“Income Inequality, Corruption, and Democratization in Developing Countries.” In progress. 

Abstract

The purpose of this paper is to disentangle the causal relationships among corruption, economic development, and democratization processes in developing countries.  Specifically, this paper aims to solve an important and interesting puzzle: Why do democratization and economic modernization in developing countries result in greater income inequality? Many studies have documented a more equal income distribution in developed countries than in developing regions.  This empirical fact alone may not be surprising, since social demands for redistribution are addressed in developed democracies with various social welfare policies, whereas such demands are easily ignored or suppressed in developing countries.  Yet, if democratic countries enjoy a more equal income distribution, why does the democratization process in many developing countries lead to greater income inequality?  Put differently, why does this cross-national empirical regularity between income equality and democracy fail to manifest itself inter-temporally?  Obviously, the key mechanism identified in the conventional wisdom – social demand for redistribution – falls short of answering this question. The democratic transition unleashes strong social demands for redistribution, but these social demands are attenuated and not translated into improved equality.

I argue that the key to solving this puzzle lies in a better understanding of the patterns of democratization and the consequences of corruption in developing countries. While democratization ideally takes place after construction of a solid institutional foundation of rule of law, realistically most developing countries democratize by introducing elections before they have structured a system of accountability. This type of electoral democracy, despite legitimizing the government, does not hold the ruling elites accountable through an effective system of checks and balances.  As a result, corruption becomes rampant at every level. Most importantly, corruption attenuates the social demand for redistribution during democratization, since corruption leads to tax evasion that is systematically biased toward the rich and well connected. This in turn reduces tax progressiveness and offsets the welfare implications of the tax system.  Additionally, corruption misallocates social welfare and education programs from those who are truly in need to those who are inside the patronage network.