Democracy, Diversification, and Growth Reversals

There is much evidence that less democratic countries experience more high-frequency growth volatility. In this paper we report a similar finding about volatility in the medium term: we find evidence that reversals of trend-growth are sharper and more frequent in non-democracies. Motivated by this evidence, we construct a model in which non-democracies have high barriers of entry for new firms. This leads to less sectoral diversification and so, in an uncertain environment, to larger growth swings in less democratic countries. We present empirical evidence that confirms the positive relation between democracy and industrial diversification.