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Fractionalization and Economic Freedom

Diversity is often thought to create conflict and harm economic institutions. We hypothesize, however, that the impact of diversity on economic institutions is conditional on political institutions, and may be negative in some settings but positive in others, due to differences in the nature of rent seeking in different regimes. To test this hypothesis, we estimate the impact of ethnic and linguistic fractionalization on economic freedom, conditional on the level of political rights. We find that the marginal impact of ethnic and linguistic fractionalization on economic freedom is positive in the most democratic nations and that the marginal impact of ethnic fractionalization is negative in the most autocratic nations. Our results suggest that the nature of the relation between diversity and economic institutions may be more complicated than prior literature conveys.