Democracy, Volatility, and Economic Development

Growth stability is an important objective-because development requires sustained increases in income, because volatility is costly for the poor, and because volatility deters growth. We study the determinants of average growth and its volatility as a two-equation system, and find that higher levels of democracy and diversification lower volatility, whereas volatility itself reduces growth. Muslim countries instrument for democracy, and measures of diversification identify volatility. In contrast to the lack of consensus on the democracy-growth relationship, the democracy-stability link is robust. Rather than focus on growth, this paper forges an alternative link between democracy and development through the volatility channel. © 2005 President and Fellows of Harvard College and the Massachusetts Institute of Technology.