Abstract
The objective of this study is to analyze the causality between democracy and economic growth in Indonesia for the period of 1995 to 2017. More specifically, this paper also attends to investigate the existence of a long-run relationship between them. This study perform a multivariate cointegration test with political stability as a control variable and cross-check this long-run relationship with an autoregressive distributed lag (ARDL) model approach to cointegration. This study also use the Granger causality test within a vector error correction model (VECM) framework and estimate three different models using a non-linear specification: Ordinary Least Squares (OLS) estimation, Fully Modified OLS (FM-OLS) and Dynamic Ordinary Least Squares (DOLS). The results show cointegration among the variables specified in the model when political stability is taken into account. Indeed, for economic growth and democracy to move together in the long run, they need to be associated with political stability. The tests for Granger causality conducted show a long-run causality running from GDP and political stability to democracy. In other word, the economic growth and political stability Granger cause democracy. It is the economic performance that influences democracy and not the reverse. In short-run, there is neutrality causation between democracy and growth, democracy and political stability, growth and political stability. These results suggest that economic growth through strong institutions is a precondition for democratization.
Highlights
There has been a surge of interest in the relationship between democracy and economic growth in recent years
For economic growth and democracy to move together in the long run, they need to be associated with political stability
The tests for Granger causality conducted show a long-run causality running from gross domesticproduct (GDP) and political stability to democracy
Summary
There has been a surge of interest in the relationship between democracy and economic growth in recent years. Althoughmost studies have found that economic growth has a positive effect on democracy, there is no consensus on this issue, at lowlevels of economic development.Tavares and Wacziarg (2001) find that democracy fosters growth by improving the accumulation of human capital and by lowering income inequality, but hinders growth by reducing the rate of physical accumulation and by raising the ratio of government consumption to GDP. They find that the net effect of democracy on growth is moderately negative.
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