Income and democracy: a semiparametric approach

Abstract We examine heterogeneous nonlinear effects of income on democracy using country-level data from 1960 to 2000. Existing studies mainly focused on a linear relationship or restricted nonlinear ones and find mixed findings about the effects of income on democracy. The strong positive cross-country correlation between income and democracy is often found to disappear after controlling country specific fixed effects, although the result varies with different estimation methods and samples. In contrast to previous studies, we apply a flexible semiparametric additive partially linear dynamic panel data model to explore the heterogeneous effects of income on democracy. We assume income is endogenous and it enters in the regression model nonparametrically. Our model specification also allows for different democracy equilibria and adjustment speeds toward equilibria. We propose a nonlinearity test for our model and a penalized sieve minimum distance estimator to solve the ill-posed inverse problem in the semiparametric instrumental variable estimator. The finite sample performance of the proposed test and estimator are evaluated by simulations. In the empirical model, we find that the relationship between income and democracy is nonlinear and it is more complex than a simple inverted U-shape. Specifically, depending on the choice of the democracy measure, income may have positive effects on democracy for low-income countries, negative effects for middle-income countries, and no effects for high-income countries.