Political instability, ethnic fractionalization and economic growth

A number of developing countries have been experiencing high rates of ethnic fragmentation, corruption and political instability. The persistent poverty in many of these countries has led to an increased interest among both researchers and policy makers as to how these factors impact a country's economic growth. Previous research has found mixed results as to whether ethnic fragmentation, corruption and political instability affect economic growth. However, this research has been focused on the direct impact of these variables on growth. This paper innovates by empirically modelling the impact of ethnic fractionalization and corruption on economic growth, both directly and indirectly through their role in affecting political stability. The analyses also add to the literature by testing a new data set with both fixed effects and GMM estimators. Results from a large panel data set of 157 countries from 1996-2014 finds that ethnic fractionalization and corruption negatively impact economic growth indirectly by increasing political instability, which has a negative direct effect on economic growth. Once the indirect effects are accounted for, ethnic fractionalization has no significant direct effect on growth. There is weak evidence to suggest that corruption may, in some countries, actually have a positive direct effect on growth by enabling firms to circumvent bureaucratic red tape, consistent with the "greasing the wheels" hypothesis. These results emphasize the importance of establishing strong institutions which are able to accommodate diverse groups and maintain political stability. Additional results find these implications to be particularly relevant for low-income and/or sub-Saharan African countries. The results also suggest that a country having a wide diversity of languages and religions need not be a hindrance to economic growth if a robust political system is in place.