New paper on transparency and output volatility

I have a new paper coming out in the Economics of Governance journal. The paper, along with all the data, can be found in the ‘Research and CV’, and ‘Datasets’ links above.

Excessive volatility in output (GDP) can be quite damaging for countries. Past research (for example Ramey and Ramey, 1995) has noted that countries that experience wild swings in GDP have also grown more slowly over time. Ideally, one would like countries to have stable, sustained economic growth to raise standards of living.  The next obvious question is what might cause this volatility, because if we can find out why countries experience this volatility, then perhaps policies can be put in place to minimise this volatility.  There have, of course, been a number of candidates put forward over the years, from over-reliance on single sectors in an economy (such as natural resources), through to poor institutions.  Mobarek (2005), following this latter line of thought, looked specifically at democracies.  On average, he found that democracies have exhibited more stable growth than autocracies over the years.  This was an interesting result, but it begged another question – what exactly is it about democracies that helps promote stable growth?  Perhaps people are naturally risk averse creatures, and because democracies represent the will of the majority, the resultant economic policies are also quite risk averse in nature. Hence the country gets more stable growth. Others similarly look at democracy’s ability to solve internal conflicts in a non-violent (and hence more stable) manner.

It’s at this point that I jump in.  One of the other salient features of democracies is that they exhibit greater transparency, in all its forms, from political transparency (the existence for example of a free and independent media), through to what we might call ‘informational transparency’, in that democratic governments also collect, collate and (importantly) release a lot of economic, social and financial information for its citizens. Greater access to information may allow the private sector to adjust more quickly to any adverse shocks that might lead to high volatility.  So in a nutshell my argument is that it’s the greater transparency one gets from democracy, rather than democracy per se, that helps output be more stable over time.

In order to test this theory, I combine two transparency-type indicators – the Freedom of the Press indicator (from Freedom House) to proxy for political transparency, and an index I constructed a few years ago for another paper that proxies the amount of information governments release. I then ran a series of tests using this data.  The results were, to be honest, a lot stronger than what I had envisaged when I first started thinking about this issue.  In the absence of the transparency indicator, democracy did indeed demonstrate a negative relationship with output volatility (that is, democracies had lower volatility). However, as soon as I introduced transparency into the analysis, this effect completely disappeared, and it was transparency that showed a highly negative relationship with volatility.  I ran a large number of other tests to see whether this was sensitive to other competing hypotheses. For example, greater transparency is also associated with lower corruption. Perhaps the link is indirect – greater transparency reduces corruption, which subsequently helps reduce volatility.  This was found not to be the case – corruption was indeed an important component of higher volatility, but transparency continued to be an important factor as well. This suggests (to me at least) that the link might indeed be a fairly direct one – the greater the access to information, the lower is volatility.

Since writing this paper, I”ve been focussing a lot more on the issue of trying to measure transparency in a more accurate way – the proxies I used in this paper were good, but hardly definitive.  Having slaved at this for the past couple of months, I’m hoping to have a draft of a paper that sets out in detail how one might go about constructing such an index. At this stage, transparency has been divided into two groups, similar to above (political and information transparency), and I have put together a number of individual sources that measure aspects of each of these into two composite indicators.  Similar to the Corruption Perceptions index, or the World Bank’s Governance indicators.  I’ll post something more on this when it’s done!

 

Marc F. Bellemare

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