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Does Economic Success Require Democracy?

From the May/June 2007 Issue

Sadly, no. In fact, the politically unfree countries are enjoying more economic growth than the politically free ones. Kevin Hassett tells why.

When Kenneth Arrow was awarded the Nobel Prize in Economics in 1972, one of the contributions the awards committee cited was his miraculous “impossibility” theorem. Decades from now, Arrow’s theorem, originally drawn in his doctoral dissertation, will be viewed as the 20th-century idea that best anticipated the 21st century.

While mathematical in origin, the impossibil­ity theorem is simple to describe in words:

A government is really just a mechanism that makes collective decisions for a large number of cit­izens who have different preferences. I might want to spend our tax dollars on dog parks; you might prefer more police. The government’s job is to work it out. This job is called “aggregating preferences.” In the U.S., we send signals with voting to help the government aggregate preferences.

Dictatorships now understand that they have to provide a good economy to keep citizens happy, and they understand that free-market econ­omies work best.

Arrow was able to show that no voting scheme can be devised that will create a government that has rational preferences, where rationality is defined precisely by Arrow as meeting a number of condi­tions. Democracy might be a form of government that many prefer to live under, but there is nothing theoretically compelling that suggests that it is the form of government that best reflects the underly­ing preferences of citizens. As a result, democracies will not necessarily outperform other types of mech­anisms for preference aggregation as a route to economic prosperity. Democracies will not always win.

In the latter half of the 20th century, this obser­vation seemed irrelevant. The United States, with its free markets and democracy, defeated the Soviet Union, with its centrally planned economy and party dictatorship.

But in the 21st century, things look different. Dictatorships, as in China, appear to have learned from the failure of the Soviets. While they continue to oppress political opponents, they allow a high level of economic freedom within their borders.

So far, this approach is working, and in a big way—as the chart illustrates. An organization called Freedom House rates the level of political freedom of the world’s nations on a scale of 1 to 7, with 1 the most free. For example, according to the 2006 sur­vey, countries like the United States and Italy are rated 1, while Singapore is rated 4.5, China and Saudi Arabia 6.5, and North Korea 7. In addition, the Fraser Institute in Canada rates the economic freedom of nations, looking at taxes, regulation, trade barriers, and the like.

Economic Growth

The chart shows the economic growth of two different sets of countries. The first set comprises nations that are both politically and economically free; the second, those that are repressed politically (have high numbers on the Freedom House scale) but are economically free. In each case, I looked at the average five-year growth rate of GDP, weighted by the size of each respective economy.

The chart tells a striking story: the countries that are economically and politically free are underper­forming the countries that are economically but not politically free. For example, unfree China had a growth rate of 9.5 percent from 2001 to 2005. But China was not the whole story—Malaysia’s GDP grew 9.5 percent from 1991 to 1995, Singapore’s GDP grew 6.4 percent from 1996 to 2000, and Russia’s grew 6.1 percent from 2001 to 2005.

The unfree governments now understand that they have to provide a good economy to keep citizens happy, and they understand that free-market econ­omies work best. Also, nearly all of the unfree nations are developing countries. History shows they grow faster, at least for a while, than mature nations. But being unfree may be an economic advantage. Dictatorships are not hamstrung by the preferences of voters for, say, a pervasive welfare state.

So the future may look something like the 20th century in reverse. The unfree nations will grow so quickly that they will overwhelm free nations with their economic might. The unfree will see no reason to transition to democracy.

Meanwhile, democracies may copy many of the market-friendly policies of the dictatorships, but it seems unlikely that free citizens will choose to reduce their own political freedoms.

Democracies will stay in the game, but, as Arrow showed long ago, their victory is not assured.

Kevin Hassett is director of economic policy studies at the American Enterprise Institute.

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