The Role of Liberal Democracy and Policy Uncertainty in Shaping Economic Growth: An Empirical Analysis

Abstract

The world is witnessing a decline in democratic quality alongside a rise in economic policy uncertainty (EPU). This trend is significant because democratic institutions are shaped not only by political conditions but also by the economic and policy environment in which they operate. Although the literature has extensively examined the democracy–growth and uncertainty–growth relationships separately, limited empirical evidence exists on their joint impact on economic growth. This study addresses this gap by examining the combined effects of liberal democracy and EPU on economic growth across 21 countries from 1997 to 2021. The empirical results confirm a stable long-run relationship among the variables. GDP is positively associated with the Liberal Democracy Index (LDI) and negatively associated with EPU, after controlling for foreign direct investment (FDI), trade openness, and the consumer price index (CPI). In addition, the interaction term (LDI × EPU) has a positive and significant effect on GDP, suggesting that stronger liberal democratic institutions enhance economic resilience under conditions of elevated uncertainty. Panel causality results further reveal bidirectional causality between LDI and GDP, along with a unidirectional causal effect from LDI × EPU to GDP. Our findings underscore the centrality of a robust democratic framework in fostering sustainable economic growth, while highlighting the necessity of policy interventions that mitigate economic uncertainty.