Political Economics - Explaining Economic Policymkredler/ReadGr... · 2014-05-05 · Political...

Political Economics - Explaining Economic Policy

T. Persson and G. Tabellini (Book - 2000; Chapters 1-5)presented by Salvatore Lo Bello

Macro Reading Group UC3M

November 14, 2012

T. Persson and G. Tabellini (Book - 2000; Chapters 1-5) presented by Salvatore Lo Bello (Macro Reading Group UC3M)Political Economics - Explaining Economic Policy November 14, 2012 1 / 17

Introduction

The Motivation

Economic policies vary greatly across time and place: in the late1990s total government spending was more than 60% of GDP inSweden, above 50% in many continental Europe countries, around35% in Japan, Switzerland, USA.

The composition of the spending is also characterized by a greatvariability across countries (e.g. transfers are high in Europe but lowin Latin America).

How can we explain the variations in the data? Is there anysystematic correlation with other aspects of the economic and socialenvironment?

Final goal: explain economic policy in modern democracies, size/formof redistributive programs, extent/type of public good provision, sizeof government deficits, extent of corruption. We are at the boundarybetween poltical science and economics.


Introduction

Politics

Motivation of Politicians:

opportunistic (office seeking, rent seeking) - standard assumption.partisan (they maximize a social welfare function with disproportionateweights).

Timing of Politics:Preelection Politics: electoral promises are binding and enforceable;candidates propose policies to maximize their chances of winning.

Voters only like economic policies =⇒ median voter theorem =⇒assumptions on the motivation of politicians become unimportant.Voters also like other fixed factors of politicians (ideology) =⇒ themotivations of politicians matter.

Postelection Politics: electoral promises are not binding or too vague toeven matter; voters select the politician, not directly the policy.

Winner takes all: one politician free to set the policy.Legislative Bargaining.


Notation and Preferences

Preferences

Heterogeneous agents (characterized by αi specific feature), affected by apolicy vector q.

W (q,p;αi) = maxci

[U(ci,q,p;αi)|H(ci,q,p;αi) ≥ 0].

The policymaker sets q, respecting the market-determined value of p andsome other constraints: G(q,p) ≥ 0. The constraint will typically bebinding =⇒ p = P (q).Therefore, we can define the preferred policy of voter i:

q(αi) = arg maxq

W (q;αi)



Restricting Preferences

Arrow (1951) has shown that no general rule enables a democracy toconsistently aggregate individual preferences =⇒ majority rule does notalways generate well-defined equilibrium policies.

Definition 1

A Condorcet winner is a policy q∗ that beats any other feasible policy ina pairwise vote.

Definition 2

Policy preferences of voter i are single peaked if:If q′′ ≤ q′ ≤ q(αi) (or if q′′ ≥ q′ ≥ q(αi)) =⇒ W (q′′;αi) ≤W (q′;αi).

Proposition 1

If all the voters have single-peaked preferences over a given ordering ofpolicy alternatives, a Condorcet winner always exists and coincides withthe median-ranked bliss point. This equilibrium is also unique.



Restricting Preferences

Definitions 3

The preferences of voters in A satisfy the single-crossing property if:If q > q′ and αi

′> αi (or if q < q′ and αi

′< αi), then

W (q;αi) ≥W (q′;αi) =⇒ W (q;αi′) ≥W (q′;αi

′)

Voters in A have intermediate preferences if:W (q;αi) = J(q) +K(αi)H(q), where K(αi) is momotonic in αi.

Both these conditions guarantee existence and unicity of the equilibrium.

Example - Redistributive Distortionary Taxation

wi = ci + V (xi)ci = (1− q)li + f , where f ≤ ql = qL(q) (gov. budget constraint)1− αi ≥ xi + li

Optimal labor supply: li = 1− α− V −1x (1− q)− (αi − α).W i(q;αi) = L(q) + V (1− L(q)− α)− (1− q)(αi − α).



Nonexistence of a Condorcet Winner


Electoral Competition

Electoral CompetitionA Simple Model of Public Finance

A society inahabited by a continuum of citizens.

wi = ci +H(g) (1)

ci = (1− τ)yi (2)

Government budget constraint:

τy = g (3)

=⇒ W i(g) = (y − g)yi

y+H(g)

=⇒ gi = H−1g (yi

y)

Normative benchmark:∫iW

i(g)dF = W (g) =⇒ g∗ = H−1g (1)



Downsian Electoral Competition

1 Candidates A,B commit to a policy g, in order to maximize thechance of winning p.

2 Elections are held.

3 The elected candidate implements his announced policy.

pA =

0 if Wm(gA) < Wm(gB)12 if Wm(gA) = Wm(gB)

1 if Wm(gA) > Wm(gB)

Trivially, the equilbrium will be: gm = H−1g (ym

y ) =⇒ Suboptimality.



Probabilistic Voting

Candidates may differ in other dimensions unrelated to the policy(ideology, a second policy dimension in which they cannot makecredible commitments).

Three groups: R,M ,P (yR > yM > yP ). Share of group j is αj , suchthat

∑j αj = 1.

Voter i of group J prefers candidate A if:

W J(gA) > W J(gB) + σij + δ (4)

σij and δ are distributed as U [− 12φj

, 12φj

] and U [− 12ψ ,

12ψ ].

Swing voter of group j: W J(gA) = W J(gB) + σj + δ




1 The two candidates announce their electoral platforms: gA,gB.

2 The actual value of δ is realized and all the uncertainty is resolved.


4 The elected candidate implements his announced policy.

Candidate A will maximize the following:

πA =∑J

αjφj(σj +

1

2φj

)(5)

pA = Prob

[πA ≥

1

2

]=

1

2+ψ

φ

[∑J

αjφj [W j(gA)−W j(gB)]

](6)

where φ =∑

J αjφj is the average density across groups.

FOC :∑J

αjφjHg(g) =1

y

∑J

αjφjyj =⇒ gS = H−1g

(∑J α

jφjyj

φy

)T. Persson and G. Tabellini (Book - 2000; Chapters 1-5) presented by Salvatore Lo Bello (Macro Reading Group UC3M)Political Economics - Explaining Economic Policy November 14, 2012 11 / 17



Figure : Electorate in a ProbabilisticVoting Model Figure : Bliss Points of Different Swing

Voters


Partisan Politicians


Policy Convergence (binding commitments)Two exogenous candidates (L, R), same timing as before.

pL =

0 if Wm(gL) < Wm(gR)12 if Wm(gL) = Wm(gR)

1 if Wm(gL) > Wm(gR)

Candidate L maximizes: E[WL(g)] = pLWL(gL) + (1− pL)WL(gR)

=⇒ gL = gR = gm

Policy Divergence (no binding commitments)

Only one credible announcemnt for L: gL = H−1g (yL

y )Candidate L wins if Wm(gL) > Wm(gR)



Partisan Politicians - Endogenous Candidates

1 Any citizen can enter as a candidate at a cost of ε.


3 The elected candidate sets the policy gP ; if nobody runs, g isimplemented.

No policy commitment =⇒ gp = H−1g (yP

y ).Unicity of equlibrium under : Wm(gm)−Wm(g) ≥ ε.Otherwise, infinitely many equilibria under:

Wm(gR) = Wm(gL)

1

2[WR(gR)−WR(gL)] ≥ ε

1

2[WL(gL)−WL(gR)] ≥ ε


Agency Problems

Agency Problems

Can the voters discipline rent-seeking politicians?Gov. budget constraint: τy = g + rCandidates now maximize E(vP ) = pP (R+ γr)

Under efficient electoral competition:

Voters’ preferences: W i(g) = (y − (g + r))yi

y +H(g)

pA =

0 if Wm(gA) < Wm(gB)12 if Wm(gA) = Wm(gB)

1 if Wm(gA) > Wm(gB)

gA = gB = gm = H−1g

(ym

y

)rA = rB = rm = 0


Agency Problems

Agency Problems

Under inefficient electoral competition (probabilistic voting):

pA =1

2+ ψ[W (gA, rA)−W (gA, rB)] (7)

∂[E(vA)]

∂gA= (R+ γrA)

∂pA∂gA

= (R+ γrA)ψWg(gA, rA) = 0 (8)

∂[E(vA)]

∂rA= (R+ γrA)

∂pA∂rA

+ pAγ = −(R+ γrA)ψ +1

2≤ 0 (9)

∂pA∂rA

= ψWr = −ψ (10)

=⇒ r = max

[0,

1

2ψ− R

γ

]Positive rents in equilibrium.


Summary

Summary

We analyzed two different electoral competition models: Downsianmodel and probabilistic voting =⇒ policy convergence.

Introducing partisan politicians it is possible to obtain policydivergence.

We analyzed the conflict of interests between voters and rent-seekingpoliticians. It is possible to obtain positive rents in equilibrium.

We abstained from agency problems in postelection politics modelsand from legislative bargaining.


Political Economics - Explaining Economic Policymkredler/ReadGr... · 2014-05-05 · Political...

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Transcript of Political Economics - Explaining Economic Policymkredler/ReadGr... · 2014-05-05 · Political...