On the relationship between economic development and political democracy

Abstract

A politico-economic model is defined, in which consumers, at date 0, decide how much to invest in a firm (and how much of its stock to purchase), whose production possibilities are determined by the outcome of an election, to be held at date 1. At date 1, consumers vote on the level of pollution the firm shall be allowed to emit. There are incomplete markets; the states of the world are the two possible electoral outcomes at date 1, each associated with the victory of a particular party. In turn, the parties represent poor and rich voters; voters’ interests at date 1 are determined by the investments they have made at date 0. Because parties are uncertain about a parameter of voter preferences, the electoral (Nash) equilibrium at date 1 is not median-voter: there are two possible policies (pollution levels), occurring with probabilities that can be calculated. A full equilibrium of the model is an economic equilibrium with incomplete markets at date 0 and a political equilibrium at date 1, each of which induces the other. In a fictional ‘benevolent dictatorship,’ elections are called off, and the dictator announces a pollution policy which is the expected outcome of the would-be elections. By substituting the expected value of a lottery for a lottery, the utilities of citizens, who are risk-averse, increase. There are, however, costs to dictatorship, in the form of the absence of civil liberties. For any economic environment, it is possible to compute the equilibria under democracy and benevolent dictatorship, and to evaluate what coalition of the population prefers one to the other. In this way, the benevolent dictatorship is a benchmark against which to measure the costs of democracy. We examine to what extent the support for democracy, contrasted with benevolent dictatorship, grows among the population as economic development occurs. Development is simulated in five different ways, and it is not unambiguously the case that it induces a growing social preference for democracy.