I'm thinking of a word -- and it's not democracy.

Photographer: Georges Gobet/AFP/Getty Images

Democracy Is Good for Business

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
Read More.
a | A

As China and Russia have surged in power during the past 15 years, more and more people have started to wonder if democracy is really the best economic system. For example, consider Hungarian President Viktor Orban's comments in a Bloomberg News article last July:

The global financial crisis in 2008 showed that “liberal democratic states can’t remain globally competitive,” Orban said...He listed Russia, Turkey and China as examples of “successful” nations, “none of which is liberal and some of which aren’t even democracies.”

He’s not alone. Countries such as Turkey and Thailand are also questioning democracy’s usefulness. And a few business leaders have been challenging the concept as well. To cite just one example, venture capitalist Tom Perkins suggested that votes should be based on how much tax people pay, not on one person, one vote. Some have also argued that democracy is the reason India’s growth has been slower than China’s.

Supporters of democracy often reply that it helps countries get rich. After all, there’s an obvious correlation between wealth and democracy  -- note that Europe, Japan, and the U.S. are all wealthy democracies. Sure, China has experienced great growth, but that’s because it started out poor and is huge in size.

But is it correlation, or causation? Does democracy actually make countries richer, or is democracy merely a luxury in which rich countries can indulge?

This question is hard to answer. For one thing, countries only get rich once, and democracies usually only become democratic once or twice. Also, there are lots of other things about countries that might cause wealth, democracy or both. Although we will never know the answer for sure, a top team of economists has done what is just about the most careful study that is humanly possible.

MIT economist Daron Acemoglu and James Robinson of Harvard, famous for the idea that “inclusive institutions” are the key to national development, teamed up with Suresh Naidu and Pascual Restrepo to tackle the problem. They use a large number of different statistical techniques to examine the effect of democratizations. They also use an alternate technique, where they look at waves of democratization.

All of the methods give the same answer: Democracy increases gross domestic product  by about 20 percent in the long run.

That isn't a huge number -- almost certainly less than democracy’s proponents would like. But it’s not nothing, either. It turns out that Viktor Orban is wrong; authoritarianism probably won’t help his country get rich, though it won’t doom Hungary either.

Acemoglu and company also examine the question of how democracy boosts growth. They find that countries with democracy have better government -- they pursue more economic reforms, provide more schooling, provide more public goods and reduce social unrest. They also find, contrary to many who have been following China’s story, that business investment is higher in democracies.

Now, that isn't a definitive, final answer. We may never have one -- or at least, not for hundreds of years. Maybe democracies have done well in the last century simply because they could trade with, and be protected by, the U.S. -- the richest and most powerful country around. Perhaps now that China, by dint of its sheer size, is wresting the crown away from the U.S., we will see things reverse. We can’t yet rule that out.

But the institutional improvements that Acemoglu et al. find suggest that the reasons go deeper into the structure of society. These observations match the theory of New York University political scientist Bruce Bueno de Mesquita, who hypothesizes that in democracies, there are too many voters to pay off with cronyism, forcing leaders to provide more public goods like education, infrastructure and property rights.

Our best guess is that democracy really is the best form of government currently available.

There is also the question, however, of whether democracy will survive. Some critics of democracy observe that humanity spent a very long time under some kind of authoritarian rule, such as monarchies or military dictatorships, while democracy is only a recent innovation.

But economists Toke Aidt, Raphael Franck, Peter Jensen, and Gabriel Leon recently did a study that found that since the early 1800s, revolution, or the threat of revolution, has tended to nudge countries toward democracy. If this study is to be believed, it means that democracy is a more stable configuration for a society than autocracy in the modern, industrial age. Just as a tower of blocks tends to fall over when shaken, autocracies tend to turn into democracies when the system is disturbed. This clearly wasn’t the case before the Industrial Revolution, so democracy is best seen as an adaptation to the new technological environment.

Not only is democracy good for business, it's here to stay unless the world undergoes some other dramatic shift on the scale of the Industrial Revolution. Viktor Orban, and even China’s mighty Communist Party, really do seem to be on the wrong side of history.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Noah Smith at nsmith150@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net