Forms of Democracies and Financial Development

The empirical literature on the political economy of finance emphasizes the importance of political institutions as crucial determinants of financial development and shows that democratic regimes are positively and robustly correlated with financial development. By using a three years periodic panel of 140 countries over 1984-2007, we show that democratic regimes appear to be significantly and positively correlated with financial development, but the opposition between democracies and dictatorships is not sufficient to account for differentials in financial development between countries. Indeed, our results highlight a significant and highly heterogeneous relationship between democratic regimes and financial development since the positive effect induced by democracies on financial development is explained by the presence of specific democratic political institutions, namely: parliamentary form of government and to a lesser extent federal state form. Thus, democracies seem to better foster financial development if its constitutional arrangement allows horizontal flexibility and vertical stability in the political decision-making process.