NCPA - National Center for Policy Analysis

Democracy and Inflation

November 8, 2002

Many argue that democracy itself is a primary cause of inflation. According to their theory, politicians must win support from the masses and engage in prolific spending to finance their popularity. A recent study investigates this hypothesis.

Researchers used data from developing countries over the past 50 years. Developing countries are especially prone to bouts of inflation. According to the data, since 1957:

  • Over two-thirds of the 133 developing countries have experienced inflation of over 25 percent per year.
  • Over one-thirds have experienced inflation of over 50 percent per annum.

The authors find that democracy can be a force for inflation if excessive inequality is present. Using Gini coefficients -- measures of the inequality of income distribution with 0.00 representing perfect equality and 1.00 representing perfect inequality -- researchers find that:

  • In countries with a Gini coefficients generally below 0.40, democracy appears to restrain inflationary pressures.
  • After that threshold, the effect reverses, and democracy and widespread political representation appear to generate inflation.

The inequality forces politicians to engage in inflationary spending to redistribute income. Inflation punishes wealth accumulations and alleviates debt, an attractive outcome to a country with a large poor population.

Furthermore, researchers argue that the findings help explain why different countries have had different inflationary experiences when establishing democracies. In Latin America, wealth distribution is very lopsided. Thus, their democracies engage in inflationary spending to redistribute income. In contrast, transition countries in Eastern Europe had Gini coefficients very close to 1.00 due to Soviet policies. Consequently, their democracies avoided inflationary policies.

Source: Raj M. Desai, Anders Olofsgard, and Tarik Yousef, "Democracy, Inequality, and Inflation," Georgetown University, Edmund A. Walsh School of Foreign Service Working Paper, May 2002 .

For text:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=313024

 

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