Threshold nonlinearities and the democracy-growth nexus

Abstract

Summary This paper investigates the relationship between democracy and economic growth in the context of a linear index threshold regression model. We first introduce the baseline model with endogeneity and propose a two-step smoothed generalised method of moments estimation method. We establish the consistency and derive the asymptotic distributions of the proposed estimators. We then extend the approach to a dynamic panel context and employ the model to explore the impact of democratisation on economic growth. Our findings reveal that democratisation’s impact on growth is nonlinear and depends on the country’s current institutional quality level. Furthermore, democracy’s impact on economic growth is more pronounced in countries with higher education levels than others, suggesting that education also plays a crucial role in enhancing the positive effects of democracy. Our proposed estimator can be used in other situations that require the use of more than one threshold variable. In these cases, our hybrid estimator has less stringent data requirements than an alternative model where the thresholds would enter separately, especially when the threshold variables are correlated.