Political budget cycles and election outcomes

Jeroen Klomp 0 1 2 3 Jakob de Haan 0 1 2 3 JEL Classification E 0 1 2 3 H 0 1 2 3 0 J. de Haan ( ) De Nederlandsche Bank, PO Box 98, 1000 AB Amsterdam, The Netherlands 1 J. de Haan University of Groningen , Groningen, The Netherlands 2 J. Klomp Wageningen University , Wageningen, The Netherlands 3 J. de Haan CESifo, Munich, Germany This paper addresses two empirical questions. Is fiscal policy affected by upcoming elections? If so, do election-motivated fiscal policies enhance the probability of re-election of the incumbent? Employing data for 65 democratic countries over 1975-2005 in a semi-pooled panel model, we find that in most countries fiscal policy is hardly affected by elections. The countries for which we find a significant political budget cycle are very diverse. They include 'young' democracies but also 'established' democracies. In countries with a political budget cycle, election-motivated fiscal policies have a significant positive (but fairly small) effect on the electoral support for the political parties in government. This paper addresses two empirical questions. Is fiscal policy affected by upcoming elections? If so, do election-motivated fiscal policies enhance the probability of re-election of the incumbent? As to the first issue: several recent studies suggest that political budget cycles occur, but there is disagreement about the circumstances making election-motivated budget deficits - more likely. For instance, opinions differ as to whether political budget cycles are more likely in young democracies compared to established democracies (Persson and Tabellini 2002; Shi and Svensson 2006; Brender and Drazen 2005). It is quite surprising that the second issue has hardly been researched. Brender and Drazen (2008) do not find evidence that election-motivated budget deficits enhance the chances of re-election of the incumbent. In fact, they even report that these deficits reduce the probability that an incumbent is re-elected as voters punish politicians who create deficits.1 Our analysis is based on data for 65 democratic countries over the period 1975 to 2005. To estimate the impact of election-induced fiscal policy on the incumbents support we use a two-step approach. In the first step, we estimate whether elections affect the governments budget balance and government spending. Most recent studies on election-motivated fiscal policy at the national level use panel models for a large sample of countries, pooling the data. However, in view of the heterogeneity of the countries included in those studies, it is questionable whether the data can be pooled (Pesaran et al. 1996). According to Pesaran et al. (1999), neglecting parameter heterogeneity in a pooled panel estimation procedure can produce inconsistent and misleading estimates of the long-run coefficients. Tests of heterogeneity indicate that our data cannot be pooled. We therefore use a semi-pooled model suggested by Hsiao et al. (1999). In this model, the political budget cycle (PBC) effect varies across countries, while the other control variables are restricted to be homogenous. Employing an election variable that takes the timing of the election in the course of the year into account as suggested by Franzese (2000), we find that fiscal policy in mostbut not allcountries in our sample is hardly affected by upcoming elections. The countries for which we find a significant political budget cycle are very diverse. They include young democracies but also established democracies. In the second step of our analysis, we examine for countries with election-motivated fiscal policy, whether this PBC increases electoral support for the incumbent. In contrast to Brender and Drazen (2008), we take into account that many countries have coalition governments (Hanusch 2012). We therefore focus on votes received by political parties participating in the government. We conclude that government spending has a significant positive (but fairly small) effect on the electoral support for the parties in government. We also find an indirect positive effect of election-motivated fiscal policy through its impact on economic growth. The remainder of the paper is structured as follows. The next section discusses in more detail how our contribution is related to previous studies of political budget cycles and economic voting. Section 3 shows our results for the influence of elections on fiscal policy, while Sect. 4 presents our estimates of the relationship between political budget cycles and election outcomes. The final section offers our conclusions. 2 Previous studies We combine two strands of the political economy literature. The first one addresses the existence of a political budget cycle. Older theoretical PBC models emphasize the incumbents intention to secure re-election by maximizing his/her expected vote share at the next election (Nordhaus 1975). It is assumed that the electorate is backward looking and evaluates the government on the basis of its past track record. As a result, these models imply that governments, regardless of ideological orientation, adopt expansionary fiscal policies in 1In Sect. 2, we will also discuss some recent studies on the effect of fiscal policy on local election outcomes. the late year(s) of their terms in office in order to stimulate the economy (Potrafke 2012). More recent PBC models emphasize the role of temporary information asymmetries regarding the politicians competence level in explaining electoral cycles in fiscal policy. In these models, signalling is the driving force behind the PBC (see, e.g., Rogoff and Sibert 1988; Persson and Tabellini 2002; and Shi and Svensson 2006). For instance, in the moral hazard model of political competition of Shi and Svensson (2006), politicians may behave opportunistically even if most voters know the governments policy, but some voters are uninformed. The larger is the number of voters that fail (ex ante) to distinguish electionmotivated fiscal policy manipulations from incumbent competence, the more the incumbent profits from boosting expenditures before an election. Alt and Lassen (2006) argue that the greater is the transparency of the political process, the lower is the probability that politicians behave opportunistically. Drazen and Eslava (2006, 2010) explain the relationship between opportunistic spending of the government and the election outcome within a game theoretic framework. The incumbent uses public expenditure to attract votes. In equilibrium, expenditures targeted to particular voters are higher in an election period than in a non-election period. Swing voters will rationally vote for the incumbent who provides more targeted expenditures even though they know that such expenditures may be electorally motivated. Brender and Drazen (2005) argue that until recently a PBC was generally thought to be a phenomenon of less developed economies. For instance, Schuknecht (1996) reports evidence for a PBC in his samp (...truncated)