Does Political Stability Lead to Financial Development?

At last week’s Law and Economics Seminar, Mark Roe presented a fascinating new paper (coauthored with Jordan I. Siegel) called Political Instability and Financial Development.  Unlike previous work, which largely attributes financial development to legal origin, Professors Roe and Siegel argue that political stability, at least in part, explains differences in development across countries.  The Abstract explains:

Political instability impedes financial development and is a primary determinant of differences in financial development around the world.  Conventional measures of political instability–such as Alesina and Perotti’s well-known index of instability and a subsequent index derived from Banks’s work–persistently predict a wide rang of national financial development outcomes for recent decades.  These results are quite robust to legal origin, to trade openness, to latitude, and to other measures that have obtained prominence in the past decade.  These findings are for a range of key financial outcomes for all available years and for all available countries over several decades–data that has been previously examined only partially.  Surprisingly, despite the widespread view in the law and finance literature of legal origin’s importance, not only is political stability highly robust to legal origin, but, for many years, our results for key indicators and specifications neither show Common Law to be consistently superior nor French Civil Law to be consistently inferior to other legal families in generated strong financial development outcomes.  The robust significance of political stability tells us that there are powerful channels to financial development running through political stability that go a long way toward explaining cross-country differences in financial development.

Professor Roe’s presentation led to a lively debate at the Seminar.  Some students and faculty wondered whether the instability indexes used in the paper’s empirical analysis accurately captured the relative stability of a country’s political environment; others asked whether stability might partially be capturing other country characteristics (such as the rigor of law enforcement) that drove the authors’ results.  All agreed, though, that the paper offers an important new perspective on the determinants of financial development around the world.

The full Article is available for download here.

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