Strategic redistribution: The political economy of populism in Latin America

European Journal of Political Economy 34 (2014) 39–51

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Strategic redistribution: The political economy of populism in Latin America Gabriel Leon ⁎ Faculty of Economics, St Catharine's College, University of Cambridge, Austin Robinson Building, Sidgwick Avenue, Cambridge CB3 9DD, United Kingdom

a r t i c l e

i n f o

Article history: Received 16 October 2012 Received in revised form 12 December 2013 Accepted 17 December 2013 Available online 27 December 2013 JEL classification: H3 H5 Keywords: Populism Neo-liberalism Inequality Redistribution Military Coup d'Etat

a b s t r a c t Why do some countries in Latin America redistribute too much (“left-wing populism”), while others allow high levels of inequality to persist or even increase over time (“neo-liberalism”)? We argue that when a group's political influence is increasing in its wealth, there is a strategic motive for redistribution: by taking money away from a group, its ability to influence future policy is reduced. Populism arises when the poor respond to this strategic motive, while neo-liberalism results when the rich use their wealth to limit redistribution. Assuming that wealth increases political influence because it enables a group to stage a coup, we find that populism is both more likely and more extreme when the military is biased in favor of the rich. We conclude by discussing the policies of Hugo Chavez in Venezuela and Alberto Fujimori in Peru in light of our findings. © 2014 Elsevier B.V. All rights reserved.

“[P]opulism is rooted in the distributive political struggles that have characterized Latin America since the beginning of the century. Although such redistributive struggles are ubiquitous in the region, variations in institutional arrangements across countries and time periods determine the extent to which they are expressed through populist policies.”(Kaufman and Stallings, 1991) 1. Introduction Some low-income democracies in Latin America engage in redistribution that is excessive and generates substantial deadweight losses, yet others adopt redistributive policies that are inadequate and allow high levels of inequality to persist or even increase over time. The news media often associate the first of these policies with left-wing populism, where very high levels of redistribution typically increase short-run consumption, but at the expense of future output and consumption. These policies are still common in Latin America; those of Hugo Chavez in Venezuela, Evo Morales in Bolivia, and Daniel Ortega in Nicaragua are some recent examples. The second type of policies is often associated with neo-liberalism, which generally involves market-friendly policies and the absence of government initiatives to redress inequality. In Latin America, policies of this type were implemented in the 1990s following the Washington Consensus.1 It is generally acknowledged that populist and neo-liberal policies have political, rather than economic, goals. However, standard political economy frameworks cannot satisfactorily explain these policy choices. The reasoning behind models of the ⁎ Tel.: +44 1223 335 285. E-mail address: [email protected]: http://www.caths.cam.ac.uk/personal/gleon. 1 There are many definitions of the term ‘populism’ and so the concept can be quite vague; see Weyland (2001) for a discussion. In this paper we follow Dornbush and Edwards (1991) and use an economic definition. Other definitions exist; for example, one can think of populist policies as those that are popular, but cannot be implemented. See Conniff (1999) for an excellent discussion of the history of populism in Latin America. 0176-2680/$ – see front matter © 2014 Elsevier B.V. All rights reserved. http://dx.doi.org/10.1016/j.ejpoleco.2013.12.005

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G. Leon / European Journal of Political Economy 34 (2014) 39–51

median voter like those in Meltzer and Richard (1981), Alesina and Rodrik (1994) and Persson and Tabellini (1994), where the tax rate is determined by a median voter who trades off transfers and deadweight losses, would generally predict that higher inequality would result in greater redistribution. This is the opposite of what happens during neo-liberal episodes. Furthermore, populism often imposes substantial deadweight losses on the economy, and it is unclear why this would be optimal for the median voter who chooses policy in these models.2 This paper presents a new framework that can explain why the low income democracies of Latin America often implement extreme redistribution policies; for example, through the expropriation and redistribution of land. Our explanation is based on the simple but important observation that money is a central determinant of a group's ability to influence policy. This is particularly true in countries with corrupt militaries, where the rich can enlist the support of military officers for a rebellion, and so wealth provides the rich with more voice over policy than democracy's intended “one-man-one-vote.” This has the fundamental implication that redistribution not only re-allocates money, but it also re-allocates the ability to influence policy in the future. This endogeneity means that there is a strategic motive for redistribution: by taking money away from a group, its future ability to oppose policy is diminished. Concern over the relative influence of other groups may thus be a central factor in determining how much redistribution each particular group favors. One way in which money can affect a group's influence is that it may allow it to drive a government out of office. The threat of doing so can then be used to influence policy. We focus on one specific method for removing governments that is particularly relevant in the Latin American context: the coup d'Etat. Money is required to buy the support of members of the armed forces for such a plot, and many well-known coups have been aimed at removing governments that threatened the interests of the rich, including Pinochet's 1973 coup in Chile and the 2002 attempted coup against Chavez in Venezuela. Taking into account the importance of wealth inequality in determining political influence introduces two considerations into the policy decision. First, redistribution may be constrained by the opposition of the rich, who may use their resources to enlist the help of the military and threaten a coup. This may force the poor to pursue a low amount of redistribution and potentially give rise to neo-liberalism; we illustrate this with a case study of Alberto Fujimori's government in Peru. Second, the poor will consider the effect of redistribution on the future distribution of wealth, and by implication, on their own future ability to set policy. This can give rise to populism: high redistribution, by reducing the future wealth of the rich, increases the poor's ability to set future policy. We later argue that Hugo Chavez's policy choices in Venezuela can be rationalized in this way. When inequality is low, the threat of a coup places no constraint on redistribution. In this case the strategic incentive is weak and policy is set largely based on the base effect: low redistribution allows the rich to accumulate wealth, which by increasing their future wealth allows for higher redistribution tomorrow. When inequality is high, coups become a genuine concern and redistribution is constrained by their threat. This provides a rationale for redistributing as much as possible (conditional on not triggering a coup): high redistribution lowers the future wealth of the rich, decreasing the threat of a coup tomorrow and relaxing future constraints on redistribution. We refer to the fact that higher redistribution today may allow for higher redistribution tomorrow as the rate effect. In our model, the military's bias in favor of the rich is instrumental in determining whether populism or neo-liberalism will arise. The greater this bias, the lower the level of inequality for which redistribution will be constrained. It also causes the amount of redistribution preferred by the poor to be greater, as they must reduce the wealth of the rich further to keep them from blocking future policy. This potentially gives rise to more excessive populism, which might explain why populism is so common in Latin America, a region where the military has generally had an intrinsic bias in favor of the economic elites. This paper makes two main contributions. First, it provides an explanation for the extreme redistribution policies implemented by many low-income democracies in Latin America. Populism is puzzling because it is generally very destructive. We show that it is not necessary to rely on the poor being myopic or having bounded rationality to explain these policies: the institutional constraints under which low-income democracies operate may create the incentives for the adoption of populist policies. Second, this paper improves our understanding of the military's potential impact on economic policy, as we show how its bias may affect policy decisions. Although the literature has emphasized other channels (in particular, the role of bribes or campaign contributions), in Latin American countries the threat of a coup is a widely used and very effective pressure mechanism. It is then possible that the failure of many Latin American democracies to adopt better policies is partly due to their corrupt militaries.3 2 Harms and Zink (2003) review the literature that looks at the forces that limit the amount of redistribution in a setting similar to mine: democratic societies where the poor majority have comprehensive political rights. In these papers majority-voting does not provide a good description of how the extent of redistribution is determined, as there are other forces constraining this decision. The authors then explore why in a majority-voting setting the poor may find it in their self-interest to choose a moderate degree of redistribution. More generally, there are a number of issues with using median voter models to analyze representative democracy. For example, Tridimas and Winer (2005) argue that these models are problematic because they do not allow for a distinction between the economic welfare and political influence of different groups. A better set of models use probabilistic voting; as shown by Coughlin and Nitzan (1981), these can reconcile political outcomes with a Nash-type social welfare function. Hettich and Winer (1999) use probabilistic voting models to study how tax policy can be an outcome of democratic choices. 3 Corruption and rent-seeking can explain a large number of policy outcomes. Anne Krueger (1974) argues that the creation of contestable rents leads to rentseeking, and that this often presents an obstacle to economic and political reforms that would reduce these contestable rents. Verwimp (2003) argues for a connection between rent-seeking in Rwanda (in particular, through the manipulation of the producer price of coffee) and the 1994 genocide. More closely related to our analysis, McChesney (1987) suggests that political competition, and in particular the need to receive campaign contributions, can induce politicians to create new sources of rents (or destroy old ones). Although it is possible that populist policies allow for corruption or rent-seeking, explanations based exclusively on these two phenomena cannot explain why voters usually support these policies. One alternative would be to follow Congleton (1991), who shows how economic groups can try to persuade voters to support particular policies. Alternatively, Kiss (2012) argues that an incumbent politician may seek to polarize the electorate because that reduces its ability to hold him accountable.

G. Leon / European Journal of Political Economy 34 (2014) 39–51

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This paper is related to a growing literature on populism. Mejia and Posada (2007) show that an oligarchy may distribute resources to the masses in order to pre-empt a revolution, and call this “populist redistribution” because it is aimed at preserving the elite's political control. Debs and Helmke (2010) show that the probability that a left-leaning candidate is elected as a function of inequality follows an inverted-U relationship, and present empirical evidence from Latin America that is consistent with this prediction. Acemoglu et al. (forthcoming) extend the political agency framework and explain populism by arguing that honest politicians can signal that they are not captured by the elite by choosing policies to the left of the median voter. Maskin and Tirole (2004) present a political agency model of the type described in Besley (2006), where an incumbent chooses a popular policy because it helps him win re-election, despite knowing that a better policy is available. Jennings (2011) extends the political agency framework to incorporate both expressive and ‘rational irrational’ voters, and shows that this might lead to the existence of ‘populist’ politicians who will always do what the majority of voters want, even if it is not in the voters' best interest. Tullock (1971) develops a framework where individuals derive expressive utility from choices and opinions that confirm their own views of themselves, and Hillman (2010) uses a similar framework to argue that societies may fall into expressive-policy traps; it is possible that populist policies are sometime supported primarily because of an expressive motive. Binswanger and Prüfer (2012) extend the model in Maskin and Tirole (2004) by incorporating bounded rationality.4 There is very little work in economics on the military and its potential impact on the economy. Acemoglu et al. (2010) look at the military as an agent of the elite, and show when the military will protect a nondemocratic regime and when it will take over and establish a military dictatorship. Besley and Robinson (2010) look at the optimal size of the military; their main finding is that in the absence of commitment, the government will create a tin pot military in order to avoid coups; when commitment is possible, larger militaries can be created without triggering coups by paying soldiers an efficiency wage. In Leon (forthcoming-a, b), I present a model in which military involvement in politics is determined by the need to fight wars. Kimenyi and Mbaku (1995) show empirically that there is a negative relationship between transfers to the military and democracy. Gupta et al. (2001) establish that there is an empirical relationship between corruption and military spending (as a share of GDP or government spending), and between corruption and arms purchases (as a share of GDP or government spending). They explain that this relationship arises both because of supply-side factors, e.g. when arms producers pay bribes to win contracts, and demand-side factors, e.g. when the military engages in activities that allow for corruption. In an empirical study (Leon, 2013a), I find that a country is more likely to experience a coup when its military expenditures are low, suggesting that money motivates the military to intervene. Alptekin and Levine (2012) conduct a meta-analysis of the literature that examines the relationship between military spending and growth, and find that there is no evidence of a negative relationship between military spending and growth (which would follow from crowding out), and that the relationship is positive in developed countries (because of supply-side spillovers and aggregate demand effects). The rest of this paper is organized as follows: Section 2 presents the model, and Section 3 solves for the equilibrium. Section 4 discusses the role of the military, Section 5 illustrates our results with a discussion of Hugo Chavez's government in Venezuela and Alberto Fujimori's government in Peru, and Section 6 concludes. The proofs can be found in the Appendix. 2. Redistribution and coups 2.1. Definitions: populism and neo-liberalism The terms populism and neo-liberalism are widely used in the popular press and everyday conversation, and their intended meaning can vary considerably depending on the context. However, populism generally refers to “too much” redistribution, while neo-liberalism involves “too little.” We measure this with respect to the optimal amount of redistribution that results from the poor solving a simple intertemporal optimization problem, where they weigh off the benefits from increased income against the cost of collection, both administrative and in terms of intertemporal distortions. We then say that a redistribution policy is populist when it involves redistribution greater than the amount given by the benchmark, while it is neo-liberal when redistribution is below that level. 2.2. The model There are two groups, the poor (P) and the rich (R), and two periods t ∈ {1,2}. At the end of period t the poor hold total wealth kpt , while the rich have krt ; at the beginning of period 1 they hold initial wealth kp0 and kr0. All members of a group are homogeneous, there is no population growth, and the poor are assumed to be more numerous. We measure wealth inequality as the ratio of the total wealth of the rich to that of the poor: It ¼

k rt : k pt

4 This paper is also related to Falkinger (1999), who shows that the threat of social instability can be countered through redistribution, but that in countries in the early stages of development there may be no income distribution that ensures social stability. In a related model, Acemoglu and Robinson (2001, 2005) show that the tax rate may be constrained by the threat of a coup. Dal Bo and Di Tella (2003) show that groups can employ threats to ‘capture’ politicians. Bar-El (2009) argues that threats against a dictator can be a way of extracting concessions.

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G. Leon / European Journal of Political Economy 34 (2014) 39–51

We assume that groups only value the wealth they hold at the end of each period, and that there is no consumption.5 Their utility is then given by
 i i i i u k1 ; k2 ¼ k1 þ βk2 for i ¼ p; r where β ≤ 1 is a discount factor. We assume that the poor choose the government that is in power at t = 1, and so indirectly they choose the fraction τ1 of the wealth held by the rich that is expropriated at the beginning of period 1. We abstract from political agency considerations, and assume that the government implements the rate τ preferred by the poor.6 Furthermore, it is possible that a fraction of what is expropriated is kept by the government (and that this is a primary motivation for expropriating the rich in the first place); however, how the expropriated wealth is divided between the government and the poor is not important for our results.7 e . The parameter γ e measures the military's The government chooses the leader of the military, who will have a bias given by γ bias in favor of the rich: a larger bias makes coups more likely to succeed (for a given level of inequality). Furthermore, we assume   e ∈ γ; γ H . This implies that the extent to which the government can that officers will have a bias in the region [γ,γ H], so that γ choose the military's bias is constrained by the officers from which it must choose.8 Expropriation is costly, where the cost is given by a continuously differentiable convex function C(τt):[0,1] → [0,1], where C(0) = 0, C′(0) = 0, and C′(1) = 1. We assume that the rich are expropriated, and the poor (and the government) accumulate the net proceeds.9 For example, the government might expropriate private lands and distribute some of it to the poor, while government officials might keep some of the best land for themselves. The rich must decide whether to stage a coup d'Etat to avoid expropriation. A coup in period t succeeds with probability   e I t−1 , where It − 1 measures wealth inequality at the beginning of period t. We further assume that σ (.) is convex, σ γ   e AI 1 b1, so that the probability of success is an increasing continuously differentiable and that σ(0) = 0, σ′(0) ≥ βA2 and σ ′ γ function of inequality. The assumptions ensure that βA2 ≤ σ′(.) ≤ 1, where AI1 is the maximum inequality possible in any period. If a coup is staged at time t, we assume that no redistribution happens in that period or the next, and that no second coup can take place in that period. Coups are costly, and we capture this by assuming that the loser experiences the destruction of a proportion 1 − δ of its wealth. This is a very simple setup that captures the essence of what the rich can achieve by staging a coup: they can avoid redistribution, but at the risk of losing and experiencing a destruction of 1 − δ of their wealth. This is the “defensive” motive for coups.10 We have explicitly left out the second benefit that coups may bring: they may allow the rich to take over the government and expropriate the poor. Our assumptions rule out this “expropriation” motive, and we focus entirely on the “defensive” aspect of coups. Case study evidence shows that coups are often triggered when the interests of the elite are threatened, suggesting that the defensive motive is quite important in practice. We assume that a coup can only take place if the rich support it; in particular, the military cannot stage a coup independently.11 Political science provides a large number of examples in support of the view that the military relies on certain civilian groups to come to and stay in power. For example, the collapse of the Argentine dictatorship (1976–1983) is often attributed to its loss of support from the business elite following years of economic mismanagement. Similarly, Trinkunas (2005) explains that the military recognized the election of Romulo Betancourt as president of Venezuela in 1958 only after the business federation emphatically expressed its opposition to any intervention by the armed forces. We assume that wealth grows at a (normalized) factor of 1 for the poor and A N 1 for the rich. The parameter A measures the difference in productivity between the rich and the poor, with the rich being more productive. This difference may arise because of differences in education, for example. In the absence of expropriation, it follows that r

r

k tþ1 ¼ Ak t ; 5

p

p

k tþ1 ¼ k t

ð1Þ

We are essentially assuming that groups derive utility from holding inventories; see, for example, Adda and Cooper (2003, p. 20). Our goal is to model class struggle, and so we abstract from the political agency problems that may arise between a government and the voters. Instead, we assume that the government implements the policy preferred by the poor. In the language used by Besley (2006), we assume that the government is ‘disciplined’ by the voters, so that the desire to win re-election is enough to induce the government to act as the voters wish. We also rule out the possibility of the rich bribing the government in order to avoid redistribution, or situations in which the government acts in a selfish manner that hurts the masses. This allows us to focus on class conflict, which we believe is the main cause behind populism in Latin America. 7 Hillman and Ursprung (2000) show that rent-seeking might increase during political liberalization, so that it might be particularly severe in the types of democracies we focus on in this paper. Kahana and Qijun (2010) discuss how corruption might be endemic, and spread from the high ranks of the bureaucracy to the lower ranks. These papers emphasize the fact that the benefits from being in office are often related to rent-seeking or corruption; in this paper this is all bundled under the term ‘expropriation’. Dabla-Norris and Wade (2002) argue that initial wealth affects the choice between spending time extracting rents and engaging in productive activities. Gupta et al. (2002) present empirical evidence that corruption increases income inequality. 8 Dewan and Myatt (2010) show that a shrinking talent pool from which to choose government ministers can affect the quality of the government. (This is particularly true in parliamentary democracies where the ministers must be members of parliament). 9 The expropriation is constrained to 0 ≤ τt ≤ 1. 10 For simplicity, we assume that the losses experienced by the losing side in a coup are symmetric. The nature of the results and the conclusions we draw from them are not affected if we allow for asymmetric losses. 11 Naturally, in practice coups are sometimes staged by the military without any support from the elites; we abstract from that possibility in order to focus on the strategic interaction between the rich and the poor. 6

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and Itþ1 ¼ AIt :

ð2Þ

Inequality increases in this case. We place the following constraints on the parameters of the problem: Parameter Assumption 1: βA b 1. This is a standard assumption.   e AI1 ≤1: This assumption allows us to avoid having to place an explicit constraint on σ(.). Parameter Assumption 2: σ γ 2.2.1. Timeline e. 2.2.1.1. Period 1. 0) The poor appoint the leader of the military, and hence set the bias γ 1) The poor choose the redistribution policy, τ1. 2) The rich decide whether to stage a coup. (i) If no coup is staged, the redistribution policy is implemented. (ii) If a successful coup is staged, the poor lose a proportion 1 − δ of their wealth and no redistribution takes place. (iii) If a failed coup is staged, the rich lose a proportion 1 − δ of their wealth and no redistribution takes place. 3) Production takes place. 2.2.1.2. Period 2. 1) If no coup was staged in period 1, the poor announce τ2. 2) If no coup was staged in period 1, the rich decide whether to stage a coup. (i) If no coup is staged, redistribution takes place. (ii) If a successful coup is staged, the poor lose a proportion 1 − δ of their wealth and no redistribution takes place. (iii) If a failed coup is staged, the rich lose a proportion 1 − δ of their wealth and no redistribution takes place. 3) Production takes place. 3. Equilibrium redistribution and inequality 3.1. Benchmark case We first solve the model in the benchmark case in which the rich are assumed to be unable to stage coups. The problem for the poor can be written as p

p

max k1 þ βk2 ; τ1 ;τ2

such that 0≤τ 1 ; τ2 ≤1: Using the fact that k p1 = k p0 + (τ1 − C(τ1))kr0, kp2 = k p1 + (τ2 − C(τ2))k r1 and kr1 = A(1 − τ1)k r0, we can write the poor's problem as follows: max

0 ≤ τ1 ≤ 1

  p  r r ð1 þ βÞ k0 þ ðτ 1 −C ðτ 1 ÞÞk0 þ β max ðτ2 −C ðτ2 ÞÞAð1−τ1 Þk0 : 0 ≤ τ2 ≤ 1

ð3Þ

This is a standard two period optimization problem where the poor must decide how much to redistribute today and how much to leave to be redistributed tomorrow. Redistribution period 1 brings a benefit of τ1 at a convex cost of C(τ1), but causes the future wealth of the rich to decrease. We call this the base effect: higher redistribution today reduces the wealth that can be redistributed tomorrow. Leaving the money in the hands of the rich for an extra period allows the poor to benefit from their higher productivity A. We begin by solving for τ^2 . It is straightforward to see that the first order condition is given by
 ′ r 1−C ðτ^2 Þ Að1−τ1 Þk0 ¼ 0 so that τ^2 ¼ 1.12 We can then rewrite Eq. (3) as follows:  p r r max ð1 þ βÞ k 0 þ ðτ1 −C ðτ 1 ÞÞk 0 þ βð1−C ð1ÞÞAð1−τ1 Þk 0 :

0 ≤ τ1 ≤ 1

12

We show later that τ^1 b1.

ð4Þ

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G. Leon / European Journal of Political Economy 34 (2014) 39–51

The first order condition for this problem is
 βA ′ b C τ^1 ¼ 1− ð1−C ð1ÞÞ; 1þβ

ð5Þ

where the superscript b refers to the benchmark case. b

Lemma 1. There exists a unique 0bτ^1 b1, and it is decreasing in A and β. When the rich are more productive (higher A), it is optimal for the poor to leave a larger proportion of wealth in their hands, since they can take advantage of this greater productivity by redistributing in period 2. When the poor are more patient (higher β), it is also optimal for them to leave a larger proportion of the wealth to be redistributed in the future, for the usual reasons. b Although τ^ b1 is not a function of inequality, initial inequality will determine whether τ^ 1 causes inequality to increase. In fact, to check when inequality will increase over time, we check for when I1 N I0, which gives
 A 1−τ^ b1 −1
 : I0 b τ^b1 −C τ^ b1 In words, inequality will increase whenever it is low, as given by the expression above, and it will decrease otherwise. High inequality will tend to fall like in the standard median voter models of redistribution. Here, however, the effect is not due to the impact of inequality on policy. Instead, policy remains constant, so the amount that is redistributed increases with inequality. This, in turn, increases the proportion of the economy that is transferred to the poor. When inequality is large, this transfer offsets the push towards even greater inequality induced by the differences in productivity A. (Greater inequality also implies that the
 b r proportion of the economy that is being destroyed as a consequence of redistribution, C τ^ 1 k0 , is larger.) In practice, this setup is unrealistic because it assumes that the poor are free to set their preferred level of redistribution in every period. This is unlikely to be the case, as the rich may use their resources to oppose redistribution. This makes it potentially dangerous to leave money in the hands of the rich to take advantage of their greater productivity, as this money might allow the rich to block future redistribution. We model this possibility in the next section by allowing the rich to stage a coup d'Etat in b

response to the policy set by the poor, and characterize populism and neo-liberalism as deviations from the period 1 choice τ^ 1 . 3.2. Populism and neo-liberalism e ¼ γ. We now First, notice that the government will choose the officer who is most favorable towards the regime; that is, γ proceed by solving backwards. 3.2.1. Period 2 The poor set a policy τ2 and the rich decide whether to stage a coup. If the rich stage a coup, it succeeds with probability σ(γI1). The rich will not stage a coup if r

r

r

Að1−τ 2 Þk1 ≥ Aσ ðγI1 Þk 1 þ Að1−σ ðγI1 ÞÞδk 1 ; which is the period 2 no coup constraint. The left hand side is the value of not staging a coup, while the right hand side is the expected payoff from doing so. Notice that the period 2 policy only affects the left hand side. Solving for this rate, τ2 ≤ ð1−δÞð1−σ ðγI1 ÞÞ ≡ τ2 : This is a purely defensive constraint: the rich stage a coup to avoid redistribution, even if at the risk of failing and losing a proportion 1 − δ of their wealth. Notice that as the probability of success increases, the constraint tightens. This will be the case when either inequality or the military's bias increases, reflecting how these factors may impose a tighter constraint on the policies the poor can choose. In particular, we have shown that τ′2 ðτ 1 ÞN0; higher redistribution, by decreasing inequality, relaxes the constraint faced in the next period. Finally, as the destructiveness of a failed coup 1 − δ increases, the constraint is relaxed. The problem for the poor in period 2 is then  p p p r max ð1−σ ðγI1 ÞÞk1 þ σ ðγI1 Þδk 1 ; max k 1 þ ðτ 2 −C ðτ 2 ÞÞk1 0 ≤ τ2 ≤ τ2

ð6Þ

where they must choose between triggering a coup and obtaining the expected payoff in the first entry of Eq. (6), and setting a policy that fulfills the no coup constraint and receiving the payoff in the second entry. Notice that the first entry is always less than

G. Leon / European Journal of Political Economy 34 (2014) 39–51

45

or equal to the second (this follows from (1 − σ(γI1))k p1 + σ(γI1)δk p1 ≤ k p1), so that there will be no coups in period 2. The problem then simplifies to p

r

max k1 þ ðτ 2 −C ðτ2 ÞÞk1 :

0 ≤ τ2 ≤ τ2

If we ignore the constraint on policy, it is straightforward to see that the first order condition for this problem implies that the optimal policy is τ2 = 1. Furthermore, the second order condition − C″(τ2)kr1 b 0 is always fulfilled, and so we know that the constraint τ2 ≤τ2 will bind. The following lemma summarizes these results: Lemma 2. The optimal policy in period 2 is given by τ^2 ¼ τ2 ¼ ð1−δÞð1−σ ðγI1 ÞÞ. 3.2.2. Period 1 In this period the poor must set τ1 and the rich must decide whether to respond by staging a coup. If they stage a coup, the rich do not face redistribution again. If the coup fails, however, they experience a proportional loss of 1 − δ of their wealth. It follows that they will not stage a coup if r

Að1−τ1 Þk0 þ βA

2


h i h i r r 2 r r 2 r 1−τ2 Þð1−τ1 Þk0 ≥ σ ðγI0 Þ Ak0 þ βA k0 þ ð1−σ ðγI0 ÞÞ Aδk0 þ βA δk0 :

This is the period 1 no coup constraint. The left hand side is the value of not staging a coup, while the right hand side is the expected payoff from doing so. Notice that the period 1 policy only affects the left hand side; it enters both directly and through its effect on τ 2 . Since τ ′2 ðτ1 ÞN0, coups will be avoided if τ1 ≤τ1 , where τ 1 is the solution to ð1−τ 1 Þ½1 þ βAð1−τ2 Þ ¼ ½δ þ σ ðγI0 Þð1−δÞ½1 þ βA:

ð7Þ

Lemma 3. τ 1 ðI0 Þ is strictly decreasing in initial wealth inequality I0. An increase in initial inequality increases a coup's probability of success, and so decreases the amount of redistribution the rich will tolerate. (It also decreases τ2 , which partially offsets the effect). The poor must decide between triggering a coup and setting a policy 0 ≤τ1 ≤τ 1 . Their period 1 problem is 9 8  p  p p p = < ð1−σ ðγI 1 ÞÞ k0 þ βk0 þ σ ðγI1 Þδ k0 þ βk 0 ;   p r r max ð1 þ βÞ k 0 þ ðτ 1 −C ðτ1 ÞÞk0 þ βðτ2 −C ðτ 2 ÞÞAð1−τ 1 Þk0 ;: : 0 ≤max τ ≤τ 1

1

The first entry shows the expected value from triggering a coup, which means that there is no redistribution. The second shows the payoff from not triggering a coup, and includes the amount that is redistributed in both periods 1 and 2. It is straightforward to verify that the second entry will always be greater than or equal to the first, and so the statement of the poor's problem simplifies to

Fig. 1. Optimal Redistribution (Unconstrained).

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G. Leon / European Journal of Political Economy 34 (2014) 39–51

 p   r r max ð1 þ βÞ k0 þ ðτ1 −C ðτ1 ÞÞk0 þ β τ 2 −C τ 2 ÞÞAð1−τ 1 Þk0

0 ≤ τ1 ≤ τ1

ð8Þ

where τ2 ðτ 1 Þ depends on the choice of policy in period 1. This is similar to problem (4) except that now τ^2 ¼ τ 2 instead of 1. This difference is important because an increase in τ1 now has two effects on the second term of expression (8). As before, there is a base effect as higher redistribution diminishes the wealth that can be redistributed in period 2. In addition, now higher redistribution in period 1 increases the policy τ2 that is chosen in period 2. We call the latter the rate effect, and it is this effect that gives rise to the strategic motive for redistribution. The first order condition for this problem is given by
  ∂τ
′ r r ′ r ð1 þ βÞ 1−C ðτ1 Þ k0 −βAðτ 2 −C ðτ2 ÞÞk0 þ βA 2 1−C ðτ2 Þ ð1−τ1 Þk0 ¼ 0 ∂τ1

ð9Þ

which differs from that in the benchmark case (Eq. (5)) in two respects: first, we again have τ^2 ¼ τ 2 instead of 1, since the policy choice is constrained. Second, there is an extra term (the third term in expression (9)) that captures the rate effect. Notice that the base effect, as captured by the second term, and the rate effect work in opposite directions. We can now establish the following: Lemma 4. There exists a unique τ^1 that solves the optimization problem (Eq. (8)) for the poor. In the absence of a constraint on ^ u1 would always be interior. policy, this solution π We can then characterize this optimal policy in the absence of constraints: u b Lemma 5. The unconstrained optimal policy is always greater than the benchmark, τ^1 N τ^1 , and it is strictly increasing in initial inequality I0.

The strategic motive for redistribution results in the poor preferring higher redistribution. Redistribution increases with initial inequality I0, because higher inequality means that a coup is more likely to succeed, which tightens the constraint on policy. It u b then follows that the difference between the unconstrained and the benchmark policies τ^1 −τ^1 will increase with initial inequality. Fig. 1 illustrates this result. It will not always be possible for the poor to set this preferred rate, however. As we have shown, redistribution in period 1 will be subject to the period 1 no coup constraint, which will bind when initial inequality is high. We can establish the following result: u

Lemma 6. If τ^1 ðI0 ¼ 0Þb1−δ, there exists a value of initial inequality Ic such that 

  u c c   c  u c  1−τ^1 I Þ 1 þ βA 1−τ2 τ^1 I ; I ÞÞ− δ þ σ γI ð1−δÞ ½1 þ βA ¼ 0:

u For low values of initial inequality I0 b Ic, the policy will be that preferred by the poor τ^1 ¼ τ^1 ðI0 Þ, while for high values of initial c inequality I0 N I it will be constrained to τ^1 ¼ τ1 ðI0 Þ. The policy preferred by the poor increases with I0, but so does the ability of the rich to constrain this policy, since it is then that coups are likely to succeed and represent a threat to the poor.13 For large enough values of initial inequality, the amount the poor would like to be redistributed exceeds the amount the rich will allow, and so the redistribution choice is constrained. Fig. 2 illustrates this result. u  Notice that the highest amount of redistribution will be for I0 = Ic and will equal τ^1 Ic . The following remark then follows:

Remark 1. The observed choice will be a non-monotonic function of initial inequality, increasing at low levels but decreasing at high levels of inequality. We can now establish the main result of this paper. b Proposition 1. If τ^1 ðI0 ¼ 0Þb1−δ, there exists a value of initial inequality I⁎ such that


h

i     b b  − δ þ σ γI ð1−δÞ ½1 þ βA ¼ 0: 1−τ^1 1 þ βA 1−τ2 τ^1 ; I For values of initial inequality below I⁎, the economy will experience populism in period 1. For values above I⁎, it will experience neo-liberalism. This is the value of initial inequality at which the constraint is equal to the benchmark level of redistribution. For values below it, the policy may or may not be constrained, but it will be greater than the benchmark. For values of initial inequality over I⁎, the b policy will be constrained and will equal τ1 , which will be below the benchmark rate τ^1 . 13

u The condition τ^1 ðI 0 ¼ 0Þb1−δ simply ensures that the constraint does not lie below the unconstrained optimal policy for all values of I0.

G. Leon / European Journal of Political Economy 34 (2014) 39–51

47

Fig. 2. Optimal Redistribution (Constrained).

Notice that the introduction of coups gives rise to populism and neo-liberalism, but does not allow for the benchmark except at I⁎. This is simply a consequence of the starkness of our definitions. In practice, for values slightly above or below the benchmark we would not speak of populism or neo-liberalism. When we speak of populism, for example, we have in mind a situation like that when I0 = Ic, and the difference between the rates is substantial. 4. The military as a channel for influence We have argued that the military plays an important role in translating wealth into political influence, since the rich can use their money to gain its support and stage a coup d'Etat. We have assumed that this support is manifested in an increased probability of success, which in turn makes the threat of a coup more serious. This can happen in a number of ways. One possibility is that money can be used to buy the support of officers, with the coup's probability of success increasing in the number of officers who sides with the plotters. This assumes that officers are motivated by the personal rewards they may obtain in exchange for their support.14 As we argue in the case study at the end of this paper, potential rewards appear to have been a decisive factor in determining who the officers supported during the 2002 attempted coup against Chavez, and this in turn sealed the fate of the coup. We have included a parameter that measures the military's bias and affects a coup's probability of success. In the model this bias measures the responsiveness of the probability of success to changes in wealth inequality. A pro-rich military will be very responsive to changes in the relative wealth of the rich, and the probability that a coup succeeds will be high. On the other hand, a low bias will imply a low probability of success for all except very high levels of inequality. This bias may have a socioeconomic foundation, as in Latin America the military has traditionally sided with the economic elites. 5. Case studies 5.1. Hugo Chavez and the Bolivarian Revolution We illustrate the main arguments in this paper by considering Hugo Chavez's government in Venezuela. We focus on the period beginning in February 2, 1999, when Hugo Chavez was sworn in as president for the first time, and ending in April 14, 2002, when he returned to power after being briefly deposed in a coup d'Etat. Our choice is made on the basis of three considerations. First, the situation in Venezuela at the time was characterized by social conflict between the poor, who supported Chavez, and the rich (and the middle class), who opposed him. Second, both groups agreed on the content and intended goals of Chavez's policies; the cause of the conflict was disagreement over the desirability of those goals. Finally, in this period Chavez was 14

In Leon (2013a), I present empirical evidence that shows that the military might stage coups in order to increase its funding.

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G. Leon / European Journal of Political Economy 34 (2014) 39–51

involved in an effort to remove from the military all officers unsympathetic to his government. In our terminology, he was choosing the bias parameter γ. Chavez won the presidential election in 1998 with a platform that promised radical political and economic reforms. Trinkunas (2005) explains that Chavez's “main campaign themes were a condemnation of the existing democracy and a promise to conduct major changes to reduce poverty and create a new participative and Bolivarian democracy.” In his first two and a half years in office, however, little was done to undermine private property or interfere with the economy, despite repeated claims that a “revolution” was under way: “his former mentor Douglas Bravo… described the Bolivarian process as ‘democratic neo-liberalism’, the lesser of two evils, battling the ‘fascist neo-liberalism’ of Venezuela's traditional power brokers” (McCaughan, 2004; p.68). Despite often claiming that the military was on his side, one of Chavez's main concerns was that he might be overthrown by officers sympathetic to the opposition. In part motivated by this fear, he engaged in a transformation of the armed forces that would give him control over the institution. In our terminology, he was trying to decrease its pro-rich bias. Trinkunas (2002) explains that among the measures adopted, “Chavez took charge of military promotions and assignments, alleging that the legislature's role in this process during the previous four decades had politicized it. Although the reform theoretically gave control over promotions to the armed forces, in practice these fell under the personal purview of the president… Chavez exacerbated the politicization of the armed forces by using his control of promotions to favor officers who supported his political agenda with plum commands and assignments. Many of those generals and admirals who had opposed the Chavez-led 1992 coup attempts were shunted into administrative duties, retired, or placed on extended leave.” Chavez's concern is further reflected in his creation of a secret radio network, Red Tiburon, that connected officers loyal to him and excluded a number of top ranking officers, including the commander of the Army. In addition, he placed loyal officers in command of combat units. In short, Chavez thought that a coup d'Etat was possible, and his initial moderation in economic policy partly reflected this fear. In late 2001 Chavez felt safe enough to finally pursue his economic agenda. He sought to use special powers granted to him by Congress to enact 49 laws regulating the economy, including land ownership, the structure of the banking and insurance industry, and the tax system. These laws were widely seen as the first serious move by the Chavez government against the economic elites, which to that date had remained virtually unaffected by his policies. Jones (2007) explains that “[a]s 2001 drew to a close, Chavez shifted his Bolivarian Revolution into high gear, sending the opposition into a frenzy… On November 13, using an “enabling law” that was about to expire, he issued forty-nine decrees… In general the measures were aimed at consolidating for the first time and enshrining in law his reform program on behalf of the majority poor. They were a direct challenge to the elite… Two decrees in particular set off a firestorm. One dealt with the oil industry… The other decree that provoked the opposition's ire centered on land reform” (p.305–306). Lopez Maya (2005) explains that “investors and the vast majority of Venezuelan economic groups with ties to multinational capital rejected the return to a state with regulatory capabilities over economic and social life, the reaffirmation of government ownership of oil reserves, the right of workers to welfare and benefits, among other things… (p. 263).” These laws were redistributive in nature and one of their goals was to weaken the elites and concentrate power in the hands of the government. As Jones (2007) argues, “…the decree set off a revolt among landowners… They contended his incendiary statements were prompting a wave of invasions by squatters. They feared they were going to lose their livelihoods… They called the program a threat to private property and a throwback to communist-style economies” (p.307). This was made worse by the government, as it “…contributed to create significant additional tension through a clumsy, and in some aspects authoritarian, political management” (Lopez Maya, 2005; p.264). The elites responded by “developing a strategy of sustained resistance and confrontation” (Lopez Maya, 2005; p.264) that progressively escalated and turned violent on April 11, 2002. Following deadly clashes between pro- and anti-Chavez demonstrators outside the presidential palace, “the commander of the Army, General Efraim Vasquez Velasco, announced in a nationally televised address that he would no longer obey presidential orders. Other senior generals and admirals soon followed him onto the airwaves, expressing their solidarity with the Army commander and their opposition to the president. Within hours, the senior military officer in the Venezuelan armed forces, General Lucas Rincon Romero, announced President Chavez's resignation” (Trinkunas, 2002). A junta led by businessman Pedro Carmona, the head of the Federation of Chambers of Commerce (Fedecamaras), assumed control of the government. Carmona's government “was drawn from a narrow right-wing slice of the political spectrum that excluded key elements of the opposition to Hugo Chavez, most notably the leadership of the country's labor unions.15 Images of the well-heeled participants in the televised self-proclamation of Pedro Carmona as president quickly confirmed the sectarian upper-class nature of the new government…” (Trinkunas, 2005). When the officers withdrew their support, Carmona's government collapsed. Less than 48 h after being deposed, Chavez returned to the presidential palace and retook control of the government. Trinkunas (2002) explains that one of the main reasons for the coup's failure was that interim president “Carmona erred in the military arena, appointing as Minister of Defense an admiral who had very little authority within the officer corps, rather than a senior Army general. He then selected a recently cashiered officer, Admiral Molina Tamayo, as head of presidential security. These appointments, which contravened military lines of seniority and merit, angered a number of senior officers who had initially supported the Carmona government.” He continues, “as Pedro Carmona sheltered in a nearby military base, the junior and mid-ranking officers who actually commanded the combat units of the armed forces made it clear to their superiors that they would only support efforts to restore constitutional rule. This paved the way for a swift return of Hugo Chavez Frias to power on 15 The leadership of the most important labor unions, organized into the Confederacion de Trabajadores de Venezuela (CTV), was considered to be part of the traditional political establishment, with close links to the largest and most successful political party, Accion Democratica (AD). As such, it was not seen as representing ‘the poor’.

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14 April 2002.” Chavez's return was coordinated by senior officers who had been ignored and left out of the new Carmona government. Many of these officers were handsomely rewarded with promotions and high-ranking appointments, and it is likely that the expectation of such professional advancement weighed heavily on their decision to help bring Chavez back. 5.2. Alberto Fujimori in Peru The model predicts that neo-liberalism will arise in countries with high inequality and a military that is biased in favor of the elite. Peru is a country where both of these are true, and so our model suggests that Peruvian governments, even if elected with the support of the poor majority, will tend to govern from the right. In the last two and a half decades the Peruvian political life has been dominated by presidents who ran on populist platforms. As Madrid (2012) observes, Alberto Fujimori in 1990, Alejandro Toledo in 2001, and Ollanta Humala in 2011 all ran on platforms that exploited ethnic linkages to the largely poor indigenous majority: “in the 1990 elections Fujimori effectively played on resentment of the white Lima elite, which his main competitor, Mario Vargas Llosa, embodied. Moreover, … Fujimori, Toledo and Humala all sought to enhance their attractiveness to indigenous and cholo voters by recruiting many candidates of indigenous descent and making direct ethnic appeals” (p.121). Although Fujimori ran as a left-wing candidate, he ruled as a right-wing president. Madrid (2012) explains that his policy choices had “little to do with Fujimori's ideological position, whose political antecedents locate him more in the center left than these economic policies would imply” (p.222). Part of the reason for this is explained by Obando (1998): “Fujimori was concerned that, bereft of a political party or other organised back-up in civil society, he might be a possible victim of a coup. Although his image as an independent had been a valuable asset in electoral terms, his isolation made him vulnerable” (p.199). His policy choices were shaped by the groups on whose support Fujimori's government depended; as Madrid (2012) explains: “the alliances that Fujimori created to give his regime stability had two important sources of support: the first came from the Congress and the second came from the armed forces” (p.222). 6. Concluding remarks This paper addresses the question of why some Latin American countries with high levels of inequality redistribute very little, while others redistribute so much that little is left for the future. These neo-liberal and populist policies impose considerable hardship in the countries where they are adopted, and are all too common to be ignored. Our answer is based on the observation that economic resources can often be translated into the ability to influence policy. This implies that when inequality is high, the poor will be unable to redistribute and inequality will increase even further. On the other hand, it also creates a strong incentive for the poor to choose a high level of redistribution. A central element in our explanation was the military's role in transforming wealth into influence over policy. This organization has traditionally played a central role in politics, yet economists are just starting to pay attention to it. Furthermore, many Latin American countries seem to experience cycles and switch between populist and neo-liberal policies. Although beyond the scope of this paper, this is a question that merits further attention. Acknowledgments I wish to thank Toke Aidt, Christopher Bliss, Clare Leaver, and Gilat Levy for their help and comments. Appendix A. Proofs Lemma 1. Proof. We can verify that the second order condition − (1 + β)C″(τ1)kr0 b 0 holds for 0 ≤ τ1 ≤ 1, so there is a unique maximum in [0,1]. Evaluating the first order condition at τ1 = 0 we find that [(1 + β) − βA(1 − C(1))]Akr0 N 0, and at τ1 = 1 we find that − βA(1 − C(1))Akr0 b 0, so that this maximum is at an interior point. The right-hand side of Eq. (5) is decreasing in A and β, and the result then follows from the convexity of C(.). Lemma 3. Proof. Define Gðτ1 ; I 0 Þ ¼ ð1−τ 1 Þ½1 þ βAð1−τ 2 Þ−½δ þ σ ðγI0 Þð1−δÞ½1 þ βA. This function is continuously differentiable, and Gτ1(τ1,I0) b 0. The implicit function theorem holds, and τ′1 ðI 0 Þ ¼ −GI0 ðτ1 ; I 0 Þ=Gτ1 ðτ1 ; I 0 Þ. To show the result, we need to establish that GI0 ðτ 1 ; I0 Þb0. This follows from GI0 ðτ; I0 Þ ¼

2

′

2

ð1−τ1 Þ βA γð1−δÞσ ðγI1 Þ 2

½1 þ ðτ1 −C ðτ 1 ÞÞI0  2

′

′

−σ ðγI0 Þγ ð1−δÞð1 þ βAÞ

′

b βA γð1−δÞσ ðγI 1 Þ−σ ðγI0 Þγ ð1−δÞð1 þ βAÞ 2

2

b βA γð1−δÞ−βA γ ð1−δÞð1 þ βAÞ 2

¼ βA γð1−δÞ½1−ð1 þ βAÞ b 0:

where the second line follows from the fact that ∂I∂I ¼ 1 0

p Að1−τ 1 Þk0

½1 þ ðτ 1 −C ðτ 1 ÞÞI0 2

and the fourth uses the fact that βA2≤σ′(.) ≤ 1.

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G. Leon / European Journal of Political Economy 34 (2014) 39–51

∂I Lemma 4. Proof. Using the fact that ∂τ b 0 and

2

∂ I1

1

1

2

ð∂τ 1 Þ

N0, we can verify that the second derivative of expression (9) with respect to τ1

is strictly decreasing in [0,1], and so there is a unique maximum in this interval. To prove the second part, evaluate the first r derivative at τ1 = 1. In this case it becomes −β ðτ2 −C ðτ 2 ÞÞAk0 b 0, with τ 2 ¼ 1−δ. It is then not optimal to set τ1 = 1. Setting τ1 = 0 h
 i r ′ ∂τ we find that the derivative is 1 þ β þ βA∂τ 1−C ðτ2 Þ −βAðτ2 −C ðτ 2 ÞÞ k0 , which is always strictly greater than 0 because 2 1

1≥βAðτ2 −C ðτ2 ÞÞ. So the solution will always be interior.  u u Lemma 5. Proof. To prove the first part of the lemma, we solve for C ′ τ^ 1 in the first order condition for τ^1 , which gives us
 h
 i b ′ ^u  ′ ′ βA βA ∂τ C τ1 ¼ 1−ð1þβ 1−C ðτ2 Þ ð1−τ 1 Þ N1−ð1þβ τ^1 , and the result follows from the convexity of C(.). Þ τ 2 −C ðτ 2 Þ−∂τ Þ½1−C ð1Þ ¼ C 2 1

u We can apply the implicit function theorem, and using ∂∂ττ2 N0; ∂∂Iτ2 b0 and ∂τ∂ τ∂I2 b0, we find that τ^1 ðI0 Þ is increasing in I0. 2

1

0

1

0

u Lemma 6. Proof. Such a value exists because we have shown τ 1 to be strictly decreasing in I0 (Lemma 3) and τ^1 to be strictly u c c increasing (Lemma 5). These will cross exactly once, and that point is given by I . For values below I we know that τ 1 N τ^ 1, while the reverse holds for values above it. b Proposition 1. Proof. Such a value exists because we have shown τ1 to be strictly decreasing in I0 (Lemma 3) and τ^ 1 is not a u b function of I0. We know that for values below I⁎ the economy will experience populism because both τ^ and τ1 are above τ^ . For 1

1

b

values of initial inequality above it the rate will be constrained at τ 1 , which will be below τ^1 .

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