Democracy and Income Distribution

Democracy and Income (Distribution) Jess Benhabib NYU August 2011Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 1 / 43

Democracy and Income Distribition My preferred title would be Democracy and Income, for reasons that will be clear in a moment. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 2 / 43

Democracy and Income Distribition My preferred title would be Democracy and Income, for reasons that will be clear in a moment. The questions will be: Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 2 / 43

Democracy and Income Distribition My preferred title would be Democracy and Income, for reasons that will be clear in a moment. The questions will be: 1 Why is democracy more sustainable at high levels of income but not at low levels? Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 2 / 43

Democracy and Income Distribition My preferred title would be Democracy and Income, for reasons that will be clear in a moment. The questions will be: 1 Why is democracy more sustainable at high levels of income but not at low levels? 2 Are growth, and democracy, driven by good institutions (property rights, rule of law, constraints on executive) or are they endogenous, primarily a function of wealth or income? Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 2 / 43

Democracy and Income Distribition My preferred title would be Democracy and Income, for reasons that will be clear in a moment. The questions will be: 1 Why is democracy more sustainable at high levels of income but not at low levels? 2 Are growth, and democracy, driven by good institutions (property rights, rule of law, constraints on executive) or are they endogenous, primarily a function of wealth or income? I will attempt a sketch of some theory, give an overview of the recent work, and then turn to the debate on the empirics of Democracy and Income. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 2 / 43

Democracy and Income Distribition My preferred title would be Democracy and Income, for reasons that will be clear in a moment. The questions will be: 1 Why is democracy more sustainable at high levels of income but not at low levels? 2 Are growth, and democracy, driven by good institutions (property rights, rule of law, constraints on executive) or are they endogenous, primarily a function of wealth or income? I will attempt a sketch of some theory, give an overview of the recent work, and then turn to the debate on the empirics of Democracy and Income. Finally I will discuss our recent empirical paper (Benhabib, Corvalan and Spiegel (2011)) that adresses the questions raised above. (Let’ s postpone the de…nition of Democracy to later.) Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 2 / 43

Inequality, Growth and Democracy Let me start however, with Democracy and Inequality. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 3 / 43

Inequality, Growth and Democracy Let me start however, with Democracy and Inequality. The most obvious hypothesis is that excessive and persistent inequality leads to social con‡ict and coups, and is incompatible with democracy. In the absence of redistribution that mediates and ameliorates inequality, democracy cannot survive. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 3 / 43

Inequality, Growth and Democracy Let me start however, with Democracy and Inequality. The most obvious hypothesis is that excessive and persistent inequality leads to social con‡ict and coups, and is incompatible with democracy. In the absence of redistribution that mediates and ameliorates inequality, democracy cannot survive. But this may be too simplistic: the goverment may redistribute only to the point which avoids revolt by the poor (left), or stop short of the level of redistribution that would trigger a coup by the rich (right). Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 3 / 43

Inequality, Growth and Democracy Let me start however, with Democracy and Inequality. The most obvious hypothesis is that excessive and persistent inequality leads to social con‡ict and coups, and is incompatible with democracy. In the absence of redistribution that mediates and ameliorates inequality, democracy cannot survive. But this may be too simplistic: the goverment may redistribute only to the point which avoids revolt by the poor (left), or stop short of the level of redistribution that would trigger a coup by the rich (right). Here speci…cs of the distribution of power, the costs of collective action , the degree of repression and the potential use of force all matter. (For example recently new social media may have reduced collective action costs.) Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 3 / 43

Inequality, Growth and Democracy Let me start however, with Democracy and Inequality. The most obvious hypothesis is that excessive and persistent inequality leads to social con‡ict and coups, and is incompatible with democracy. In the absence of redistribution that mediates and ameliorates inequality, democracy cannot survive. But this may be too simplistic: the goverment may redistribute only to the point which avoids revolt by the poor (left), or stop short of the level of redistribution that would trigger a coup by the rich (right). Here speci…cs of the distribution of power, the costs of collective action , the degree of repression and the potential use of force all matter. (For example recently new social media may have reduced collective action costs.) So political economy is di¢ cult. Empirically, what do we know from some classic papers? Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 3 / 43

"We are speci…cally interested in two questions:I. Does income inequality increase political instability?2. Does political instability reduce investment?According to our …ndings, the answer to both questions is ’ . First, yes’more unequal societies are more politically unstable: in particular, ourresults suggest that political stability is enhanced by the presence of awealthy middle class. Second, political instability has an adverse e¤ect oninvestment and, therefore, on growth. Furthermore, these two e¤ects(from inequality to instability, and from instability to investment) are notonly statistically signi…cant, but also economically signi…cant."A. Alesina and R. Perotti "Income distribution, political instability, andinvestment" EER, 1996. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 4 / 43

"More equal societies have lower fertility rates and higher rates of investment in education. Both are re‡ected in higher rates of growth. Also, very unequal societies tend to be politically and socially unstable, which is re‡ected in lower rates of investment and therefore growth. Finally, the data do not support the idea that more equal societies, particularly those with democratic institutions, grow faster because they generate fewer demands for redistribution and therefore fewer distortions."R. Perotti, "Growth, Income Distribution, and Democracy: What the DataSay," Journal of Economic Growth, (1996) Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 5 / 43

"More equal societies have lower fertility rates and higher rates of investment in education. Both are re‡ected in higher rates of growth. Also, very unequal societies tend to be politically and socially unstable, which is re‡ected in lower rates of investment and therefore growth. Finally, the data do not support the idea that more equal societies, particularly those with democratic institutions, grow faster because they generate fewer demands for redistribution and therefore fewer distortions."R. Perotti, "Growth, Income Distribution, and Democracy: What the DataSay," Journal of Economic Growth, (1996) Here we also have hints of inequality retarding growth through credit market imperfections and social instability. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 5 / 43

"More equal societies have lower fertility rates and higher rates of investment in education. Both are re‡ected in higher rates of growth. Also, very unequal societies tend to be politically and socially unstable, which is re‡ected in lower rates of investment and therefore growth. Finally, the data do not support the idea that more equal societies, particularly those with democratic institutions, grow faster because they generate fewer demands for redistribution and therefore fewer distortions."R. Perotti, "Growth, Income Distribution, and Democracy: What the DataSay," Journal of Economic Growth, (1996) Here we also have hints of inequality retarding growth through credit market imperfections and social instability. The point in bold: In more equal countries with democratic institutions, typically richer countries, there may be more redistribution, rather than less. Redistribution is mediated by the government and a welfare state. Maybe because the stakes are higher? Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 5 / 43

"Evidence from a broad panel of countries shows little overall relation between income inequality and rates of growth and investment. For growth, higher inequality tends to retard growth in poor countries and encourage growth in richer places."R. Barro, "Inequality and Growth in a Panel of Countries," JOEG, (2000). Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 6 / 43

"Evidence from a broad panel of countries shows little overall relation between income inequality and rates of growth and investment. For growth, higher inequality tends to retard growth in poor countries and encourage growth in richer places."R. Barro, "Inequality and Growth in a Panel of Countries," JOEG, (2000). Note the di¤erential impact of inequality between rich and poor. Can richer countries tolerate more inequality with less social disruption and adverse e¤ects on growth? Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 6 / 43

Income, Growth and DemocracyProperty Rights?So let’ move to explore the relationship of income, rather than income sdistribution, on growth and democracy. A key concept, often measured and included in econometric speci…cations, is the "security of property rights." The following sketch of model, though problematic and too abstract, can set some tentative initial ideas. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 7 / 43

Income, Growth and DemocracyProperty Rights?So let’ move to explore the relationship of income, rather than income sdistribution, on growth and democracy. A key concept, often measured and included in econometric speci…cations, is the "security of property rights." The following sketch of model, though problematic and too abstract, can set some tentative initial ideas. What if "property rights / institutions" are endogenous, a function of more basic fundamentals, like wealth or income? Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 7 / 43

Expropriation, Appropriation, Tragedy of the Commons Expropriative redistributive activities can result from nationalizations, con…scations, required bribes to o¢ cials, arbitrary taxes, coups... Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 8 / 43

Expropriation, Appropriation, Tragedy of the Commons Expropriative redistributive activities can result from nationalizations, con…scations, required bribes to o¢ cials, arbitrary taxes, coups... Appropriative redistributive activities can have legitimate, clientelist forms: subsidies, regulations, wage and price controls, taxes targeted to speci…c groups, an overvalued currency to favor urban vs rural areas producing exportables (agricultural and mineral goods), restrictions on mineral and agricultural exports to be channeled through govenment marketing boards, govenment fertilizer monopolies, allocation of civil service jobs... (whether the government is elected or not.) Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 8 / 43

Expropriation, Appropriation, Tragedy of the Commons Expropriative redistributive activities can result from nationalizations, con…scations, required bribes to o¢ cials, arbitrary taxes, coups... Appropriative redistributive activities can have legitimate, clientelist forms: subsidies, regulations, wage and price controls, taxes targeted to speci…c groups, an overvalued currency to favor urban vs rural areas producing exportables (agricultural and mineral goods), restrictions on mineral and agricultural exports to be channeled through govenment marketing boards, govenment fertilizer monopolies, allocation of civil service jobs... (whether the government is elected or not.) To simplify, the absence of well-de…ned property rights over the long-horizon may give rise to a dynamic "Tragedy of the Commons". (Benhabib and Radner, 1992, Benhabib and Rustichini, 1996). Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 8 / 43

Expropriation, Appropriation, Tragedy of the Commons Expropriative redistributive activities can result from nationalizations, con…scations, required bribes to o¢ cials, arbitrary taxes, coups... Appropriative redistributive activities can have legitimate, clientelist forms: subsidies, regulations, wage and price controls, taxes targeted to speci…c groups, an overvalued currency to favor urban vs rural areas producing exportables (agricultural and mineral goods), restrictions on mineral and agricultural exports to be channeled through govenment marketing boards, govenment fertilizer monopolies, allocation of civil service jobs... (whether the government is elected or not.) To simplify, the absence of well-de…ned property rights over the long-horizon may give rise to a dynamic "Tragedy of the Commons". (Benhabib and Radner, 1992, Benhabib and Rustichini, 1996). With various interest groups engaging of appropriation/expropriation (even with pre or post …sc equality) expected returns on productive activities are reduced, and growth can slow down, or get trapped. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 8 / 43

QuestionsWith actors or interest groups having long term, forward-lookingobjectives, this problem can get complicated. Does it pay for the various interest groups to adhere to institutional constrains and refrain from short-term expropriation in order to sustain higher growth and future well-being? Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 9 / 43

QuestionsWith actors or interest groups having long term, forward-lookingobjectives, this problem can get complicated. Does it pay for the various interest groups to adhere to institutional constrains and refrain from short-term expropriation in order to sustain higher growth and future well-being? Can you sustain cooperation because the high short-term payo¤ of revolt and too high expropriation is just not worth it in the long run? Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 9 / 43

QuestionsWith actors or interest groups having long term, forward-lookingobjectives, this problem can get complicated. Does it pay for the various interest groups to adhere to institutional constrains and refrain from short-term expropriation in order to sustain higher growth and future well-being? Can you sustain cooperation because the high short-term payo¤ of revolt and too high expropriation is just not worth it in the long run? The twist we are looking for is whether cooperative actions are sustainable from income/wealth levels above a treshold, but not below it (for a given discount rate). Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 9 / 43

Sustainable Growth: A Model Too Abstract Suppose groups voluntarily agree not to expropriate, or revolt because the one time gain is not worth trigerring a bad (high appropriation) equilibrium with low and uncertain e¤ective returns for the longer run. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 10 / 43

Sustainable Growth: A Model Too Abstract Suppose groups voluntarily agree not to expropriate, or revolt because the one time gain is not worth trigerring a bad (high appropriation) equilibrium with low and uncertain e¤ective returns for the longer run. Suppose a …rst-best cooperative outcome with growth is self-sustaining as an equilibrium from high income levels. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 10 / 43

Sustainable Growth: A Model Too Abstract Suppose groups voluntarily agree not to expropriate, or revolt because the one time gain is not worth trigerring a bad (high appropriation) equilibrium with low and uncertain e¤ective returns for the longer run. Suppose a …rst-best cooperative outcome with growth is self-sustaining as an equilibrium from high income levels. But it may not be at lower income levels: The marginal utility of one time expropriation is smaller at high levels of income, and the loss associated with reversion to a bad equilibrium too big... Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 10 / 43

Sustainable Growth: A Model Too Abstract Suppose groups voluntarily agree not to expropriate, or revolt because the one time gain is not worth trigerring a bad (high appropriation) equilibrium with low and uncertain e¤ective returns for the longer run. Suppose a …rst-best cooperative outcome with growth is self-sustaining as an equilibrium from high income levels. But it may not be at lower income levels: The marginal utility of one time expropriation is smaller at high levels of income, and the loss associated with reversion to a bad equilibrium too big... The same is not true at low wealth and income levels: marginal utilities are high and the bene…ts of slow accumulation are distant... Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 10 / 43

Sustainable Growth: A Model Too Abstract Suppose groups voluntarily agree not to expropriate, or revolt because the one time gain is not worth trigerring a bad (high appropriation) equilibrium with low and uncertain e¤ective returns for the longer run. Suppose a …rst-best cooperative outcome with growth is self-sustaining as an equilibrium from high income levels. But it may not be at lower income levels: The marginal utility of one time expropriation is smaller at high levels of income, and the loss associated with reversion to a bad equilibrium too big... The same is not true at low wealth and income levels: marginal utilities are high and the bene…ts of slow accumulation are distant... Rocking the boat is not worth it if you are rich, only if you are poor.. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 10 / 43

Second Best? The second-best sustainable equilibrium may entail slower growth and accumulation until a treshold wealth level is crossed, or in the extreme, we could get a poverty trap. (all for a given discount rate). Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 11 / 43

Second Best? The second-best sustainable equilibrium may entail slower growth and accumulation until a treshold wealth level is crossed, or in the extreme, we could get a poverty trap. (all for a given discount rate). Redistributive pressures arising from inequality, or con‡icts over the distribution of income and wealth may be mediated through political and democratic processes, but may in certain cases lead to social instability, coups or repression in poorer countries. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 11 / 43

Second Best? The second-best sustainable equilibrium may entail slower growth and accumulation until a treshold wealth level is crossed, or in the extreme, we could get a poverty trap. (all for a given discount rate). Redistributive pressures arising from inequality, or con‡icts over the distribution of income and wealth may be mediated through political and democratic processes, but may in certain cases lead to social instability, coups or repression in poorer countries. So we may observe expropriative activities and coups more frequently at lower income/wealth levels. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 11 / 43

In a PictureThink of "a" as repression" Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 12 / 43

Digression: HomotheticityA technical digression about homogeneity: Why should enforcability ofcooperation depend on wealth if production and preferences arehomothetic? Even if if production and preferences are homothetic, butthere is a …xed factor, you can get this result: (there may be a maximumtime endowment to be allocated between labor and leisure for example. ) Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 13 / 43

Role of Institutions? We can already signal a basic question to be addressed later: Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 14 / 43

Role of Institutions? We can already signal a basic question to be addressed later: Can good institutions (property rights, rule of law, constraints on the executive, etc) secure cooperation and good behavior, or are institutions endogenous, so that they evolve to re‡ect (or their implementation re‡ects) self interested computations by various groups? Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 14 / 43

Role of Institutions? We can already signal a basic question to be addressed later: Can good institutions (property rights, rule of law, constraints on the executive, etc) secure cooperation and good behavior, or are institutions endogenous, so that they evolve to re‡ect (or their implementation re‡ects) self interested computations by various groups? We’ get to this. ll Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 14 / 43

Some problems with the model: First, a signi…cant source of growth is TFP, not investment. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 15 / 43

Some problems with the model: First, a signi…cant source of growth is TFP, not investment. Second, TFP growth di¤uses from technology leaders and can (irresistibly) drive growth, despite the political regimes and expropriations. Distance to the leader and educational levels may drive technology adoption and the di¤usion rate. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 15 / 43

Some problems with the model: First, a signi…cant source of growth is TFP, not investment. Second, TFP growth di¤uses from technology leaders and can (irresistibly) drive growth, despite the political regimes and expropriations. Distance to the leader and educational levels may drive technology adoption and the di¤usion rate. Parente and Prescott (1993, 2002) reintroduce politics to explain TFP di¤usion across countries. They make the point that technology adoption can be blocked or retarded by vested interests through various political barriers. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 15 / 43

Some problems with the model: First, a signi…cant source of growth is TFP, not investment. Second, TFP growth di¤uses from technology leaders and can (irresistibly) drive growth, despite the political regimes and expropriations. Distance to the leader and educational levels may drive technology adoption and the di¤usion rate. Parente and Prescott (1993, 2002) reintroduce politics to explain TFP di¤usion across countries. They make the point that technology adoption can be blocked or retarded by vested interests through various political barriers. Nevertheless so far the analysis, while it is dynamic and allows forward looking agents, is too abstract and too much of a black box. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 15 / 43

A model of sustainable democracy (Benhabib-Przeworski,ET (2006)) Now we switch from sustainability of high growth rates to sustainability of democracy. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 16 / 43

A model of sustainable democracy (Benhabib-Przeworski,ET (2006)) Now we switch from sustainability of high growth rates to sustainability of democracy. Democracy here is the median voter setting taxes and redistributions (Note: we show the median voter thm holds in our context even with the in…nite sequence of taxes) Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 16 / 43

A model of sustainable democracy (Benhabib-Przeworski,ET (2006)) Now we switch from sustainability of high growth rates to sustainability of democracy. Democracy here is the median voter setting taxes and redistributions (Note: we show the median voter thm holds in our context even with the in…nite sequence of taxes) Agents are long-lived, and heterogeneous in initial wealth. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 16 / 43

The upper x% and the lower y % of the wealth tail may attempt acoup if they …nd the redistribution excessive or insu¢ cient, that istheir long-term expected utility is higher under the coup for everyonein that tail.Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 17 / 43

The upper x% and the lower y % of the wealth tail may attempt acoup if they …nd the redistribution excessive or insu¢ cient, that istheir long-term expected utility is higher under the coup for everyonein that tail.If the left or the right revolts there is a probabilistic outcome of a leftor right dictatorship.Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 17 / 43

The upper x% and the lower y % of the wealth tail may attempt acoup if they …nd the redistribution excessive or insu¢ cient, that istheir long-term expected utility is higher under the coup for everyonein that tail.If the left or the right revolts there is a probabilistic outcome of a leftor right dictatorship.Under a right dictatorship taxes and redistrubutions are zero, under aleft dictatorship rediredistribution equalizes wealth immediately (withzero taxes afterwards. An interesting tangential issue here: willinequality nevertheless re-emerge in some form? Remember Pareto.)Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 17 / 43

The upper x% and the lower y % of the wealth tail may attempt acoup if they …nd the redistribution excessive or insu¢ cient, that istheir long-term expected utility is higher under the coup for everyonein that tail.If the left or the right revolts there is a probabilistic outcome of a leftor right dictatorship.Under a right dictatorship taxes and redistrubutions are zero, under aleft dictatorship rediredistribution equalizes wealth immediately (withzero taxes afterwards. An interesting tangential issue here: willinequality nevertheless re-emerge in some form? Remember Pareto.)All else equal, everyone prefers democracy. There is a …xed cost underdictatorship (which can di¤er for the right and left, depending who isin power.).Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 17 / 43

RESULTS We ask what redistributions of income and assets are feasible in a democracy, given the initial assets and their distribution. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 18 / 43

RESULTS We ask what redistributions of income and assets are feasible in a democracy, given the initial assets and their distribution. The question is motivated by the possibility that if redistribution is insu¢ cient for the poor or excessive for the rich, they may turn against democracy. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 18 / 43

RESULTS We ask what redistributions of income and assets are feasible in a democracy, given the initial assets and their distribution. The question is motivated by the possibility that if redistribution is insu¢ cient for the poor or excessive for the rich, they may turn against democracy. In turn, if no redistribution simultaneously satis…es the poor and the wealthy, democracy cannot be sustained. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 18 / 43

RESULTS CONT’ D Hence, the corollary question concerns the conditions under which democracy is sustainable. We …nd that democracies survive in wealthy societies. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 19 / 43

RESULTS CONT’ D Hence, the corollary question concerns the conditions under which democracy is sustainable. We …nd that democracies survive in wealthy societies. Conditional on the initial income distribution, each country has a threshold of capital stock above which democracy survives. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 19 / 43

RESULTS CONT’ D Hence, the corollary question concerns the conditions under which democracy is sustainable. We …nd that democracies survive in wealthy societies. Conditional on the initial income distribution, each country has a threshold of capital stock above which democracy survives. This threshold is lower when the distribution of initial endowments is more equal and when the revolutionary prowess of right or left groups in the tails are lower. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 19 / 43

RESULTS CONT’ D Hence, the corollary question concerns the conditions under which democracy is sustainable. We …nd that democracies survive in wealthy societies. Conditional on the initial income distribution, each country has a threshold of capital stock above which democracy survives. This threshold is lower when the distribution of initial endowments is more equal and when the revolutionary prowess of right or left groups in the tails are lower. Yet in poor unequal countries there exist no redistribution scheme which would be accepted both by the poor and the wealthy.Hence, democracy cannot survive. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 19 / 43

RESULTS CONT’ D As endowments increase, redistribution schemes that satisfy both the poor and the wealthy emerge. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 20 / 43

RESULTS CONT’ D As endowments increase, redistribution schemes that satisfy both the poor and the wealthy emerge. Moreover, as capital stock grows the wealthy tolerate more and the poor less redistribution, so that the set of feasible redistributions becomes larger. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 20 / 43

RESULTS CONT’ D As endowments increase, redistribution schemes that satisfy both the poor and the wealthy emerge. Moreover, as capital stock grows the wealthy tolerate more and the poor less redistribution, so that the set of feasible redistributions becomes larger. Since the median voter prefers one such scheme to the dictatorship of either group, democracy survives. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 20 / 43

EMPIRICS (based on Przeworski et al, 2000) Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 21 / 43

Modernization Theory"The general income level of a nation also a¤ects its receptivity todemocratic norms. If there is enough wealth in the country so that it doesmake too much di¤erence whether some redistribution takes place, it iseasier to accept the idea that it does not matter greatly which side is inpower. But if loss of o¢ ce means serious losses for major groups, they willseek to retain o¢ ce by any means available."Lipset, S.M.: Political man: the social bases of politics. Garden City:Doubleday 1960. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 22 / 43

What is democracy?Robert A Dahl (1971): Electoral Competition and ParticipationPrzeworski et al (2000):Countries are democratic if the following all hold:1 The chief executive is elected2 The legislature is elected3 There is more than one party competing in the elections4 An alternation in power under identical electoral rules has taken placeOtherwise, countries are coded as dictatorships. This is a binary measure. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 23 / 43

Polity IVThe Polity measure of democracy is the di¤erence of two scores.1 Democracy score2 Autocracy scoreThe Polity IV measure is based on attributes:1 competitiveness of executive recruitment2 openness of executive recruitment3 constraints that exist on the executive4 regulation of political participation5 competitiveness of political participationThis is a continuous measure from aggegating the above, ranging from -10to 10. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 24 / 43

Freedom HouseFreedom House’ annual measure has two dimensions that produce a scontinuous measure:1 Political rights dimension2 Civil rights dimensionRaters score 10 questions, from 0 to 4, summed to produce a score from 0to 40. The 0-40 score is converted into a 1 to 7 scale. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 25 / 43

Freedom House Cont’ dExample questions used to develop the political rights dimension:1 Is the head of state elected in free and fair elections?2 Is there pervasive corruption?3 Is the government open, accountable, and transparent between elections?4 Is there a competitive opposition?Example questions used to develop the civil rights dimension:1 Are the media free and independent?2 Is there an independent judiciary?3 Is there equal treatment under the law?4 Is there equality of opportunity?5 Do citizens have the right to own property? Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 26 / 43

VanhannenScores are generated from multiplying two attributes and dividing by 100:Competition: 1 % of votes to the largest partyParticipation: % of total population votingNote: The democracy indices are highly correlated. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 27 / 43

Institutions and Critical Junctures in History"We favor another explanation for this pattern. Even in the absence of asimple causal link from income to democracy, political and economicdevelopment paths are interlinked and are jointly a¤ected by variousfactors. Societies may embark on divergent political-economicdevelopment paths, some leading to relative prosperity and democracy,others to relative poverty and dictatorship. Our hypothesis is that thepositive cross-sectional relationship and the 500-year correlationbetween changes in income and democracy are caused by the factthat countries have embarked on divergent development paths atsome critical junctures during the past 500 years."Acemoglu, Johnson, Robinson, Yared, "Income and Democracy " (AER,2008) Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 28 / 43

Using Settler Mortality as Instrument for Institutions"We provide support for this hypothesis by documenting that the positiveassociation between changes in income and democracy over the past 500years is largely accounted for by a range of historical variables. For thewhole world sample, the positive association is considerably weakenedwhen we control for date of independence, early constraints on theexecutive, and religion. We then turn to the sample of former Europeancolonies, where we have better proxies for factors that have in‡uenced thedevelopment paths of nations. AJR(2001, 2002) and Engerman andSokolo¤ (1997) argue that di¤erences in European colonizationstrategies have been a major determinant of the divergentdevelopment paths of colonial societies. This suggests that thecritical juncture for most societies corresponds to their experienceunder European colonization."Acemoglu, Johnson, Robinson, Yared, "Income and Democracy" (AER,2008) Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 29 / 43

"Furthermore, AJR(2002) show that the density of indigenous populationsat the time of colonization has been a particularly important variable inshaping colonization strategies, and provide estimates of populationdensities in the year 1500 (before colonization). When we useinformation on population density, as well as on independence yearand early constraints on the executive, the 500-year relationshipbetween changes in income and democracy in the former coloniessample disappears. This is consistent with the hypothesis that thepositive cross-sectional relationship between income and democracy todayis the result of societies embarking on divergent development paths atcertain critical junctures during the past 500 years"AJRY (2008) Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 30 / 43

Using Fixed E¤ects for Divergent Paths at Colonization Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 31 / 43

Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 32 / 43

Do Institutions Persist?"Following AJR, statistical studies of the impact of institutions adopt thefollowing procedure:1) Regress current incomes for a recent date (or an average of recentdates) on recent institutions and some control variables;2) Instrument recent institutions by instrumenting institutions at sometime immemorial.Yet this assumption is patently false. Here is a crosstab of institutionalquality as measured by the variable used by AJR (“constraints on the chiefexecutive”), of exit-year institutions (when countries ceased to exist orinformation is last available) by entry-year institutions (the year ofindependence or soon after) for all countries that appear in the PolityIVdata set (including those that were never colonies)."A. Przeworski, "The Last Instance: Are Institutions the Primary CauseofEconomic Development?", Arch.europ.sociol.,(2004). Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 33 / 43

Another Hypothesis on Settlers"The correlation between AJR’ proposed instruments and their preferred smeasures of institutions is very high indeed. For example, the logarithm ofsettler mortality is correlated at -.54 with average executive constraints,and -.51 with average expropriation risk, while the logarithm of populationdensity in 1500s is correlated at -.35 and -.40 with the same measures ofinstitutions.Edward L. Glaeser, Rafael La Porta, Florencio Lopez-de-Silanes, andAndrei Shleifer, "Do Institutions Cause Growth?" Journal of EconomicGrowth, 2004" Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 35 / 43

Settlers and Human Capital, Income and Growth"...Still, both settler mortality and 1500 population density are stronglycorrelated with today’ per capita income. Why might this be so?... We shave seen that human capital is an important determinant of economicgrowth. The importance of malaria in determining current income pointsin the same direction. Could the in‡uence of AJR’ proposed instruments son today’ development work through human capital? Put di¤erently, sperhaps when colonizers settled, they brought with them their know-howrather than constraints on the executive."Glaeser et al, JOEG, 2004. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 36 / 43

Settlers, Human Capital, Growth, Income and Democracy"Our evidence suggests in contrast that the Lipset-Przeworski-Barro viewof the world is more accurate: countries that emerge from povertyaccumulate human and physical capital under dictatorships, and then,once they become richer, are increasingly likely to improve theirinstitutions." Glaeser et al, JOEG, 2004. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 37 / 43

Benhabib, Corvalan, Spiegel, 2011 on Fixed E¤ectRegressionsOur analysis confronts two primary issues: First, more and better-measured data on both income and democracy has become available since the publication of AJRY (2008). This development is crucial because the inclusion of country …xed e¤ects reduces inference to that based on within-country variation in the data. However, as we show below, the initial Penn World Tables 6.1 (PWT 6.1) sample has data for shorter time spans than those available in either the newer Penn World Tables 6.3 data set [Heston, et al, (2009)] (PWT 6.3), or the alternative Maddison (2003) data set. There is reason to believe that these new panels will be more informative, as the (within country) coe¢ cients of variation in all of the democracy measures considered increases when one goes from the original PWT 6.1 data set to either the PWT 6.3 or Maddison alternatives. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 38 / 43

Second, the measures of democracy used in AJRY are discrete(Przeworski et al), or censored (Freedom House, Polity (two-sided),Vanhanen (one-sided)) violating the maintained assumptions underOLS. We respond to this issue by using either a two-sided Tobitspeci…cation or the double-censoring speci…cation of Alan, Honoré,and Leth-Petersen (2008) and we use conditional and unconditionalLogit speci…cations to obtain estimates for the binary Przeworskimeasure. Additionally, for the four measures of democracy – FreedomHouse, Polity, Index of Democratization and DD – we also use theWooldridge (2005) estimator (WE). This estimator generalizes theChamberlain (1980) estimator used by AJRY (2009) andparameterizes the …xed e¤ects as well as the initial conditions in adynamic panel.Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 39 / 43

Conclusion Why is Democracy more sustainable at high levels of income but not at low levels? Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 43 / 43

Conclusion Why is Democracy more sustainable at high levels of income but not at low levels? 1 Current wealth and current democracy are both the result of early and persistent institutions that secure property and constrain the executive. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 43 / 43

Conclusion Why is Democracy more sustainable at high levels of income but not at low levels? 1 Current wealth and current democracy are both the result of early and persistent institutions that secure property and constrain the executive. 2 Democracies survive in wealthy societies. The general income level of a nation a¤ects its receptivity to democratic norms: "Higher incomes reduce the intensity of con‡ict over the distribution of income, and thereby give way to democratic institutions that discourage expropriation and support redistributive …scal policies under the rule of law." (Benhabib, Corvalan, Spiegel, 2011). Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 43 / 43

Conclusion Why is Democracy more sustainable at high levels of income but not at low levels? 1 Current wealth and current democracy are both the result of early and persistent institutions that secure property and constrain the executive. 2 Democracies survive in wealthy societies. The general income level of a nation a¤ects its receptivity to democratic norms: "Higher incomes reduce the intensity of con‡ict over the distribution of income, and thereby give way to democratic institutions that discourage expropriation and support redistributive …scal policies under the rule of law." (Benhabib, Corvalan, Spiegel, 2011). We think the second explanation is more likely. Jess Benhabib (NYU) Democracy and Income (Distribution) August 2011 43 / 43

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Democracy and Income Distribution

by Barcelona Graduate School of Economics (GSE) on Sep 20, 2011

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