INTEREST GROUPS, DEMOCRACY, AND POLICY VOLATILITY

I. INTRODUCTION Empirical evidence suggests democratic polities produce more stable policy than do autocracies. For example, Henisz (2004) finds that democracy is associated with more stable fiscal policy, and Dutt and Mobarak (2007) find that democracy is associated with more stable fiscal and trade policy. The literature has focused attention on the decentralized decision-making that characterizes democracy as the causal factor linking political regime-type to policy stability. Checks and balances and the presence of veto-players in more democratic polities, in particular, are thought to constrain policy-makers and thereby produce policy stability (Dutt and Mobarak 2007; Lindblom 1959; Lindblom 1965; Tsebelis 1995). In this paper, we explore an alternative source of the policy stability observed in democracies: special interest groups. As noted by Freedom House, a cornerstone of democracy is the granting of both political rights and civil liberties. Under their definition, the latter include associational and organizational rights, which promote civil society. However, such rights also enable the proliferation of special interest groups which may seek to influence policy. Indeed, studies have shown that distributional coalitions, or Olson-groups as they are sometimes called (based on Olson 1982), are positively correlated with the degree of democracy (Coates, Heckelman, and Wilson 2007; Murrell 1984). According to Olson (1982), distributional coalitions impede a society's ability to redirect resources as needed in response to changing conditions. This occurs both in markets by erecting barriers to entry and stifling innovations, and in the public sphere by lobbying and influencing policy-makers. Mokyr (2000) and Parente and Zhao (2006) have studied the former, but the latter has not yet been directly tested. We aim here to bridge the gap by noting the connection between interest groups and policy stability. Olson argued that special interest groups tend to form and accumulate in societies with stable institutions. In the aftermath of institutional upheaval, old groups may be destroyed and new groups may form. For a period of time, one might expect the group formation process to contribute to policy instability, as the power of old groups diminishes in a new institutional environment and new groups seeking special favors engage politicians. However, once the formation process is complete, existing groups are expected to use their privileged positions to preserve the status quo in order to protect their rents. We therefore hypothesize that the status quo bias of groups may manifest in a more limited range of policy options and changes over time. Thus, interest groups are expected to reduce policy volatility. A finding consistent with our hypothesis contributes to the literature in several ways. In particular, our hypothesis identifies a previously unexamined mechanism to explain policy stability. Moreover, if our hypothesis is correct, then prior literature has likely overstated the role of decentralized decision-making (checks and balances and veto-players) in policy stability. The relationship between democracy and policy stability may have less to do with democracy's decentralized decision-making and more to do with the large number of interest groups that accumulate in democracies and the natural tendency of such groups toward preservation of the status quo. The stability associated with democracy is commonly construed as beneficial, but it is important to draw a distinction between institutional stability and policy stability. In the case of policy, the normative implications of stability are ambiguous. In particular, to the extent that policy stability reduces uncertainty and risk and thereby spurs productive investment, its normative implications are positive. Such positive normative effects may occur irrespective of the mechanism that generates the stability--checks and balances and veto-players or interest groups. …