JOURNAL OF APPLIED ECONOMETRICS

J. Appl. Econ. (2016)

Published online in Wiley Online Library
(wileyonlinelibrary.com) DOI: 10.1002/jae.2536

INCOME AND DEMOCRACY: A SMOOTH VARYING

COEFFICIENT REDUX
ALEXANDER L. LUNDBERG,a KIM P. HUYNHb AND DAVID T. JACHO-CHÁVEZa*
a
Department of Economics, Emory University, Atlanta, GA, USA
b
Bank of Canada, Ottawa, ON, Canada

SUMMARY
Acemoglu et al. (American Economic Review 2008; 98: 808–842) find no effect of income on democracy when
controlling for fixed effects in a dynamic panel model. Work by Moral-Benito and Bartolucci (Economics Letters
2012; 117: 844–847) and Cervellati et al. (American Economic Review 2014; 104: 707–719) suggests that the
original model might have been misspecified and proposes alternative specifications instead. We formally test
these parametric specifications by implementing Lee’s (Journal of Econometrics 2014; 178: 146–166) dynamic
panel test of linear parametric specifications against a general class of nonlinear alternatives robustly and reject
all these specifications. However, using a more flexible model proposed by Cai and Li (Econometric Theory
2008; 24: 1321–1342) we find that the relationship between income and democracy appears to be mediated by
education, but results are not statistically significant. Copyright © 2016 John Wiley & Sons, Ltd.

Received 7 April 2015; Revised 13 March 2016

Supporting information may be found in the online version of this article.

1. INCOME AND DEMOCRACY

Acemoglu et al. (2008), hereafter AJRY, find no effect of income on democracy when controlling for
fixed effects in a dynamic panel model. This result is evidence against the ‘modernization hypothe-
sis’, which suggests that countries will become more democratic as income grows. AJRY’s original
specification is of the following form:
di;t D ˛di;t 1 C yi;t 1 C x0i;t 1 ˇ C ıi C t C ui;t (1)
The dependent variable, di;t , is a measure of democracy for country i in period t , while yi;t 1 is the lag
of log income per capita, xi;t 1 includes other controls, such as education or population,1 t denotes
a common time effect, and ıi represents the country-i fixed effect. Using a variety of methods, AJRY
estimate model (1) for up to 150 countries during the years 1955–2000. They find the estimate of the
coefficient on the lag of log income,  , to be near zero and estimated with relative precision, implying
that income does not cause democracy.

* Correspondence to: David T. Jacho-Chávez, Department of Economics, Emory University, 1602 Fishburne Drive, Atlanta GA
30322, United States. E-mail: djachocha@emory.edu
1
The democracy measure is either the Freedom House or Polity Democracy index, and GDP comes from the Penn World Tables
6.1; see AJRY for a complete description of the data.

Copyright © 2016 John Wiley & Sons, Ltd.

 A. L. LUNDBERG, K. P. HUYNH AND D. T. JACHO-CHÁVE

Even under the assumption that income does not affect democracy on average, it might affect
democracy under certain conditions. Moral-Benito and Bartolucci (2012), hereafter MBB, reconsider
the model with the simple addition of a quadratic term in the log of income, i.e.
2 0
di;t D ˛di;t 1 C yi;t 1 C yi;t 1 C xi;t 1 ˇ C t C ıi C ui;t (2)

They find that for low-income countries, income does predict democracy, but for high-income coun-
tries the effect vanishes. Perhaps income provides a foundation for democracy in developing countries,
but once a country becomes rich enough income provides no further incentives.
Cervellati et al. (2014), hereafter CJSV, also reconsider the model but with the addition of a
former-colony dummy, ci , interacted with income, as in Equation 3:

di;t D ˛di;t 1 C yi;t 1 C .yi;t 1  ci / C x0i;t 1 ˇ C t C ıi C ui;t (3)

They find that income has a positive effect on democracy for non-colonies but a negative effect for
former colonies. One explanation is that certain former colonies were subject to a more extractive
colonization process and left with worse institutions. Income might exert a destabilizing force in those
countries but a stabilizing force in countries with more developed institutions.

2. PARAMETRIC INFERENCE
The findings of MBB and CJSV raise the question of whether income truly has no effect on democracy
or whether the result is an artifact of the given linear (in parameters) specification. To examine this
possibility, we first replicate all the results in AJRY using the http://cran.r-project.org/web/packages/
plm/index.htmlplm package in the http://www.r-project.org/R statistical language; see Croissant and
Millo (2008). All tables are faithfully reproduced and are available upon request.2 Next, we formally
test the linear specifications of Equations (1), (2) and (3).
Lee (2014b) introduces a test for the linear specification of dynamic panel models. In a model of
the form

di;t D xR 0i;t  C ıi C ui;t . / (4)

the null and alternative hypotheses are stated for the one-way error component model as

H0 W E.di;t jIi;t 1 ; ıi / D xR 0i;t  C ıi

H1 W E.di;t jIi;t 1 ; ıi / ¤ xR 0i;t  C ıi

where Ii;t 1 contains all information known at time t  1, including xR 0i;t , which corresponds to all
right-hand-side variables in Equations (1), (2) and (3) above, including the common time effects, t ,
and with  collecting the right-hand-side parameters in the same equations.
The test is inspired by the sequential moment condition (or martingale property), which, under the
null, EŒui;t ./jIi;t 1 ; ıi  D 0 a.s. for some  , where, for each specification, the dependence of the error
term on the parameters is made explicit by the notation ui;t . /. If the model is correctly specified, the
residuals from a consistent estimator O will asymptotically satisfy the sequential moment condition,
and any misspecification will be captured by dependence in the residuals. However, using a frequency
domain approach is not ideal because it may capture serial dependence in the higher-order moments of
the error, not just the mean. The test is therefore constructed from a partial derivative of the individual

2
AJRY’s original analysis was performed using the Stata software.

Copyright © 2016 John Wiley & Sons, Ltd. J. Appl. Econ. (2016)
DOI: 10.1002/jae
 INCOME AND DEMOCRACY REDUX

Table I. p -values from Lee’s (2014b) specification test

q =1 q =2 q =3
Freedom Freedom Freedom
House Polity House Polity House Polity

AJRY Ma 1.27e05 2.07e04 2.55e06 9.54e05 7.27e03 2.56e02

Mb 6.24e06 3.79e04 2.51e07 3.19e05 2.88e02 7.34e01
MBB Ma 1.26e05 1.90e04 2.54e06 8.91e05 7.27e03 2.30e02
Mb 6.34e06 1.43e04 2.54e07 1.26e05 2.94e02 5.01e01
CJSV Ma 8.92e06 1.97e04 1.89e06 9.25e05 5.80e03 2.49e02
Mb 7.44e07 6.66e05 2.70e08 5.05e06 1.39e02 4.43e01
GENERAL Ma 1.03e05 1.89e04 2.13e06 9.35e05 5.97e03 2.30e02
Mb 4.45e07 1.05e05 1.49e08 7.36e07 7.47e03 1.95e01

Note:The quadratic spectral (QS) kernel is used throughout. The bandwidth parameter (lag length) is
denoted by q . Countries are excluded from the testing sample unless they provide at least six observations
in the time dimension. The p -values are based on asymptotically standard normal test statistics. ‘Ma ’ and
‘Mb ’ refer to the heteroskedasticity-consistent and heteroskedasticity-corrected versions of the statistic,
respectively. ‘AJRY’ refers to the basic fixed-effects estimator of Equation 1. ‘MBB’ refers to Equation 2.
‘CJSV’ refers to Equation 3 and ‘GENERAL’ refers to Equation 3 with a quadratic income term interacted
as well.

(country)-specific generalized spectral function, which allows for conditional heteroskedasticity (and
other higher moments) of unknown form. The test statistic is an asymptotically normal function of the
residuals under H0 .
Table I contains the p -values of the asymptotically standard normal test statistics for specifications
(1)–(3) as well as a more general specification that includes all three parametric models as special
cases. The quadratic spectral (QS) kernel is used for the calculations, and results are presented for a
bandwidth parameter (lag length) denoted as q ranging from one to three. ‘Ma ’ and ‘Mb ’ refer to the
heteroskedasticity-consistent and heteroskedasticity-corrected versions of the statistic, respectively.
For almost all cases, the linear models above (Equations (1)–(3) as well as the more general model)
are strongly rejected using either the Freedom House or the Polity measure of democracy. The result
is robust to the choice of bandwidth parameter and kernel.3 Since a rejection of the null results from
either a misspecified functional form or an omitted variable (including, for example, an improper lag
structure), these results suggest that the previous parametric models might be misspecified.4

3. A VARYING COEFFICIENT DYNAMIC PANEL MODEL

The previous results motivate the use of a more flexible model. Cai and Li (2008) introduce a varying
coefficient dynamic panel model, which allows for both nonlinearities and differing interaction effects
in a semiparametric fashion. The basic model is dPi;t D xP 0i;t g.Pzi;t / C uP i;t , where xP i;t includes a constant
and may contain lags of the dependent variable dPi;t , g./ represents the vector of unknown smooth
varying coefficients and uP i;t is an error term. It is assumed that EŒuP i;t jPzi;t  D 0 but allowed that
EŒuP i;t jPxi;t  ¤ 0.
In our context, dPi;t is the first-differenced measure of democracy, xP 0i;t includes a constant,
first-differenced lag of democracy, first-differenced lag of income and a colony dummy. Time effects

3
For example, using the Bartlett kernel instead of the QS kernel yields similar results.
4
The conventional Sargan test for over-identification in the Arellano–Bond approach to estimation rejects at the 5% significance
level for model (1) but fails to reject for the more general models, suggesting that perhaps the additional regressors do improve
the specification. However, Sargan’s test contrasts a composite hypothesis of correct specification and instrument validity that
could have low power in small samples—see, for example, Roodman (2009)—while Lee’s (2014b) test is for specification only.

Copyright © 2016 John Wiley & Sons, Ltd. J. Appl. Econ. (2016)
DOI: 10.1002/jae
 A. L. LUNDBERG, K. P. HUYNH AND D. T. JACHO-CHÁVE

are captured by the constant since the model is applied in first differences.5 The model is applied in first
differences to allow for comparison with the previous models, and the inclusion of the colony dummy
is purely an empirical device. We use education in levels6 as the exogenous conditional variable
zP i;t because education is cited as a prime link between income and democracy in previous literature
(e.g. Glaeser et al., 2004; Murtin and Wacziarg, 2014). Education is measured by the average number
of years of schooling for the population aged 25 or older. Although including education as a control
did not affect the results in AJRY, it could still be mediating the link between income and democracy
through other variables. Murtin and Wacziarg (2014) find both education and income to be important
predictors of democracy over a 1870–2000 period. However, over a sample from 1950 to 2000, simi-
lar to our study, income was not significant, which motivates our study to include education inside the
nonparametric function.7
The estimation takes place in two stages according to Cai and Li (2008, equations (3) and (4)), i.e.

EŒuP i;t jPvi;t  D 0 (5)

0
g.z/ D ŒE.ı.Pvi;t /ı.Pvi;t / jPzi;t D z/ 1
E..Pvit /dPi;t jPzi;t D z// (6)

P 0i;t ; zP 0i;t 0 , w
where vP i;t D Œw P i;t is a d  1 vector of instrumental variables with the first component equal
to one, such that EŒuP i;t jw P i;t  D 0, and ı.Pvi;t / D EŒPxi;t jPvi;t . In the spirit of Arellano and Bond’s (1991)
estimator, we use as instruments the second lag in levels of the first-differenced variables.8
In the first stage of estimation, elements of ı./ are estimated by a nonparametric local constant
regression as readily available in the http://cran.r-project.org/web/packages/np/index.htmlnp package
using least squares cross-validated bandwidths. In the second stage, the estimates for ı./ are plugged
into Equation 6, which is estimated by another nonparametric local constant regression using least
squares cross-validated bandwidths; see Hayfield and Racine (2008) and Ho et al. (2011). In each
case, the search algorithm for bandwidths was restarted 10 times to avoid finding local minima.
Figure 1 contains the results. The first column displays the estimated coefficients for values of
education ranging from approximately the 10th to the 90th sample percentiles, along with double
bootstrapped 95% confidence intervals, shaded in grey. The second column presents a zoomed-in
version of each plot. To interpret the estimates, recall that the model is estimated in first differences.
The dependent variable ranges from zero to one. Thus, for example, a coefficient of 2 on the lag of log
income means that a 1% increase in income results in a 0.02 increase in the democracy score, holding
everything else constant.
While higher levels of education appear to enhance the link between income and democracy, the
estimates are not statistically significant. The 95% confidence intervals are wide, especially for higher
levels of education. The confidence intervals were constructed from a double-resampling bootstrap

5
We thank a referee for the following two suggestions. (i) To estimate an additive, nonparametric model of the form
di;t D g1 .di;t 1 / C g2 .yi;t 1 ; ´i;t 1 / C g3 .xi;t 1 / C t C ıi C ui;t . Su and Lu (2013) and Lee (2014a) offer applica-
ble estimators. However, we encountered various numerical problems when trying to implement Su and Lu’s (2013) estimator
because of data sparseness. A longer time series per country might aid the implementation of these alternatives in the future.
(ii) To estimate the model including time dummies in zi;t instead. The results are qualitatively the same; see the supplementary
material (supporting information).
6
Using the first difference yields qualitatively the same results, but uncovers a potential point of discontinuity in the estimated
g./.
7
We thank a referee for asking us to clarify the motivation for this nonparametric model. We estimated a variant of the
Acemoglu et al.’s (2008) model that includes both: (i) linear interaction of education and income and (ii) square interaction
of education and income; we find that the square interaction is statistically significant and therefore motivates the need for a
flexible functional form via the varying coefficients panel data model.
8
To the best of our knowledge, there is no test to assess the serial correlation in the error term in this new varying coefficient
specification.

Copyright © 2016 John Wiley & Sons, Ltd. J. Appl. Econ. (2016)
DOI: 10.1002/jae
 INCOME AND DEMOCRACY REDUX

Figure 1. Smooth varying coefficient estimates. The left-hand column displays the estimated coefficients for
values of education ranging from the 10th to the 90th sample percentile, with bootstrapped 95% confidence
intervals shaded in grey. The right-hand column presents a zoomed-in version of each plot. Horizontal dashed
lines are included at zero for reference

procedure.9 First, countries are resampled with replacement from the original sample. Next, a block
bootstrap is applied to each of those resampled countries. After recalculating estimates for 999 itera-
tions, the upper and lower intervals are obtained as the ˛ D 0:025 and ˛ D 0:975 quantiles from the
recalculated estimates.10

4. CONCLUSION
MBB and CJSV suggest that the primary model of AJRY, Equation 1, might be misspecified. An
application of Lee’s (2014b) test supports the conjecture—the specifications of Equations (1)–(3) are
robustly rejected. Using a more flexible model by Cai and Li (2008), the relationship between income
and democracy appears to be more nuanced, with education mediating this relationship. However, the
confidence intervals are quite wide, and the results are not statistically significant.

9
This bootstrapped procedure was proposed by Hounkannounon (2011), and it builds upon Kapetanios (2008) and Gonçalves
(2011).
10
Since the maximum available sample size in the time dimension was 7, the chosen block length is 3. To avoid dropping
countries from the unbalanced panel, if a country chosen in the first stage had a time dimension T  3 it was simply retained
for the second stage. If the country had T D 4 or 5, one block of length 3 was randomly taken, and if it had T D 6 or 7 two
blocks of length 3 were randomly taken.

Copyright © 2016 John Wiley & Sons, Ltd. J. Appl. Econ. (2016)
DOI: 10.1002/jae
 A. L. LUNDBERG, K. P. HUYNH AND D. T. JACHO-CHÁVE

5. SUPPORTING INFORMATION
Supporting information may be found in the online version of this article.

ACKNOWLEDGEMENTS

We thank Heng Chen and Geoff Dunbar for comments and suggestions. We also thank Yoon-Jin
Lee for sharing with us her original GAUSS code and discussions, and Liangjun Su and Xun Lu for
providing their original MATLAB code. We acknowledge the usage of the Bank of Canada EDITH
High Performance cluster. The views expressed in this paper are those of the authors. No responsibility
for them should be attributed to the Bank of Canada.

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Copyright © 2016 John Wiley & Sons, Ltd. J. Appl. Econ. (2016)
DOI: 10.1002/jae