Who Values Democracy? Stock Market Evidence on Democratization and Redistribution
Key Takeaways
- •The study uses stock market data from 90 countries over 200 years and finds that democratizations significantly reduce asset valuations by increasing redistribution risk.
- •Risk premia are substantially elevated before and during democratizations, at magnitudes similar to those seen during financial crises.
- •A shift in Catholic Church doctrine supporting democracy provides causal evidence that democratizations raise risk premia.
- •Successful democratizations are followed by a larger public sector, lower income inequality, and a higher labor share of income, with inequality reduction and higher taxes explaining roughly half of the asset pricing effects.
- •The model explains the muted asset price response to autocratizations, and neither macroeconomic risk nor generic political risk accounts for the results.
A new study examines the long-standing view that redistribution lies at the heart of the democratization process, using stock market data to test the proposition. The findings are consistent with that view: democratizations have a large, negative impact on asset valuations, driven by a rise in redistribution risk.
The redistribution view of democratization holds that extending voting rights shifts political power toward poorer majorities, who then vote for taxes and transfers that reduce returns to capital. Testing this empirically has long been difficult, which is what makes the paper's asset-market approach distinctive: stock prices should embed investors' expectations about future taxation and redistribution, making them a forward-looking gauge of how markets price regime change.
Drawing on data spanning 90 countries over 200 years, the paper shows that risk premia are substantially elevated in the periods before and during democratizations, with magnitudes similar to those observed during financial crises. A shift in Catholic Church doctrine in support of democracy provides causal evidence that democratizations increase risk premia.
According to the study, successful democratizations lead to substantial redistribution: the size of the public sector grows, income inequality falls, and the labor share of income rises. An extended version of the canonical redistribution-based model of democratization that incorporates asset prices can quantitatively explain these effects. Reductions in inequality and increased taxes account for roughly half of the results, while the remainder is explained by greater economic competition and equality in government spending.
The model also accounts for the negligible asset pricing response observed during autocratizations, a finding consistent with the redistribution framework: if moves toward autocracy are not expected to sharply raise or lower taxation of capital, asset prices have little reason to react. The author finds that neither an increase in macroeconomic risk nor generic political risk can explain the results.
The paper is by Max Miller and is now published in the Journal of Political Economy (JPE); an ungated copy is available here. The post originally appeared on Marginal Revolution.
