Abstract
•State capacity Granger-causes economic freedom across 99 countries, 1975–2020.•Over a period of 15 years, a one-standard deviation shock in state capacity raises economic freedom by more than a standard deviation.•Neither economic freedom nor state capacity Granger-causes democracy.•Spain and Taiwan illustrate how state-building precedes economic liberalization.•Over a period of 15 years, a one-standard deviation shock in state capacity raises economic freedom by more than a standard deviation.
The modernization hypothesis and the question of sequencing institutional development remain important for economic development, the economics of transition, and interpreting economic history. This paper applies panel vector autoregression to test whether other institutional structures precede the adoption of democracy, making use of a recently developed method of measuring historical state capacity for a large number of countries. The evidence suggests that neither strong states nor market institutions are necessary for democratization, contradicting one of the main claims of modernization theory. Relatively little evidence is found in favor of the importance of sequencing overall. Improving the quality of state institutions tends to precede liberalized economic institutions.