Financial Development and Democracy: Is the Relationship Non-Linear?

Political economy theories of financial development give no clear indication on how political regime impacts growth. There is evidence of positive, negative and no direct effect of democracy on financial growth. This paper attempts to resolve this controversy by studying the role of nonlinearities using the estimation of smooth models for panel data (PSTR). Our findings offer strong evidence that democracy non-linearly impacts financial development. More specifically, there exists a threshold below which democracy exerts a negative effect on financial development, and beyond which it is growth enhancing for emerging countries.