8/3/2014: Democracy and Inequality: A Link of Surprising Direction?

Everything written or co-authored by Daron Acemoglu is worth reading. Everything. And here is an example why. The man does not shy away from big questions in life.

"DEMOCRACY, REDISTRIBUTION AND INEQUALITY" by Daron Acemoglu, Suresh Naidu, Pascual Restrepo and James A. Robinson (Working Paper 13-24, Massachusetts Institute of Technology, Department of Economics, October 30, 2013: http://ssrn.com/abstract=2367088) looks into the relationship between democracy, redistribution and inequality.

"We first explain the theoretical reasons why democracy is expected to increase redistribution and reduce inequality, and why this expectation may fail to be realized when democracy

• is captured by the richer segments of the population; when it caters to the preferences of the middle class; or 
• it opens up disequalizing opportunities to segments of the population previously excluded from such activities, thus exacerbating inequality among a large part of the population."

From theoretical reasons for differences in inequality and redistribution, the paper moves to empirical. The authors "survey the existing empirical literature, which is both voluminous and full of contradictory results. We provide new and systematic reduced-form evidence on the dynamic impact of democracy on various outcomes."

Core empirical findings are:

1. "…there is a significant and robust effect of democracy on tax revenues as a fraction of GDP, but no robust impact on inequality." So while democracy increases taxes, it does not reduce inequality. why? Because "policy outcomes and inequality depend not just on the de jure but also the de facto distribution of power", so "those who see their de jure power eroded by democratization may sufficiently increase their investments in de facto power (e.g., via control of local law enforcement, mobilization of non-state armed actors, lobbying, and other means of capturing the party system) in order to continue to control the political process". Furthermore, "democratization can result in “Inequality-Increasing Market Opportunities”. Nondemocracy may exclude a large fraction of the population from productive occupations (e.g., skilled occupations) and entrepreneurship (including lucrative contracts) as in Apartheid South Africa or the former Soviet block countries. To the extent that there is significant heterogeneity within this population, the freedom to take part in economic activities on a more level playing field with the previous elite may actually increase inequality within the excluded or repressed group and consequently the entire society".
2. "…we find a positive effect of democracy on secondary school enrollment and the extent of structural transformation (e.g., an impact on the nonagricultural share of employment and the nonagricultural share of output)".
3. Very interestingly, "The evidence …points to an inequality-increasing impact of democracy in societies with a high degree of land inequality, which we interpret as evidence of (partial) capture of democratic decision making by landed elites."
4. "We also find that inequality increases following a democratization in relatively nonagricultural societies, and also when the extent of disequalizing economic activities is greater in the global economy as measured by U.S. top income shares (though this effect is less robust)."
5. "We also find that democracy tends to increase inequality and taxation when the middle class are relatively richer compared to the rich and poor. These correlations are consistent with Director’s Law, which suggests that democracy allows the middle class to redistribute from both the rich and the poor to itself."

"All of these are broadly consistent with a view that is different from the traditional median voter model of democratic redistribution: democracy does not lead to a uniform decline in post-tax inequality, but can result in changes in fiscal redistribution and economic structure that have ambiguous effects on inequality."