Skip to main content
×
×
Home

Democracy and Financial Crisis

  • Phillip Y. Lipscy
Abstract

Existing scholarship attributes various political and economic advantages to democratic governance. These advantages may make more democratic countries prone to financial crises. Democracy is characterized by constraints on executive authority, accountability through free and fair elections, protections for civil liberties, and large winning coalitions. These characteristics bring important benefits, but they can also have unintended consequences that increase the likelihood of financial instability and crises. Using data covering the past two centuries, I demonstrate a strong relationship between democracy and financial crisis onset: on average, democracies are about twice as likely to experience a crisis as autocracies. This is an empirical regularity that is robust across a wide range of model specifications and time periods.

Copyright
Footnotes
Hide All

I thank Jonathan Bendor, Lawrence Broz, Ruth Collier, Gary Cox, Barry Eichengreen, Jim Fearon, Jeffry Frieden, Justin Grimmer, Saumitra Jha, Steve Krasner, Helen Milner, T.J. Pempel, Jonathan Rodden, Kenneth Schultz, Michael Tomz, Steve Vogel, and participants of meetings at APSA, IPES, UC Berkeley, and Stanford for their helpful comments and suggestions. I also thank Trevor Incerti, Erica Kang, Xiaojun Li, Lizhi Liu, Ken Opalo, Sungmin Rho, Zheng Wu, and Matt Wujek for excellent research assistance. This research benefited from the generous support of Sakurako and William Fisher, the Hellman Faculty Scholar fund, and the Shorenstein Asia-Pacific Research Center at Stanford University.

Footnotes
References
Hide All
Abiad, Abul, Detragiache, Enrica, and Tressel, Thierry. 2010. A New Database of Financial Reforms. IMF Staff Papers 57 (2):281302.
Acemoglu, Daron, Johnson, Simon, Robinson, James, and Thaicharoen, Yunyong. 2003. Institutional Causes, Macroeconomic Symptoms: Volatility, Crises and Growth. Journal of Monetary Economics 50 (1):49123.
Acemoglu, Daron, Naidu, Suresh, Restrepo, Pascual, and Robinson, James A.. 2014. Democracy Does Cause Growth. National Bureau of Economic Research Working Paper Series, No. 20004.
Amyx, Jennifer. 2006. Japan's Financial Crisis: Institutional Rigidity and Reluctant Change. Princeton, NJ: Princeton University Press.
Archer, Candace C., Biglaiser, Glen, and DeRouen, Karl Jr. 2007. Sovereign Bonds and the “Democratic Advantage”: Does Regime Type Affect Credit Rating Agency Ratings in the Developing World? International Organization 61 (2):341–65.
Barbieri, Katherine, Keshk, Omar M.G., and Pollins, Brian. 2009. Trading Data: Evaluating Our Assumptions and Coding Rules. Conflict Management and Peace Science 26 (5):471–91.
Baron, Reuben M., and Kenny, David A.. 1986. The Moderator–Mediator Variable Distinction in Social Psychological Research: Conceptual, Strategic, and Statistical Considerations. Journal of Personality and Social Psychology 51 (6):1173–82.
Barro, Robert J. 1999. Determinants of Democracy. Journal of Political Economy 107 (6):158–83.
Beaulieu, Emily, Cox, Gary W., and Saiegh, Sebastian M.. 2011. Sovereign Debt and Regime Type: Re-Considering the Democratic Advantage. Working Paper.
Bebchuk, Lucian A., Cohen, Alma, and Spamann, Holger. 2010. The Wages of Failure: Executive Compensation at Bear Sterns and Lehman 2000–2008. Cambridge, MA: Harvard Law School Discussion Paper No. 657.
Bechtel, Michael M., Hainmueller, Jens, and Margalit, Yotam M.. 2014. Preferences Toward International Redistribution: The Divide Over the Eurozone Bailouts. American Journal of Political Science 58 (4):835–56.
Beck, Nathaniel, and Katz, Jonathan N.. 2001. Throwing out the Baby with the Bath Water: A Comment on Green, Kim, and Yoon. International Organization 55 (2):487–95.
Beck, Nathaniel, Katz, Jonathan N., and Tucker, Richard. 1998. Taking Time Seriously: Time-Series-Cross-Section Analysis with a Binary Dependent Variable. American Journal of Political Science 42 (4):1260–88.
Beck, Thorsten, Demirguc-Kunt, Asli, and Levine, Ross Eric. 2000. A New Database on Financial Development and Structure. World Bank Economic Review 14:597605.
Bernanke, Ben S. 2000. Japanese Monetary Policy: A Case of Self-Induced Paralysis? In Japan's Financial Crisis and Its Parallels to US Experience, edited by Posen, Adam S. and Mikitani, Ryoichi, 149–66. Washington, DC: Institute for International Economics.
Boix, Carles. 2011. Democracy, Development, and the International System. American Political Science Review 105 (4):809–28.
Boix, Carles, Miller, Michael, and Rosato, Sebastian. 2013. A Complete Data Set of Political Regimes, 1800–2007. Comparative Political Studies 46 (12):1523–54.
Bordo, Michael D., Eichengreen, Barry J., and Irwin, Douglas A.. 1999. Is Globalization Today Really Different Than Globalization a Hunderd Years Ago? In Brookings Trade Policy Forum, edited by Collins, Susan and Lawrence, Robert, 150. Washington, DC: Brookings Institution.
Bordo, Michael D., and Murshid, Antu Panini. 2001. Are Financial Crises Becoming Increasingly More Contagious? What Is the Historical Evidence on Contagion? In International Financial Contagion, edited by Claessens, Stijn and Forbes, Kristin I., 367403. Boston: Kluwer Academic.
Broz, J. Lawrence. 2012. Partisan Financial Cycles. In Politics in the New Hard Times: The Great Recession in Comparative Perspective, edited by Lake, David A. and Kahler, Miles, 75101. Ithaca, NY: Cornell University Press.
Brune, Nancy, Garrett, Geoffrey, Guisinger, Alexandra, and Sorens, Jason. 2001. The Political Economy of Capital Account Liberalization.Working paper, UCLA. Available at <http://www.international.ucla.edu/cnes/article/3683>.
Bueno de Mesquita, Bruce, Morrow, James D., Siverson, Randolph M., and Smith, Alastair. 1999. An Institutional Explanation of the Democratic Peace. American Political Science Review 93 (4):791807.
Bueno de Mesquita, Bruce, Smith, Alastair, Siverson, Randolph M., and Morrow, James D.. 2005. The Logic of Political Survival. Cambridge, MA: MIT Press.
Calomiris, Charles W., and Haber, Stephen H.. 2014. Fragile by Design: The Political Origins of Banking Crises and Scarce Credit: Princeton, NJ: Princeton University Press.
Chancellor, Edward. 1999. Devil Take the Hindmost. London: Penguin.
Chinn, Menzie D., and Frieden, Jeffry A.. 2011. Lost Decades: The Making of America's Debt Crisis and the Long Recovery. New York: W.W. Norton.
Chwieroth, Jeffrey M. 2010. Capital Ideas: The IMF and the Rise of Financial Liberalization. Princeton, NJ: Princeton University Press.
Clague, Christopher, Keefer, Philip, Knack, Stephen, and Olson, Mancur. 1999. Contract-Intensive Money: Contract Enforcement, Property Rights, and Economic Performance. Journal of Economic Growth 4 (2):185211.
Cohen, Benjamin C. 2009. A Grave Case of Myopia. International Interactions 35 (4):436–44.
Collier, David, and Levitsky, Steven. 1997. Democracy with Adjectives: Conceptual Innovation in Comparative Research. World Politics 49 (3):430–51.
Copelovitch, Mark, Frieden, Jeffry, and Walter, Stefanie. 2016. The Political Economy of the Euro Crisis. Comparative Political Studies 49 (7):811–40.
Copelovitch, Mark S., and Singer, David A.. 2012. Financial Levees: Traditional Banking, External Imbalances, and Banking Crises around the World. Working Paper.
Cox, Gary, and Weingast, Barry R.. 2015. Executive Constraint, Political Stability and Economic Growth. Unpublished paper, Stanford University.
Dailami, Mansoor. 2000. Managing Risks of Global Financial Market Integration. In Managing Financial and Corporate Distress, edited by Adams, Charles, Litan, Robert, and Pomerleano, Michael, 447–80. Washington, DC: Brookings Institution.
Demirgüç-Kunt, Asli, and Detragiache, Enrica. 1998. The Determinants of Banking Crises in Developing and Developed Countries. Staff Papers—International Monetary Fund 45 (1):81109.
Eichengreen, Barry, and Leblang, David A.. 2008. Democracy and Globalization. Economics and Politics 20 (3):289334.
Eichengreen, Barry, and Rose, Andrew K.. 1998. Staying Afloat When the Wind Shifts: External Factors and Emerging-Market Banking Crises NBER Working Paper No. W6370.
Fearon, James D. 1994. Domestic Political Audiences and the Escalation of International Disputes. American Political Science Review 88 (3):577–92.
Financial Crisis Inquiry Commission. 2011. The Financial Crisis Inquiry Report. Washington, DC. Available at <https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf>.
Freedom House. 2017. Freedom in the World. Washington, DC. Available at <https://freedomhouse.org/report/freedom-world/freedom-world-2017>.
Galbraith, John Kenneth. 1990. A Short History of Financial Euphoria. New York: Penguin.
Gavin, Michael, and Hausmann, Ricardo. 1996. The Roots of Banking Crises: The Macroeconomic Context. In Banking Crises in Latin America, edited by Hausmann, Ricardo and Rojas-Suarez, Liliana, 2763. Washington, DC: Inter-American Development Bank.
Gerring, John, Bond, Philip, Barndt, William T., and Moreno, Carola. 2005. Democracy and Economic Growth: A Historical Perspective. World Politics 57 (3):323–64.
Giuliano, Paola, Mishra, Prachi, and Spilimbergo, Antonio. 2009. Democracy and Reforms. Centre for Economic Policy Research Discussion Paper No. 7194. London.
Goemans, H.E., Gleditsch, Kristian Skrede, and Chiozza, Giacomo. 2009. Introducing Archigos: A Data Set of Political Leaders. Journal of Peace Research 46 (2):269–83.
Grimes, William W. 2002. Unmaking the Japanese Miracle: Macroeconomic Politics, 1985–2000. Ithaca, NY: Cornell University Press.
Gründler, Klaus, and Krieger, Tommy. 2016. Democracy and Growth: Evidence from a Machine Learning Indicator. European Journal of Political Economy 45 (Supplement):85107.
Gurr, Ted Robert, and Eckstein, Harry. 1975. Patterns of Authority: A Structural Basis for Political Inquiry. New York: Wiley.
Haber, Stephen H., and Menaldo, Victor. 2011. Do Natural Resources Fuel Authoritarianism? A Reappraisal of the Resource Curse. American Political Science Review 105 (1):126.
Halper, Stefan. 2010. The Beijing Consensus: How China's Authoritarian Model Will Dominate the Twenty-First Century. New York: Basic Books.
Helleiner, Eric. 1994. States and the Reemergence of Global Finance: From Bretton Woods to the 1990s. Ithaca, NY: Cornell University Press.
Helleiner, Eric. 2010. A Bretton Woods Moment? The 2007–2008 Crisis and the Future of Global Finance. International Affairs 86 (3):619–36.
Helleiner, Eric. 2011. Understanding the 2007–2008 Global Financial Crisis: Lessons for Scholars of International Political Economy. Annual Review of Political Science 14:6787.
Henisz, Witold J. 2002. The Institutional Environment for Infrastructure Investment. Industrial and Corporate Change 11 (2):355–89.
Jacques, Martin. 2009. When China Rules the World: The End of the Western World and the Birth of a New Global Order. New York: Penguin.
Johnson, Simon, and Kwak, James. 2010. Thirteen Bankers: The Wall Street Takeover and the Next Financial Meltdown. New York: Pantheon.
Jordà, Òscar, Schularick, Moritz, and Taylor, Alan M.. 2017. Macrofinancial History and the New Business Cycle Facts. In NBER Macroeconomics Annual 2016, edited by Eichenbaum, Martin and Parker, Jonathan A.. Chicago: University of Chicago Press.
Kaminsky, Graciela L., and Reinhart, Carmen M.. 1999. The Twin Crises: The Causes of Banking and Balance-of-Payments Problems. The American Economic Review 89 (3):473500.
Kaminsky, Graciela L., Reinhart, Carmen, and Vegh, Carlos A.. 2003. The Unholy Trinity of Financial Contagion. NBER Working Paper No. 10061.
Kant, Immanuel. 1795. Perpetual Peace: A Philosophical Essay. In Kant's Principles of Politics, Including His Essay on Perpetual Peace. A Contribution to Political Science, edited by Hastie, William, 77148. Edinburgh: Clark.
Keefer, Philip. 2007. Elections, Special Interests, and Financial Crises. International Organization 61 (3):607–41.
Kindleberger, Charles P. 2000. Manias, Panics, and Crashes: A History of Fianncial Crises. New York: John Wiley and Sons.
King, Gary, Keohane, Robert, and Verba, Sidney. 1994. Designing Social Inquiry: Scientific Inference in Qualitative Research. Princeton, NJ: Princeton University Press.
King, Gary, and Zeng, Langche. 2001. Logistic Regression in Rare Events Data. Political Analysis 9 (2):137–63.
Kirkpatrick, Grant. 2009. The Corporate Governance Lessons from the Financial Crisis. OECD Journal: Financial Market Trends 2009 (1). Available at <http://dx.doi.org/10.1787/fmt-v2009-art3-en>.
Klomp, Jeroen, and de Haan, Jakob. 2009. Political Institutions and Economic Volatility. European Journal of Political Economy 25 (3):311–26.
Laeven, Luc, and Valencia, Fabian. 2008. Systemic Banking Crises: A New Database. IMF Working Paper WP/08/224.
Lake, David A. 1992. Powerful Pacifists: Democratic States and War. American Political Science Review 86 (1):2437.
Li, Quan. 2009. Democracy, Autocracy, and Expropriation of Foreign Direct Investment. Comparative Political Studies 42 (8):1098–127.
Lipscy, Phillip Y. 2017. Renegotiating the World Order: Institutional Change in International Relations. New York: Cambridge University Press.
Lipscy, Phillip Y., and Na-Kyung Lee, Haillie. Forthcoming. The IMF as a Biased Global Insurance Mechanism: Asymmetrical Moral Hazard, Reserve Accumulation, and Financial Crises. International Organization 73 (1).
Lipscy, Phillip Y., and Takinami, Hirofumi. 2013. The Politics of Financial Crisis Response in Japan and the United States. Japanese Journal of Political Science 14 (3):321–53.
Lipset, Seymour Martin. 1959. Some Social Requisites of Democracy: Economic Development and Political Legitimacy. American Political Science Review 53 (1):69105.
Lonnborg, Mikael, Ogren, Anders, and Rafferty, Michael. 2014. Banks and Swedish Financial Crises in the 1920s and 1930s. In History and Financial Crisis: Lessons from the Twentieth Century, edited by Kobrak, Christopher and Wilkins, Mira, 5674. New York: Routledge.
Mackay, Charles. 1841. Extraordinary Popular Delusions and the Madness of Crowds. New York: Rivers Press.
Maddison, Angus. 2010. Statistics on World Population, GDP and Per Capita GDP, 1–2008 AD. University of Groningen. Available at <http://www.ggdc.net/maddison/Historical_Statistics/horizontal-file_02-2010.xls>.
Maddison Project Database. 2018. Jutta, Bolt, Robert Inklaar, Herman de Jong and Jan Luiten van Zanden, Rebasing “Maddison”: New Income Comparisons and the Shape of Long-Run Economic Development. Maddison Project Working Paper 10. Available at <https://www.rug.nl/ggdc/historicaldevelopment/maddison/releases/maddison-project-database-2018>.
Mansfield, Edward D., Milner, Helen V., and Rosendorff, B. Peter. 2002. Why Democracies Cooperate More: Electoral Control and International Trade Agreements. International Organization 56 (3):477513.
Maoz, Zeev, and Abdolali, Narsin. 1989. Regime Types and International Conflict, 1816–1976. Journal of Conflict Resolution 33 (1):335.
Maoz, Zeev, and Russett, Bruce. 1993. Normative and Structural Causes of Democratic Peace. American Political Science Review 87 (3):624–38.
Marshall, Monty G., Gurr, Ted Robert, and Jaggers, Keith. 2010. Polity IV Project: Political Regime Characteristics and Transitions: 1800–2009. Center for Systemic Peace.
Martin, William McChesney. 1955. Address of Wm. Mcc. Martin, Jr., Chairman, Board of Governors of the Federal Reserve System before the New York Group of the Investment Bankers Association of America. New York. Available at <https://fraser.stlouisfed.org/files/docs/historical/martin/martin55_1019.pdf>.
McGillivray, Fiona, and Smith, Alastair. 2008. Punishing the Prince: A Theory of Interstate Relations, Political Institutions, and Leader Change. Princeton, NJ: Princeton University Press.
McGrath, Liam F. 2015. Estimating Onsets of Binary Events in Panel Data. Political Analysis 23 (4):534–49.
Milner, Helen V., and Kubota, Keiko. 2005. Why the Move to Free Trade? Democracy and Trade Policy in the Developing Countries. International Organization 59 (1):107–43.
Mobarak, Ahmed Mushfiq. 2005. Democracy, Volatility, and Economic Development. The Review of Economics and Statistics 87 (2):348–61.
Mosley, Layna, and Singer, David A.. 2009. The Global Financial Crisis. International Interactions 35 (4):420–29.
Nelson, Rebecca Marie. 2009. Essays on the Politics of Sovereign Debt Markets. PhD Dissertation, Harvard University, Cambridge MA.
Nelson, Stephen C., and Katzenstein, Peter J.. 2014. Uncertainty, Risk, and the Financial Crisis of 2008. International Organization 68 (2): 361–92.
Nordhaus, William D. 1975. The Political Business Cycle. Review of Economic Studies 42 (2): 169–90.
North, Douglass C., and Weingast, Barry R.. 1989. Constitutions and Commitment: The Evolution of Institutional Governing Public Choice in Seventeenth-Century England. The Journal of Economic History 49 (4):803–32.
Noy, Ilan. 2004. Financial Liberalization, Prudential Supervision, and the Onset of Banking Crises. Emerging Markets Review 5 (3):341–59.
Papaioannou, Elias, and Siourounis, Gregorios. 2008. Democratisation and Growth. The Economic Journal 118 (532):1520–51.
Partell, Peter J., and Palmer, Glenn. 1999. Audience Costs and Interstate Crises: An Empirical Assessment of Fearon's Model of Dispute Outcomes. International Studies Quarterly 43 (2):389405.
Przeworski, Adam, and Limongi, Fernando. 1997. Modernization: Theories and Facts. World Politics 49 (2):155–83.
Puente, Lucas. 2012. Political Influence and Tarp: An Analysis of Treasury's Disposition of CPP Warrants. PS: Political Science and Politics 42 (2):211–17.
Quinn, Dennis P. 2000. Democracy and International Financial Liberalization. Working Paper, Georgetown University, Washington, DC.
Quinn, Dennis P., and Toyoda, A. Maria. 2007. Ideology and Voter Preferences as Determinants of Financial Globalization. American Journal of Political Science 51 (2):344–63.
Raftery, Adrian E. 1995. Bayesian Model Selection in Social Research. Sociological Methodology 25:111–63.
Rancière, Romain, Tornell, Aaron, and Westermann, Frank. 2008. Systemic Crises and Growth. The Quarterly Journal of Economics 123 (1):359406.
Reinhart, Carmen M., and Reinhart, Vincent R.. 2008. Capital Flow Bonanzas: An Encompassing View of the Past and Present NBER Working Paper No. W14321
Reinhart, Carmen M., and Rogoff, Kenneth. 2008. Is the 2007 US Subprime Crisis So Different? An International Historical Comparison. American Economic Review 98 (2):339–44.
Reinhart, Carmen M., and Rogoff, Kenneth. 2009. This Time Is Different: Eight Centuries of Financial Folly. Princeton, NJ: Princeton University Press.
Rosas, Guillermo. 2006. Bagehot or Bailout? An Analysis of Government Responses to Banking Crises. American Journal of Political Science 50 (1):175–91.
Rosas, Guillermo. 2009. Curbing Bailouts: Bank Crises and Democratic Accountability in Comparative Perspective. Ann Arbor: University of Michigan Press.
Russett, Bruce, and Oneal, John R.. 2001. Triangulating Peace: Democracy, Interdependence, and International Organizations. New York: W.W. Norton.
Saiegh, Sebastian. 2005. Do Countries Have a “Democratic Advantage”? Political Institutions, Multilateral Agencies and Sovereign Borrowing. Comparative Political Studies 38 (4):366–87.
Schaeck, Klaus, and Cihak, Martin. 2007. How Well Do Aggregate Bank Ratios Identify Banking Problems? IMF Working Paper. Washington, DC: International Monetary Fund.
Schultz, Kenneth A. 1999. Do Democratic Institutions Constrain or Inform? Contrasting Two Institutional Perspectives on Democracy and War. International Organization 53 (2):233–66.
Schultz, Kenneth A., and Weingast, Barry R.. 2003. The Democratic Advantage: Institutional Foundations of Financial Power in International Competition. International Organization 57 (1):342.
Taylor, John B. 2009. The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong. NBER Working Paper No. 14631.
Thegeya, Aaron, and Navajas, Matias Costa. 2013. Financial Soundness Indicators and Banking Crises. IMF Working Paper. Washington, DC: International Monetary Fund.
Treier, Shawn, and Jackman, Simon. 2008. Democracy as a Latent Variable. American Journal of Political Science 52 (1):201–17.
Williamson, John. 2004. A Short History of the Washington Consensus. Fundación CIDOB. Barcelona, Spain. Available at <https://piie.com/commentary/speeches-papers/short-history-washington-consensus>.
Yang, Benhua. 2008. Does Democracy Lower Growth Volatility? A Dynamic Panel Analysis. Journal of Macroeconomics 30 (1):562–74.
Yu, Miaojie. 2010. Trade, Democracy, and the Gravity Equation. Journal of Developmental Economics 91 (2):289300.
Recommend this journal

Email your librarian or administrator to recommend adding this journal to your organisation's collection.

International Organization
  • ISSN: 0020-8183
  • EISSN: 1531-5088
  • URL: /core/journals/international-organization
Please enter your name
Please enter a valid email address
Who would you like to send this to? *
×
Type Description Title
UNKNOWN
Supplementary materials

Lipscy supplementary material
Lipscy supplementary material 1

 Unknown (30.5 MB)
30.5 MB

Metrics

Altmetric attention score

Full text views

Total number of HTML views: 0
Total number of PDF views: 0 *
Loading metrics...

Abstract views

Total abstract views: 0 *
Loading metrics...

* Views captured on Cambridge Core between <date>. This data will be updated every 24 hours.

Usage data cannot currently be displayed