Modelling Dynamics in the Macroeconomy Involving the Relationship between Economic Growth and Crime Rates

Abstract

The relationship between economic growth and crime rates is often the subject of statistical analyses by agencies such as the World Bank and the IMF. These agencies estimate a negative correlation between crime rates and economic growth: in environments of economic prosperity, crime tends to be lower. However, there are not many theoretical papers exploring why this has to be the case, or whether there are any underlying determinants of the growth and crime rates. One interesting paper modelling these variables is Goulas, A. and Zervoyianni, 2015: they incorporate crime rates into a standard Solow model and split public spending into productive spending and unproductive spending, where the latter stems from criminal behavior in the society. They then get a steady-state equation for aggregate output which is a function of crime rates, among others. This is one of many recent theoretical papers that try to incorporate crime rates into a general macroeconomic growth model. My project contributes to the ongoing academic discussion on the subject, featuring a statistical model where crime rates and economic growth are correlated and there is causality in both directions. This model will be used to estimate the causal effect of growth on crime rates and crime rates on growth, as well as to investigate the causal effect of institutions on both crime rates and growth. The paper also entertains the possibility of a “spiral effect”: as crime rates increase, there is a smaller fraction of the population involved in productive activities, which reduces economic growth. This in turn results in even more people resorting to criminal activities because there are less economic opportunities available as a result of economic slowdown. On the other hand, as crime rates decrease, economic growth will be enhanced, which will create even more economic opportunities and reduce crime rates even further. The statistical model is estimated by using a panel dataset involving post-colonial economies from both the advanced, developing and underdeveloped categories, spanning the years 2000 through 2019. I will use an instrumental variable approach to estimate the causal effect of growth on crime rates and crime rates on growth, as well as to test for the directionality of the causal effect of institutions on both crime rates and growth. The importance of this kind of research is evident: if the institutions of an economy play an important role in determining growth and crime rates in equilibrium, this may suggest that foreign assistance and institutional exchange programs aimed at improving institutions in poorer countries can go a long way in helping them get out of stagnant macroeconomic conditions such as meager economic growth and high crime.