent. The share of countries open to international capital flows, as measured by the International Monetary Fund, rose from 25 to 38 per cent.

Of course, every causal statement just made could be wrong Some studies not only reject the hypothesis that democratization leads to openness but concludes in favor of the opposite –Authors rationalize their findings by observing that concentrated interests may be better able to secure the imposition of protectionist policies in democracies –Other base their arguments on Stolper-Samuelson logic: in countries where labor is the scarce factor of production democratic reforms increase labor’s voice which encourages protectionism

Modern work is inconclusive Most studies look only at one of the two causal connections –Since they are not concerned with two-way causality, and sometimes they do not even acknowledge the existence of an endogeneity problem, much less develop an appropriate instrumental variables strategy. Few studies acknowledge different dimensions of globalization Few studies take advantage of the fact that there have been prior waves of globalization and democratization.

Identification Instruments for trade openness –Gravity based: geographic size, economic size, average distance from other markets Instruments for financial openness –Based on large literatures on capital mobility and capital crises –Country size, inflation, budget deficit, # of other countries with controls, systemic crises Instruments for democracy –Based on Przeworski, et al and Boix & Stokes –Prior transitions, constitutional age, colonial heritage, natural resource endowments, urbanization, population density, geographic controls.

Sample, Data Between 14 & 156 countries over the period Trade: (imports+exports)/GDP: Mitchell, Banks GDP: real gdp per capital PPP: Maddison Capital Controls: IMF & Bordo-Eichengreen Democracy:Dichotomous measure –Przeworski, et al 1950-present –Boix and Rosato –Tested robustness using POLITY (both dichotomous and continuous measure)

Statistical methods IV models estimated via GMM with Newey- West standard errors –Provides efficient estimates when residuals are heteroscedastic –Can adjust bandwidth to deal with serial correlation Note: this means that we estimate linear probability models when the dependent variable is dichotomous.

Procedure Kitchen sink approach? –Would produce relevant instruments but would likely result in overidentification We proceed as follows: –Use relevant instruments –Perform tests for overidentification and relevance –Refine instrument list based on these tests –Repeat Appropriate process because of the different processes operating at different times

Summary of other results Similar story –Using different measures of democracy –Using different datasets (POLITY, Sachs-Warner) –Putting trade and capital controls on the right hand side Markov Transition Model –Trade increases the probability that a democracy (dictatorship) will remain a democracy (dictatorship) but has no impact on the probability of a transition (in either direction) –Capital openness increases the probability that a dictatorship will become a democracy.

Extension: trade theory Trade theory suggests that the impact of democratization on openness is contingent upon a country’s factor endowment –Workers/voters prefer trade in labor abundant countries. –We interact democracy with the land/labor ratio. –We obtain a positive effect of democracy and a negative effect from the interaction. –We find this pattern using the entire sample, a sample from , and a sample from , but not for the interwar years. We find similar results when capital controls is the dependent variable.

Conclusion What do the dynamics of a democratization- globalization system look like? –Unstable Case: shocks to trade and democracy could send both in a positive or negative direction--without limit (e.g., experience of the 1930s) –Stable Case: shocks to trade and democracy could send both in a positive or negative direction--within limits (e.g., ‘third wave’ of democracy since the 70s) Our results show support for the stable case: increases in democracy lead to increases in globalization and vice versa…but each successive increase is smaller than the one prior.