This particular question can be answered while taking into consideration two aspects. First would justify it as, “Economic growth leads to the generation of higher incomes which in turn would further make people approve of the Government, which is the good growth hypothesis.” In consequence, the growth will generate stability. The second justification is that of destabilizing growth hypothesis which exclaims that “growth generates certain complex changes in society, and further, instability. A part of this instability would be political, in a manner that where the political system is not well established; growth could lead to political instability.
While on the contrary, economic growth is a well-defined concept, political stability is not. There are briefly four dimensions of political stability that are stable government, stable political system, internal law and order, and external stability.
From the political point of view, traditional societies are widely assorted. The developed countries have the propensity to be more alike. It is believed that after the transition, the successful countries become capitalist welfare states and democracies (CWD). Various economists and intellectuals speak of ‘black boxes’ when the adjoining mechanism of known linkages between variables, described by conventionalised facts is not fully understood. Although a multitude of theories exist on growth and stability, still the data fails to justify these theories.
Economic Stability is used to describe the financial system of a nation which is highlighting only the minor fluctuations in the output growth and manifest a consistently low inflation rate. The economic stability is seen as a worthwhile state for a developed economy that is time and again encouraged by the policies and actions of its central bank.
On the other hand, Political Stability can be best described as a variable of substantial importance as it is presented as a consequence of poor economic development.
It is believed that a stable financial system allocates the resources efficiently, evaluates and manages the financial risks, maintains the employment levels as close as possible to the economy’s natural rate, and eliminates the relative price movements of the real and financial assets to stabilise the monetary and economic levels. If the financial system is stable, it tends to absorb the shocks primarily through self-corrective mechanisms which prevents the unfavourable events from deranging the real economy or spread over to adjoining financial systems. The financial stability is supreme while talking about the economic growth, as most transactions in the real economy are made through the financial system.
If there is no financial stability, the banks would be more unenthusiastic to finance the profitable projects, asset prices may also diverge remarkably from their intrinsic values, and the payment schedule deviates from the norm. The possible outcome of excessive instability may lead to bank runs, hyperinflation or even stock market crashes.
The promotion of economic stability is partly a matter of circumventing economic and financial crises, the large swings in economic activity, high rate of inflation and excessive volatility in exchange rates and financial markets. Instability may lead to increasing uncertainty, discourage investment, hinder economic growth, and hurt the living standards.
Political stability, on the other hand, is not as much about democracy as simply that, governmentally firm. Any unforeseeable change in a government, regime or leadership, amalgamated with an ideological drift, caused either by warring political factions or a disgruntled public protesting seems a much better understanding of political instability.
It is feared so much because even the slightest and sudden change at government level is bound to cause shift in economic policies, which is something that every investor or businessperson fears. Business is a risky venture on its own, no one wants the added burden of uncertain policies, peculiarly for long-term projects with lengthier development period. On the other hand, investors are not sure whether the new policies would benefit their business, or they would be forced to pay more taxes, or whether the uncertainty would lead to a spike in property costs. This drives away the foreign investment desperately needed in this globalised world for developing economies in particular.
Besides the expertise and advanced technology foreign investment brings, with constant political instability, Governments do not have time or peace needed to enact economic reforms, such as incentives for domestic production.
In uncertain times, economies usually shift from production to consumption and imports, as markets might be closed due to protests, producers are unable to get loans to start own business, or rule of law is weak. Skilled workers then emigrate usually, resulting in ‘brain drain’, an asset irreplaceable immediately.
What really needs to be understood is that how vital a good governance is. Irrespective of the political system, if the governmental and social institutions are weak, there would always be uncertainty. A platform where human rights are not protected, there would always be chances of riots. If people are happy, cared and valued, even within an absolute monarchy, there can be political and economic stability. The job then, of any Government regardless of political system, is to strengthen its institutions and respect its populace.