Incomeinequality.pdf

IMPACT OF POLITICAL INSTABILITY ON
ECONOMIC GROWTH, POVERTY AND

INCOME INEQUALITY
Iram Shehzadi1, Hafiz Muhammad Abubakar Siddique2 and M. Tariq Majeed3

Abstract

We study the impact of political instability on economic growth, income distribution and poverty. The
estimates are obtained by applying Heteroscedasticity consistent OLS on a cross-section of 103 coun-
tries from 1984-2011. We take into account alternative dimensions of political instability: formal,
informal and military coups D’Etat. Formal and informal political instability has statistically signifi-
cant and positive impact on poverty and inequality. Similarly we find that direct effect of Coups
D’Etat on both poverty and income inequality is insignificant, while its indirect effect (through
economic growth) is significant. On the whole our study indicates political instability is detrimental
to the process of economic growth, worsen income distribution and increases poverty.

Keywords: Economic Growth, Income Inequality, Poverty, Political Instability, Heteroscedasticity
Consistent OLS.

JEL Classification: I390

Introduction

An emerging concept in literature relates economic growth to the instability in political
regime. Political economists disagree about the definition and measurement of political instability.
For the purpose of defining political instability we distinguish between its formal and informal dimen-
sions. Formal political instability arises due to elections and constitutional changes (Campos & Kara-
nasos, 2008). On the other hand, informal political instability originates through protests, assassina-
tions, riots, strikes and violations (Campos & Karanasos, 2008). These formal and informal measures
have been combined to define political instability. The first definition is labeled as “Social Political
Instability”. This is the simplest definition and it covers only informal measures of political

1 Govt. Degree College for Women, Gujranwala, Pakistan. Email: [email protected]
2 Federal Urdu University, Islamabad, Pakistan. Email: [email protected]
3 School of Economics, Quaid-i-Azam University, Islamabad, Pakistan. Email: [email protected]

instability. The second measures “Government Changes” covers a broader definition of political
instability and is based on informal political instability, economic and institutional measures.

Whatever are the definitional and measurement problems, higher level of political instability
is undesirable. It shortens the time span of policy makers to lead and implement optimal macroeco-
nomic policies. Absence of coherent and consistent policies greatly reduces the government ability to
response to shocks appropriately; this uncertainty cause macroeconomic misbalances such as less
economic growth, inflation, poverty, and inequality etc. There exist an ample amount of literature
documenting the relationship of political instability with growth, saving rate, investment, land
inequality, crime rate, debt, capital and inflation (Venieris & Gupta, 1986; Ozler & Tabellini, 1991;
Edwards & Tabellini, 1991; Alesina et al., 1996; Devereux & Wen, 1998; Syed & Ahmad, 2013). Less
attention has been paid to empirically examine the relationship of political instability with income
inequality and poverty.

Uncertainty associated with unstable political regimes may have adverse effects on the
wellbeing of poor segment of society. Political instability can affect poverty in a number of ways.
First, uncertainty regarding government policies reduces accumulation of human and physical capital
leading to a decline in investment. This low level of domestic and foreign investment depresses faster
economic growth, which in turn increases poverty (Dollar & Kraay, 2002). Second, political instabili-
ty is also expected to affect income inequality and poverty through its impact on growth. Any frequent
switch of government, political violence, strikes and/or revolutions may hinder the effectiveness of
pro-poor policy programs. For example, it is possible that the new government, whether obtained
through constitutional or non-constitutional changes, is such that it promotes pro-rich policies. The
alleged government then serves its own political allies and do not promote pro-poor policies; thereby
causing more inequality and poverty. Given the close linkages between political instability, growth,
income inequality and poverty no efforts has been made to collectively examine these relationships.

This study makes several contributions. First, we improve on the existing literature by exam-
ining the relationship of political instability with income distribution and poverty. To this end, we use
direct and indirect channels linking political instability to poverty and income inequality. Second, we
contribute to the existing literature by using alternative measures of political instability. We use three
broad set of measures; (i) formal political instability measures: an index of constitutional and
non-constitutional measures of political instability, (ii) informal political instability: an index of
measures of mass violation, and (iii) coups D’Etat.

This study answers the following key questions:
• Does political instability reduce economic growth?
• Does political instability increase income inequality and poverty?
• How close are the links from political instability to economic growth and then to poverty?
• How close are the links from political instability to economic growth and then to income inequality?

The rest of this paper is arranged as follows. In section 2, background and related work
clarify how this research relates to the existing work. Section 3 formulate empirical models and
explain the methodology. Section 4 defines data sources and provides some basic summary statistics.
In section 5, we interpret and discuss empirical results. The last section 6 concludes.

Literature Review

There is a large amount of studies exploring the relationship between economic growth and
political instability. Alesina et al. (1996) using data for 113 countries find that countries with higher
degree of political instability grow slower than others. Their findings reveal that political instability is
persistent in character; the occurrence of a government collapse raises the probability of future
government collapses. Gurgul and Lach (2013) while studying impact of government changes in 10
CEE transitional economies also support the negative relationship of political instability with
economic growth.

Some studies have explored channels through which political instability affects growth
(Barro, 1991; Devereux & Wen, 1998; Aisen & Veiga, 2013). Aisen and Veiga (2013) investigate
relationship between political instability and GDP growth for 169 countries from 1960 to 2004. They
find that higher degree of political instability is associated with lower growth rates. This damaging
effect of political instability on GDP growth is transferred through the negative effects of political
instability on total factor productivity, human capital and physical capital.

Similarly, Barro (1991) finds an inverse relationship between political unrest and growth rate
of GDP for a large sample of countries. He finds that political instability reduces growth and invest-
ment through its adverse effects on property rights. Moreover, Devereux and Wen (1998) developed a
linear endogenous growth model where economic growth and government spending are linked to
political instability. They find evidence from cross country regressions that political instability reduc-
es growth and increases share of government in GDP.

In the same vein, Jong-A-Pin (2009) re-examines the effect of alternative dimensions of
political instability on economic growth. He finds that instability of political regime depresses
economic growth. He also assumed the reverse causality between these dimensions. Lower economic
growth increases political instability, while, higher growth fosters stability within government.

Some studies lift up doubt on the negative relationship of political instability with economic
growth. Ali (2001) explores the relationship between a variety of political instability measures, policy
uncertainty and economic growth. His findings show that policy instability has a more significant
effect on economic growth than political instability. Similarly, Campos and Nugent (2002) using two
different measures of political instability find that the negative impact of political instability on
growth is only contemporaneous. In the long run, they did not found any evidence for the negative

relationship between political instability and economic growth.

Literature describing relationship between economic growth and political instability is quite
established. On the other end, literature regarding impact of political instability on income inequality
and poverty is yet to be developed. The link, however, has been developed from inequality and pover-
ty to political instability. Studies have found that income inequality and poverty is an important cause
of political instability. Alesina and Perotti (1996) examine the impact of income distribution on
investment through the channel of political instability. They find that income inequality cause
socio-political unrest and reduce investment, and ultimately hamper growth. Muller and Seligson
(1987) and Wang et al. (1993) using alternative techniques and robustness checks also confirm that
income inequality has positive association with political instability.

Londregan and Poole (1990) find that poverty and lower economic growth increases the
chances of coups DEtat- a measure of forced government changes (Alesina & Perotti, 1994).
Likewise, Alcantar-Toledo and Venieris (2014) suggest that political instability, fiscal policy and
income inequality are the major factors hindering economic growth. More importantly they confirm
that lower growth and socio political instability are main causes of poverty traps. Thus, the
overwhelming amount of literature suggests that political instability is inversely related with econom-
ic growth and positively with income inequality and poverty.

Empirical Model Specification And Methodology

Political instability and economic growth

The empirical model for growth is derived from Aisen and Viega (2013):

Where, Growth is dependent variable and is calculated as growth rate of GDP per capita. IGDPPC
(log), is the value of GDP per capita in 1984; it is expected to have a negative coefficient to confirm
convergence effect.

Political Instability, Poverty and Income Inequality

Based on the poverty and inequality literature (Kuznets, 1955; Chong & Calderon, 2000;
Dollar & Kraay, 2002; Gupta et al., 2002) we use following determinants of poverty and income
inequality:

Pov is explained variable and represent number of people living in moderate poverty (less
than $2/day). Gini is also dependent variable and is calculated from Lorenz curve; it represents distri-
bution of income. Ipov and IGini are values of poverty and inequality in 1984; a positive coefficient
is expected.

The explanatory variable PI in all equations is main variable and it represent political
instability index. We use three broad dimensions of political instability: (i) formal political instability
measures: an index of constitutional and non-constitutional measures of political instability, (ii) infor-
mal political instability: an index of measures of mass violation, and (iii) Coups D’Etat. All measures
are expected to have negative association with growth, and positive with poverty and income inequali-
ty. Inf , Ethnicity , Pop and Corruption are other covariates of growth, poverty and inequality. All
these determinants are expected to have inverse relationship with growth, and positive with inequality
and poverty.

Econometric Methodology

Since we are using cross country data the problem of heteroscedasticity is likely to occur. In
the presence of heteroscedasticity OLS still yields unbiased estimates but they are no longer efficient.
A variety of methods is available to correct heteroscedasticity. The simplest method involves trans-
forming functional form of dependent variable or entire model (Carroll & Ruppert, 1988). This
method is discouraged because it is difficult to know that which functional form is optimal. The
second method is Weighted Least Square (WLS). This method corrects heteroscedasticity by weight-
ing each observation by sum of square residuals (Greene, 2003; Gujarati, 2012). Although WLS
produce efficient estimates it is applicable only when the magnitude and form of heteroscedasticity is
known.

An alternative and most appropriate procedure is to use test of hetero-consistent standard
error on OLS estimates. In this method the original model is estimated using OLS and then white’s
test is applied to obtain hetero-consistent standard errors (White, 1980). In this study we are using
hetero-consistent standard error OLS (HCOLS) because it allows one to avoid heteroscedasticity
without using weights and it is also applicable even if nothing is known about the form of heterosce-
dasticity.

Data Description, Sources And Definition Of Variables

The relationship of political instability with growth, poverty and income inequality is evalu-
ated using three alternative categories of political instability. The first dimension named “formal
political instability” (FPI) is defined as propensity of government collapse by either constitutional
and/or non-constitutional means. The FPI index is composed of four celebrated measures: legislative
elections, major constitutional changes, major cabinet changes and effective executive changes. The

second index “informal political instability” (IPI) is based on five measures of mass violation: assassi-
nations, strikes, purges, riots and revolutions. The last measure “coups D’Etat” reflects the forced
transfer of power which in now commonplace in many countries. Data on all the political instability
measures is taken from Cross National Time Series Data Archives (CNTS report, 2012). Table 1
portrays the pair wise correlation matrix among different measures of political instability. Table shows
a fairly low correlation among ten measures of political instability. Only assassinations and revolu-
tions, and legislative elections and coups d’Etat have partial correlation greater than 0.50. This little
correlation among alternatives measures of political instability shows that each measure has some
information and properties that are not captured by others. Each set of these measures forms an
important dimension of political instability which is different from the other. Table 2 is the summary
statistics of all important variables used in this study. Assassinations, a measure of informal political
instability, has the highest average value (& standard deviation) of 4.14 (0.52).
Data on economic and institutional variables is from World Development Indicators online database
(2014), PovcalNet online database (2014), International Country Risk Guide database (2013) and
Alesina et al. (2003). The data set include 103 countries from both developed and developing regions
of world. The cross section is made by taking average of the data between period 1984 and 2011.
Table 3 displays the correlation matrix of political instability measures with growth, poverty and
income inequality. Each measure of political instability has standard negative relationship with
growth and positive with poverty head count ratio and income inequality.

Table 1
Correlation matrix of political instability variables

Table 2
Descriptive statistics of important variables

Table 3
Correlation matrix of political instability with growth, poverty and income inequality

Table 5 depicts results for the HCOLS estimation of political instability on poverty head
count ratio. Column 1 show that informal political instability has positive and significant coefficient
indicating that higher level of political instability worsen poverty rates. An occurrence of additional
strikes, riots, and revolutions hinder the effectiveness of Government policies, threaten foreign invest-
ment and create unemployment which worsen poverty rates. Column 2 and 4 show that formal politi-
cal instability and coups D’Etat has positive coefficients, but they are not significant statistically. Our
results also indicate that a constitutional change, an important formal political instability measure, has
significant positive impact on poverty. While direct effect of formal political instability and coups
D’Etat on poverty is insignificant there indirect effect is significant. On the other hand, indirect impact
of informal political instability is insignificant. The indirect effect of political instability measures is
channeled through economic growth and is estimated using simultaneous equation approach where all
other determinants of growth are excluded.

Table 5
Impact of political instability on poverty

(Table Continued…)

Table 6
Indirect impact of political instability on poverty

(Table Continued…)

Statistical results for the impact of political instability on income inequality are given in
Table 7 and 8. It is clear from the Tables that direct and indirect impact of formal and informal politi-
cal instability on income inequality is statistically significant. Direct impact of coups D’Etat is insig-
nificant while its indirect impact on inequality is significant. Our results confirm that all dimensions
of political instability are detriment to income inequality; higher level of political instability increases
income inequality.

We also found support for Kuznets hypothesis which states that initial level of development
in GDP will cause inequality to increase, while at alter stages growth in GDP reduces income inequali-
ty. Other detriments of income inequality, such as, ethnic tension and inflation have expected positive
signs.

Table 7
Impact of political instability on income inequality

(Table Continued…)

Table 8
Indirect impact of political instability on income inequality

Conclusion

The objective of this study has been to examine the relationship of political instability with
economic growth, poverty and income inequality. We have used three dimensions of political instabil-
ity namely, formal political instability, informal political instability and coups D’Etat. Our findings for
the impact of different dimensions of political instability on growth are in conformity with most of
literature, suggesting that higher degree of political unrest reduces the economic growth.

In analyzing the link of political instability with poverty and income inequality we have used both
direct and indirect means. Formal and informal political instability has statistically significant and
positive impact on poverty; higher level of political instability increases poverty. Similarly we find
that direct effect of Coups D’Etat on both poverty and income inequality is insignificant, while its
indirect effect (through economic growth) is significant. On the whole our study indicates that all
dimensions of political instability have damaging repercussion on poverty and income inequality.
Our results suggest that governments in highly politically instable countries need to address the root
causes of political instability and try to make a stable political system and policies. Only then, coun-
tries can attain higher and sustained economic growth and lower poverty and inequality rates.

References

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Journal of Political Economy, 29, 151-167.
Alcántar-Toledo, J., & Venieris, Y. P. (2014). Fiscal policy, growth, income distribution and sociopo
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Appendix

Data and Variables Description

Interpretation of Empirical Results

Table 4 presents heteroscadisticity consistent OLS estimation results for growth model using
averaged data for 103 countries from 1984-2011. To make analysis more comparable to existing
studies we have grouped political instability index into three dimensions. Column 1 of the Table 4
shows that coups D’Etat, a measure of forced government, has negative and statistical significant
coefficient. The estimated parameter indicates that occurrence of an additional coups D’Etat per year
will reduce economic growth by 0.04 points. Results for other measures are reported in columns 2 and
5. Our results allow us to distinguish between impacts of different dimensions of political instability
on growth. From column 2 we find that formal political instability has statistically significant impact
on growth while impact of informal political instability is insignificant. Cabinet changes and legisla-
tive elections, most widely used measures of formal political instability, also support our hypothesis
regarding adverse impact of political instability on growth.

Results regarding the other determinants of growth are also according to our expectations.
Initial GDPPC have negative and significant sign confirming conditional convergence hypothesis as
suggested by new classical growth models. Finally, higher inflation, population growth, and ethnic
tensions slow down growth. Corruption, although not significant, but has expected positive sign.

Table 4
Impact of political instability on economic growth

(Table Continued…)

PAKISTAN BUSINESS REVIEW 825

Volume 20 Issue 4, Jan, 2019Research

IMPACT OF POLITICAL INSTABILITY ON
ECONOMIC GROWTH, POVERTY AND

INCOME INEQUALITY
Iram Shehzadi1, Hafiz Muhammad Abubakar Siddique2 and M. Tariq Majeed3

Abstract

We study the impact of political instability on economic growth, income distribution and poverty. The
estimates are obtained by applying Heteroscedasticity consistent OLS on a cross-section of 103 coun-
tries from 1984-2011. We take into account alternative dimensions of political instability: formal,
informal and military coups D’Etat. Formal and informal political instability has statistically signifi-
cant and positive impact on poverty and inequality. Similarly we find that direct effect of Coups
D’Etat on both poverty and income inequality is insignificant, while its indirect effect (through
economic growth) is significant. On the whole our study indicates political instability is detrimental
to the process of economic growth, worsen income distribution and increases poverty.

Keywords: Economic Growth, Income Inequality, Poverty, Political Instability, Heteroscedasticity
Consistent OLS.

JEL Classification: I390

Introduction

An emerging concept in literature relates economic growth to the instability in political
regime. Political economists disagree about the definition and measurement of political instability.
For the purpose of defining political instability we distinguish between its formal and informal dimen-
sions. Formal political instability arises due to elections and constitutional changes (Campos & Kara-
nasos, 2008). On the other hand, informal political instability originates through protests, assassina-
tions, riots, strikes and violations (Campos & Karanasos, 2008). These formal and informal measures
have been combined to define political instability. The first definition is labeled as “Social Political
Instability”. This is the simplest definition and it covers only informal measures of political

1 Govt. Degree College for Women, Gujranwala, Pakistan. Email: [email protected]
2 Federal Urdu University, Islamabad, Pakistan. Email: [email protected]
3 School of Economics, Quaid-i-Azam University, Islamabad, Pakistan. Email: [email protected]

instability. The second measures “Government Changes” covers a broader definition of political
instability and is based on informal political instability, economic and institutional measures.

Whatever are the definitional and measurement problems, higher level of political instability
is undesirable. It shortens the time span of policy makers to lead and implement optimal macroeco-
nomic policies. Absence of coherent and consistent policies greatly reduces the government ability to
response to shocks appropriately; this uncertainty cause macroeconomic misbalances such as less
economic growth, inflation, poverty, and inequality etc. There exist an ample amount of literature
documenting the relationship of political instability with growth, saving rate, investment, land
inequality, crime rate, debt, capital and inflation (Venieris & Gupta, 1986; Ozler & Tabellini, 1991;
Edwards & Tabellini, 1991; Alesina et al., 1996; Devereux & Wen, 1998; Syed & Ahmad, 2013). Less
attention has been paid to empirically examine the relationship of political instability with income
inequality and poverty.

Uncertainty associated with unstable political regimes may have adverse effects on the
wellbeing of poor segment of society. Political instability can affect poverty in a number of ways.
First, uncertainty regarding government policies reduces accumulation of human and physical capital
leading to a decline in investment. This low level of domestic and foreign investment depresses faster
economic growth, which in turn increases poverty (Dollar & Kraay, 2002). Second, political instabili-
ty is also expected to affect income inequality and poverty through its impact on growth. Any frequent
switch of government, political violence, strikes and/or revolutions may hinder the effectiveness of
pro-poor policy programs. For example, it is possible that the new government, whether obtained
through constitutional or non-constitutional changes, is such that it promotes pro-rich policies. The
alleged government then serves its own political allies and do …