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Towards an economic theory of party ideology
European Journal of Political Economy Vol. 14 Ž1998. 223–240
Towards an economic theory of party ideology Otto H. Swank
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Erasmus UniÕersity Rotterdam, Tinbergen Institute, OCFEB, Rotterdam, Netherlands
Abstract In this paper a signalling model is used to examine the role of party ideology in the conduct of economic policy. A distinguishing feature of the model is that policy makers have more knowledge about the efficacy of economy policy than voters. This asymmetry of information generates an incentive for the policy makers to adopt an ideological view of how the economy works. It is shown that party ideologies are most likely to arise in rigid economic and polarized political systems. q 1998 Elsevier Science B.V. All rights reserved. JEL classification: D78; E61 Keywords: Party ideology; Signalling model; Economic policy
1. Introduction In this paper I develop a political economic framework to gain insight into the role of party ideology in the conduct of economic policy. Essential features of the framework are that there exist different models of how the economy works and that political parties have better information about the working of the economy than voters. It is argued that in a partisan setting election outcomes depend on voters’ perceptions of the efficacy of alternative policies. For example, the popularity of a political party favouring a small size of the government is relatively high if voters believe that public activity has large adverse effects on
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Corresponding author. Erasmus University Rotterdam H7-16, P.O. Box 1738, 3000 DR Rotterdam, Netherlands. E-mail: [email protected]. 0176-2680r98r$19.00 q 1998 Elsevier Science B.V. All rights reserved. PII S 0 1 7 6 - 2 6 8 0 Ž 9 8 . 0 0 0 0 5 - 6
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private activity. An important implication of this is that political parties have an incentive to make voters believe in a specific model of the economy. The party in office can credibly do so by basing its policy on that model. However, if that model is invalid, the incumbent incurs costs, because its policy is based on an incorrect model. Naturally, the more the model on which policy is based deviates from the correct model, the higher are these costs. We show that under certain conditions, on average each political party bases policy on a model that is favourable from an electoral point of view. This model may be interpreted as that party’s ideological view of how the economy works. However, occasionally a political party may depart from its ideological model. In that case the costs of basing policy on the ideological model are deemed too high and it seems as if the party has abandoned its traditional political position. In this paper party ideologies refer to parties’ pretended views of how the economy works. A party ideology basically serves as a means to sell partisan policies to incompletely informed voters. I try to gauge under which political and economic conditions Ž1. parties hold dogmatic ideologies and never depart from it, Ž2. parties are completely pragmatic and base policy always on the model they consider as the correct model and Ž3. parties usually base policy on an ideological model but sometimes depart from it. The analysis suggests that party ideologies are most likely to arise in countries with a rigid economic system and a polarized political system. Moreover, the higher is the utility parties receive from holding office, the higher is the probability that party ideologies arise. My paper is related to several earlier studies, in particular those dealing with the strategic role of party ideology ŽRoemer, 1994 and Swank, 1994.. Roemer examines a partisan model in which voters are uncertain about the working of the economy and each political party announces a policy and a theory of the economy. Unlike the model developed here, in Roemer’s model elections outcomes are certain so that the median voter theorem applies and the two parties propose the same policy. Moreover, in Roemer’s paper announcements of theories of the economy directly affects voters’ perceptions of how the economy works, whereas in this paper voters take announcements only seriously if policy makers’ announcements are in accordance with their actions. To put it differently, in Roemer’s model parties are identified with the platforms they are assumed to carry out after the elections. As argued by Ferejohn Ž1986., this approach raises a time-consistency problem, in the sense that once elections are held parties may diverge from their platforms and pursue their own interests or the interests of their core-constituencies. Rational voters recognize this and take parties’ platforms only serious if they are credible. In this paper, attention is restricted to time-consistent policies and announcements of economic theories. Since only the party in office can support its announcements by actions, the opposition party plays a relatively passive role in the model. In spite of the differences between the two approaches, they lead to the same notion that parties ‘use’ theories of the economy to sell their policies to voters.
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My model is also related to various signalling models of economic policy in which voters are uncertain about the type of the government. Alesina and Cukierman Ž1990. have developed a model in which voters are uncertain about the preferences of the incumbent party and Rogoff Ž1990. has examined a model in which voters do not know the policy maker’s competence. In signalling models the order of actions is important. Usually it is assumed that the policy maker moves first and that voters, after observing the policy maker’s action but not his type, move next. This may enable the policy maker to signal his type. In this paper, the types of the government refer to different models of the economy and the government may signal a model of the economy by basing its actions on it. In my model signalling may be useful, since vote decisions depend on voters’ perceptions of how the economy works. As a consequence, political parties have an incentive to make voters believe in a specific model of the economy. As discussed above, voters are assumed to be uncertain about the extent to which private activity is crowded out by government activity. The motivation of this assumption relies on Downs Ž1957., who argued that voters have few incentives to acquire information about policy matters. Rational ignorance creates the possibility for parties to supply information. However, rational voters will recognize that this source of information may be biased. The signalling framework adopted in this paper enables me to reconcile the concepts of voters’ rationality and voters’ ignorance Žcf. Rogoff, 1990.. While the logic of the approach followed in this paper is general, I will use decisions on the size of the government as an example to illustrate the main ideas behind the approach. I think this example is interesting, because economic theories typically differ in their predictions of the effects of government activities on private activities. In the example, all citizens care about government and private activities, but some benefit more from government activities than others. This assumption is in line with models emphasizing the redistributional nature of government activities Žcf. Meltzer and Richard, 1981.. The paper is organised as follows. The next section discusses the basic elements of the model. In Section 3, voter behaviour is analyzed under incomplete information. Section 4 discusses some interesting equilibria and Section 5 discusses the conditions under which these equilibria occur. Section 6 concludes the paper with a discussion of the sensitivity of the results for changes in the main assumptions underlying the model.
2. The model In this section I discuss the main features of a simple two-period political economic model in which citizens have different preferences as to the activities the government should engage in. Differences among voters may be ideological or stem from the distributional consequences of government activities. At the end of
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period 1 elections are held which determine the political colour of the government in period 2. Two parties, each catering to the desires of its core constituency, run for office. Apart from ideological or redistributional considerations, decisions on the size of the government depend on the effects of government activities on private activities. A distinguishing feature of the model is that political parties have superior knowledge about those effects compared with voters. Basically, this paper explores how political parties may use this information advantage. To keep things simple, it is assumed that voters know the preferences of political parties. 2.1. The preferences of Õoters The economy is composed of a large number of voters whose preferences are represented by linear-quadratic utility functions: Ut .i s Tt y g P Ž Gt y Gid .
2
Ž 1.
where Y is the share of Ždisposable. income in potential income, G is the share of government spending in potential income and t is a time index. It is assumed that for each voter i there exists a unique exogenous value of Gt , Gid , such that voter i would benefit from a rise in Gt for Gt - Gid and would suffer from a rise in Gt for Gt ) Gid . I assume that there is a continuum of voters in terms of Gid . The somewhat degenerate nature of the utility function is not responsible for the results. All that is required is that voters differ in their preferences over Y and G. Alternatively, I could have assumed that voters differ in g i instead of G d . The reason for introducing heterogeneity in voters’ preferences through Gid is to economize on notation later. The linear-quadratic specification of the utility function is common in models in which the efficacy of policy is uncertain Žcf. Frankel and Rockett, 1988, Ghosh and Masson, 1991 and Holtham and Hughes Hallett, 1992. and is adopted for mathematical convenience. 2.2. The preferences of the political parties There are two political parties, l and r, each representing the interests of its core constituency. Thus the parties differ in Gid , with G ld ) Grd . The utility functions of political parties deviate from those of voters in two respects. First, the political parties receive direct utility from holding office. Second, the incumbent party attaches costs to deviations of G from a certain benchmark, G). Those costs may be due to an unwilling bureaucracy which has interests in a certain size of the government Ž G). or due to a dichotomy in the political structure of the economy Žthe administration vs. Congress, where Congress aims at Gt s G).. Alternatively, adjustment of the status quo may involve costs Ž G) s Gty1 .. Period t utility of party j Ž j s l,r . is given by: 2
2
Ut , j s Ž 1 y b . P Yt y g P Ž Gt y Gjd . y b P Ž Gt y G) . q l P p t , j
Ž 2.
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where l denotes the utility attached to holding office and p t, j is a shift variable taking the value one if party j is in office and zero otherwise. The parameter b is a measure of the extent to which political parties are constrained in pursuing ideological and electoral goals. If adjustment costs are low and the incumbent party controls the apparatus of the state, b is small. Initially, G) is assumed to be fixed. Later I will elaborate upon the implications of this assumption for the results. In principle, Eq. Ž2. implies that a political party may prefer opposition to office. Throughout this paper, l is assumed to exceed a critical value, ensuring that both parties always prefer office to opposition. 2.3. Uncertainty about the efficacy of policy The relationship between Yt and Gt is described by a simple linear equation: Yt s 1 y a t P Gt .
Ž 3.
Uncertainty about the effects of Gt on Yt is incorporated in a t . I assume that a t can take on three values: a L , a M and a H , with a L - a M - a H . The value of a t evolves according to the following stochastic process: if a 1 s a L , there is a probability r that a 2 s a L and a probability Ž 1 y r . that a 2 s a M ; if a 1 s a M , there is a probability r that a 2 s a M , a probability 1r2 P Ž 1 y r . that a 2 s a L and a probability 1r2 P Ž 1 y r . that a 2 s a H ; if a 1 s a H , there is a probability r that a 2 s a H and a probability Ž 1 y r . that a 2 s a M .
Ž 4. Without affecting the main results of this paper, I assume symmetry in the sense that
a M s 1r2 P a L q 1r2 P a H . Basically, there are two interpretations of Eq. Ž4.. The first is that reality is too complex to be captured by a single model, for example because the economy can be in different stages. Each model describes a different stage. According to Eq. Ž4. there are three stages of the economy, two extreme stages and one normal stage. The stochastic process describes how the economy moves from one stage to another. The second interpretation of Eq. Ž4. is that there exists a correct model of the economy, but has not been discovered yet. The economic literature offers various models which differ in their predictions of the efficacy of policy. The value of a t reflects the state of the art in economics and may change over time when new evidence becomes available. A singular feature of the model is that political parties have better information about a t than voters. It is assumed that political parties know a t , while voters
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only know a ty1. I consider the case in which voters assign the following a priori probabilities to a 1: Prob Ž a 1 s a L . s 1r2 P Ž 1 y r . Prob Ž a 1 s a M . s r
Ž 5.
Prob Ž a 1 s a H . s 1r2 P Ž 1 y r . . The above a priori probabilities amount to the assumption that a t s a M in period 0. The specification of the stochastic process of a t is clearly an ad hoc one. For this reason, it is worth elaborating on it. One assumption underlying Eq. Ž4. is crucial. This is that a t is treated as a discrete parameter, rather than a continuous parameter. This assumption is made for tractability reasons. One way of looking at it is that political parties, like voters, are basically ignorant about alternative economic theories. Due to this, policy makers find it difficult to make subtle distinctions between various models, but are able to divide them into types. 1 For example, policy makers know that according to some models effects of Gt on Yt are small, median or large. Later on, I will discuss the implications of restricting the strategy space for the results. Two other assumptions underlying Eq. Ž4. are relatively innocuous. First, the imposed symmetry is only to reduce notation. Second, the simple stochastic process according to which a t evolves can be replaced with a more sophisticated one. What matters is that there is some persistence in the relationship between Yt and Gt , so that information about a 1 leads to a more precise forecasts of a 2 . 2.4. The order of actions Before the game starts Žstage 0., the incumbent party gathers information about the state of the art in economics. Next, in stage 1 the party in office chooses policy. At the end of period 1, before Y1 is observed Žstage 2., elections are held. When casting their ballots voters know policy in period 1, but do not know which model is correct. They update their prior beliefs about the efficacy of policy on the basis of the information captured by policy in period 1. Each voter casts his ballot for the party that offers him highest expected utility. At the beginning of the second period, nature determines how the efficacy of policy evolves. At the end of
1 In this paper there are three types of advisers which is the minimum to explain the phenomena discussed in the introduction. Assuming more than three type of advisors does not affect the main ideas behind the model.
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Fig. 1. The order of actions.
the game Žstage 3., the party which has won the elections implements policy. Fig. 1 summarizes the order of actions of the players in more formal terms.
3. Policy in period 2 and the voting function In period 2, only the party that has won the elections chooses an action. Let G 2, j denote policy in period 2 if party j has won the elections. In the second period, the incumbent party does not face an election constraint. As a consequence, G 2, j follows from maximizing period 2 utility with respect to G 2, j , subject to Eq. Ž3., yielding: G 2, j s
g P Ž 1 y b . P Gjd q b P G) y 1r2 P Ž 1 y b . P a 2 gP Ž1yb . qb
Ž 6.
Since by assumption G ld ) Grd , G 2,l ) G 2, r . Note that in period 2 the party in office has no incentive to base policy on an economic model that deviates from the correct model. Thus a 2 in Eq. Ž6. refers to party j’s actual view of the economy. Let us now consider the decision problem voters face. Voters are assumed to be rational and forward-looking. Each voter casts his ballot for the party that offers him highest expected utility. Voters know that in period 2 the party in office chooses Eq. Ž6. and bases policy on the correct model Ž a 2 .. However, voters are uncertain about a 2 , because they observe neither a 1 nor a 2 . Since in period 1 policy may convey information about a 1 , and through Eq. Ž5. about a 2 , expectations of a 2 are formed conditional on G1. Let E A < G 14 denote the expectation of
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A given that G 1 is implemented in period 1. Eq. Ž1. implies that voter i casts his ballot for party l, Õi s l, if: 2
E Ž 1 y a 2 P G 2,l . y g P Ž G 2,l y Gid . < G 1 ) E Ž 1 y a 2 P G 2, r .
½
5
½
2
yg P Ž G 2, r y Gid . < G 1
5
Ž 7.
where G 2, j is given by Eq. Ž6.. Eqs. Ž6. and Ž7. show that a 2 affects vote decisions along two channels. First, a 2 affects voters’ expectations of policies in period 2 Žsee Eq. Ž6.. and second, a 2 affects the evaluation of those policies Eq. Ž7.. By substituting Eq. Ž6. into Eq. Ž7. for j s l,r and rearranging the terms, Eq. Ž7. can be rewritten as: b Gij) E a 2 < G1 4 2Pg gP Ž1yb . qb q
g P Ž 1 y b . P Ž G ld q Grd x q 2 P b P G) 2P gP Ž1yb . qb
[T
Ž 8.
Eq. Ž8. shows that every voter i with Gid ) T votes for party l. Since in this model voters’ preferences are single peaked, to determine the election outcomes it suffices to establish for which party the median voter casts his ballot. Following Alesina Ž1988. it is assumed that the position of the median voter Ž Gmd . is uncertain and randomly distributed on the interval w0, ` ) according to a continuous density function f Ž Gmd .. The probability that party l wins the elections Ž Pl . is given by: `
Pl s Prob Ž Õm s l . s T H f Ž Gmd . dGmd .
Ž 9.
4. Equilibria The game described above is a signalling game in which the incumbent sends a message to voters about the type of the economy through G1. As it is usual in signalling games, various types of Žperfect Bayesian. equilibria may exist, including separating, pooling and partially pooling equilibria. In this section, I discuss some interesting equilibria, restricting attention to pure strategies. I consider the case in which party l is the incumbent in period 1, and I show that party l may have an incentive to make voters believe that the working of the economy is characterised by a L . The case that party r is in office in period 1 is analogous, save that it is in the interest of party r that voters believe that the working of the economy is characterised by a H . For the presentation of the equilibria, it is convenient to identify party l with the type of the economy. I pretend that there exist three types of party l: an a L-, an a M - and an a H -type. Each type of party l refers to an economic model. Thus the statement ‘an a H -type of party l mimics an
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a L-type’ means that party l bases policy on the economic model characterised by a L , while the correct economic model is characterised by a H . 4.1. A separating equilibrium In a separating equilibrium, the three types of party l choose three different actions in the first period. Here this means that party l always bases policy on the correct model of the economy. As a consequence, G 1 fully reveals the incumbent’s type and voters have complete information when casting their ballots. Let m k denote voters’ posterior belief that a 1 s a k , k g L,M,H4 and G 1 Ž a k . s argmax U1,l Ž G1 , a k . k e L,M,H 4 .
Ž 10 .
In a separating equilibrium, voters’ posterior beliefs are given by:
m k s Prob Ž a 1 s a k < G1 Ž a k . . s 1 for k e L,M,H 4 .
Ž 11 .
A necessary condition for a separating equilibrium is that the strategy to base policy always on the correct model is optimal given voters’ beliefs about how the economy works. Basing policy on an incorrect model affects the utility of party l in two ways. First, it decreases period 1 utility, since policy is based on an incorrect model. I refer to this decrease in utility as the costs of basing policy on an incorrect model ŽC.. Let a 1 refer to the correct model of the economy. The costs of basing policy on an incorrect model can be written as: C Ž a k , a 1 . s U1,l Ž G 1 Ž a 1 . , a 1 . y U1,l Ž G 1 Ž a k . , a 1 . 2
2
Ž 1 y b . P Ž a k y ya 1 . s . gP Ž1yb . qb
Ž 12 .
Eq. Ž12. shows that the costs of basing policy on an incorrect model Ž a k / a 1 . are increasing in the deviations of a k from a 1 and decreasing in b and g . Note that G 1Ž a k . and G 1Ž a 1 . are evaluated on the basis of the correct model, a 1. Second, basing policy on an incorrect model affects voters’ beliefs about a 1 and accordingly affects the probability that party l wins the elections. In a separating equilibrium, the incumbent can decrease E a 2 < G 1Ž a k .4 by basing its policy on a model that is characterised by a lower a 1 than the correct model Žsee Eq. Ž11... Given Eq. Ž11., it is easy to derive from Eqs. Ž8. and Ž9. that a lower value of E a 2 < G 1Ž a k .4 increases the probability that party l wins the election. The intuition behind this is straightforward. A rise in E a 2 < G 1Ž a k .4 increases the costs of government spending in terms of Yt and therefore decreases voters demand for government activity. The supply of government activity also decreases, but less than demand, because the policy maker is constrained. As a consequence, the policy most desired by each voter moves Žrelatively speaking. towards the policy proposed by the party favouring a small size of the government. Hence, the probability that party l wins the election increases. The increase in expected
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period 2 utility resulting from basing policy on a model that is characterised by a lower a 1 than the correct model is referred to as the benefits Ž Bs . from basing policy on an incorrect model in a separating equilibrium. In period 1, expected period 2 utility is given by the utility party l attaches to G 2, l plus the utility that party l receives from G 2, r weighted by the probabilities that those policies are implemented Ž Pl and 1 y Pl , respectively.: e U2,l s s P Pl Ž E a 2 < a 1 s a k 4 . P U2,l Ž G 2,l .
q Ž 1 y Pl Ž E a 2 < a 1 s a k 4 . . P U2,l Ž G 2, r .
Ž 13 .
where s is the discount factor Žtotal utility Uj s Ý2ts1 s ty1 P Ut, j .. Eq. Ž11. indicates that if G 1 is based on a k , rather than on a 1 , voters’ beliefs change from a 1 to a k . Hence the benefits from basing policy on a k are equal to: Bs Ž a k , a 1 . s s P Pl Ž E a 2 < a k 4 . y Pl Ž E a 2 < a 1 4 . P U2,l Ž G 2,l . y U2,l Ž G 2, r . s s P Pl Ž E a 2 < a k 4 . y Pl Ž E a 2 < a 1 4 . 2
P
½
g 2 P Ž 1 y b . P Gld y Grd gP Ž1yb . qb
2
q l q b Ž G 2, r y G) .
2
5 Ž 14 .
Clearly, if a k - a 1 , then Bs ) 0. 2 Furthermore, Eq. Ž14. shows that the benefits from basing policy on an incorrect model are increasing in l and Gld . A separating equilibrium occurs if BsŽ a k , a 1 . CŽ a k , a 1 . for k g L,M,H4 and all possible values of a 1. Under this condition, party l has no incentive to base policy on an incorrect model, given voters’ posterior beliefs. Furthermore, voters’ beliefs are optimal given the policies implemented by party l. 4.2. A pooling equilibrium In a pooling equilibrium the three types of party l choose the same policy in the first period. Here this means that party l chooses G1 s G 1Ž a L ., because party l cannot benefit from basing policy on an incorrect model if a 1 s a L . Since in the first period, policy is independent of the incumbent’s type, voters cannot infer 2
Recall the assumption that both political parties prefer office to opposition, implying that wU2, l Ž G 2,l .-U2,l Ž G 2,r .x ) 0.
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information from G1. Hence on the equilibrium path voters’ posterior beliefs are equal to their prior beliefs: m L s Prob Ž a 1 s a L < G 1 Ž a L . . s 1r2 P Ž 1 y r .
m M s Prob Ž a 1 s a M < G 1 Ž a L . . s r m H s Prob Ž a 1 s a H < G 1 Ž a L . . s 1r2 P Ž 1 y r .
Ž 15 .
so that E a 2 < G 1Ž a L .4 s a M . To check whether party l benefits from deviating from its strategy given Eq. Ž15., voters’ beliefs have to be specified when G 1Ž a M . and G 1Ž a H . are observed. Since there are no types of party l that benefit from basing policy on a model being characterised by a k for which a k ) a 1 Žsee Eqs. Ž8. and Ž9.., irrespective of voters’ beliefs, voters are assumed to assign zero probabilities to those events, implying: Prob Ž a 1 s a H < G 1 Ž a H . . s 1 and Prob Ž a 1 s a L < G 1 Ž a M . . s 0. These assumptions which are based on the intuitive criterion of Cho and Kreps Ž1987. do not determine exactly how voter beliefs’ are updated when G 1Ž a M . is observed. It restricts the corresponding expectation of a 1 to: a H G E a 1 < G1Ž a M .4 GaM. Necessary conditions for a pooling equilibrium are that both an a H -type and an a M -type increase utility by mimicking an a L-type given the above posterior beliefs. Let me first consider an a H -type. The costs of mimicking are given by Eq. Ž12. with a k s a L and a 1 s a H . The benefits of mimicking are Ž Bp Ž a H , a M ..: Bp Ž a H , a M . s s P Pl Ž a M . y Pl Ž E a 2 < a H 4 . 2
P
½
g 2 P Ž 1 y b . P Gld y Gtd gP Ž1yb . qb
2
q l q b Ž G 2, r y G) .
2
5
.
Ž 16 . If Bp Ž a H , a M . ) C Ž a k s a L , a 1 s a H . an a H -type benefits from mimicking an a L-type. Now let me consider an a M -type. The costs of implementing G 1Ž a L . are given by Eq. Ž12. with a k s a L and a 1 s a M . The benefits from mimicking are given by Eq. Ž16. after replacing E a 2 < a H 4 with E a 2 <Ž E a 1 < G 1Ž a M .4.4 where a H G E a 1 < G 1Ž a M .4 G a M . Clearly, if E a 1 < G1Ž a M .4 approximates a M , the benefits from mimicking go to zero. In this case, party l benefits from deviating from its strategy and a pooling equilibrium does not exist. In contrast, if E a 2 < G 1Ž a M .4 approximates a H , mimicking an a L-type may be fruitful. Thus a pooling equilibrium can only exist if voters assign a high probability to the event that the economy is described by a H , when G 1Ž a M . is observed. The intuition behind these results is straightforward. In a pooling equilibrium, party l cannot decrease the conditional expectation of a 2 below a M . If a H is the correct model of the economy there are benefits from mimicking, so that party l trades off the costs of basing policy on an incorrect model against increasing its chances of reelection. However, in case that a M represents the correct model, the incumbent would like
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to implement G 1Ž a M . rather than G 1Ž a L ., because G 1Ž a L . raises costs through Eq. Ž12., but does not reduce voters’ belief about a 1 below a M . Only if G 1Ž a M . makes voters believe that a 1 is higher than a M , the incumbent may benefit from implementing G1Ž a L .. 4.3. Partially pooling equilibria In a partially pooling equilibrium two types of party l choose the same policy in period 1 and the third type chooses a different policy. In principle, there are three possible partially pooling equilibria. i. Both an a L-type and an a H -type choose G 1Ž a L . and an a M -type chooses Ž G 1 a M .. On the equilibrium path voters’ beliefs are given by:
m L s Prob Ž a 1 s a L < G 1 s G 1 Ž a L . . s 1r2 m M s Prob Ž a 1 s a M < G 1 s G 1 Ž a M . . s 1
Ž 17 .
m H s Prob Ž a 1 s a H < G 1 s G1 Ž a L . . s 1r2. Clearly, the above set of strategies and beliefs are not an equilibrium. Suppose that in period 1 an a H -type is in office. By mimicking an a L-type, the conditional expectation of a 2 is a M . The beliefs on the equilibrium path Eq. Ž17. imply that this value can also be reached by mimicking an a M -type. Since the costs of mimicking an a M -type are lower than the costs of mimicking an a L-type, the latter action is dominated by the former one. Thus given Eq. Ž17., it is optimal for an a H -type not to base policy on a L . This rules out the above strategies and beliefs as an equilibrium. ii. Both an a M -type and an a L-type choose G 1Ž a L . and the a H -type chooses Ž G 1 a H .. On the equilibrium path voters’ beliefs are given by:
m L s Prob Ž a 1 s a L < G 1 s G 1 Ž a L . . s
1yr
1qr 2Pr m M s Prob Ž a 1 s a M < G 1 s G 1 Ž a L . . s 1qr
Ž 18 .
m H s Prob Ž a 1 s a H < G 1 s G1 Ž a H . . s 1. Necessary conditions for these strategies and beliefs to be an equilibrium are that an a M -type increases utility and an a H -type decreases utility by mimicking an a L-type:
s P Pl Ž E a 2 < G 1 Ž a L . 4 . y Pl Ž E a 2 < G 1 Ž a M . 4 . 2
P
½
g 2 P Ž 1 y b . P Gld y Grd gP Ž1yb . qb
) C Ž ak s a L , a1 s a M .
2
q l q b Ž G 2, r y G) .
2
5 Ž 19 .
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and
s P Pl Ž E a 2 < G 1 Ž a L . 4 . y Pl Ž E a 2 < a H 4 . 2
P
½
g 2 P Ž 1 y b . P Gld Grd
2
gP Ž1yb . qb
q l q b Ž G 2, r y G) .
2
5
- C Ž ak s a L , a1 s a H . .
Ž 20 .
In order to check whether the above strategies and beliefs are an equilibrium if Eqs. Ž19. and Ž20. are satisfied, I have to specify voters’ beliefs when G 1Ž a M . is observed. Since an a L-type and an a M -type choose G 1Ž a L ., I assume ProbŽ a 1 s a H < G 1Ž a M .. s 1. 3 In that case, Eqs. Ž19. and Ž20. are sufficient conditions for the above strategies and beliefs to be a partially pooling equilibrium. iii. Both an a M -type and an a H -type choose G1Ž a M . and the a L-type chooses G 1Ž a L .. On the equilibrium path voters’ beliefs are given by:
m L s Prob Ž a 1 s a L < G 1 s G 1 Ž a L . . s 1. m M s Prob Ž a 1 s a M < G 1 s G 1 Ž a M . . s m H s Prob Ž a 1 s a H < G 1 s G1 Ž a M . . s
2Pr 1qr 1yr
Ž 21 .
1qr
The basic idea behind the necessary conditions for an equilibrium is similar to that behind the previous case. Now an a H -type has to benefit from mimicking an a M -type, whereas an a M -type must decrease utility by basing its policy on a L :
s P Pl Ž E a 2 < G 1 Ž a M . 4 . y Pl Ž E a 2 < a H . 4 . 2
P
½
g 2 P Ž 1 y b . P Gld y Grd
2
q l q b Ž G 2, r y G) .
gP Ž1yb . qb
2
5
) C Ž ak s a M , a1 s a H .
Ž 22 .
and
s P Pl Ž E a 2 < G 1 Ž a L . 4 . y Pl Ž E a 2 < G 1 Ž a M . 4 . 2
P
½
g 2 P Ž 1 y b . P Gld y Grd gP Ž1yb . qb
- C Ž ak s a L , a1 s a M . .
2
q l q b Ž G 2, r y G) .
2
5 Ž 23 .
The above conditions can only hold if the effect of a rise in E a 2 4 on the 3
The motivation of this assumption is that an a H -type may have an incentive to masquerade its type, while an a M -type has no incentive to reveal its type if Eq. Ž19. is satisfied.
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probability that party l is reelected is much lower for high values of a 2 than for low values of a 2 . It is easy to derive that given Eq. Ž21.: E a 2 < G1 Ž a M . 4 y E a 2 < G1 Ž a L . 4 ) E a 2 < G1 Ž a H . 4 y E a 2 < G1 Ž a M . 4 .
Ž 24 . Eq. Ž24. shows that the effect of mimicking on E a 2 4 is higher if an a M -type mimics an a L-type than if an a H -type mimics an a M -type. This implies that if the effect of a 2 on Pl is independent of the value of a 2 , 4 and an a H -type increases utility by mimicking an a M -type, an a M -type increases utility by basing its policy on a L . 5 Then the above strategies and beliefs can be ruled out as an equilibrium. One might think that this way of reasoning also rules out the strategies and beliefs under ii, because the fact that an a M -type increases utility by implementing G 1Ž a L . implies that an a H -type must benefit from implementing G 1Ž a M .. However, in that case, an a M -type mimics an a L-type, so that an a H -type can only masquerade its type by basing its policy on a L . As a consequence, the costs of mimicking are lower for an a M -type than for an a H -type. 5. Evaluation of the equilibria In Section 4, I have discussed four pure strategy perfect Bayesian equilibria. Which of those equilibria arises depends on the parameters of the model and in two cases on voters’ beliefs about the incumbent’s type when out-of-equilibrium behaviour is observed. 6 As mentioned earlier, the analysis of the equilibria when party r is in office in the first period is analogous to the above analysis, except that party r has an incentive to base policy on a H in the first period. Since the political economic model is highly symmetric in its treatment of the political parties, I presume that if a certain equilibrium occurs if party l is in office, a similar equilibrium would occur if party r were in office. 7 In a separating equilibrium, political parties always base policy on the correct model of the economy. As a consequence, the outcomes of the model are the same as the outcomes of the model if voters were assumed to have full information. A 4 This occurs, for example, if the position of the median voter, Gmd Žsee Eq. Ž9.. is uniformly distributed. 5 Note that Eq. Ž12. indicates that the corresponding costs of mimicking are equal for an a H -type and an a M -type. 6 In the model there is also a multiplicity of hybrid equilibria in which in the first period parties randomize between basing policy on different models. As in the pooling and partially pooling equilibria, in hybrid equilibria, party l Ž r . is biased to base policy on a model that is characterized by a low Žhigh. value of a 1. 7 If the voting function, PlŽP., is a linear function of E a 2 < G1 4 and voters assign the same beliefs to out off equilibrium behaviour when party l is in office and party r is in office, so that the model is completely symmetric Žsee also Footnote 4..
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separating equilibrium arises when the costs of basing policy on an incorrect model exceed the benefits. Eqs. Ž8., Ž9. and Ž14. indicate that the benefits from mimicking are low when the political parties give low utility to holding office and there is a low degree of political polarization Ž G ld y Grd .. Furthermore, since the costs of basing policy on an incorrect model fall in period 1, while the benefits are reaped in period 2, a separating equilibrium is more likely to arise when the discount factor is low. Finally, note that if political parties are unconstrained in implementing policy there are no benefits from mimicking. In that case, election outcomes are independent of the costs of government activity in terms of private activity and a separating equilibrium occurs. In a pooling equilibrium, party l bases policy always on a L and party r always bases policy on a H . As a consequence, it seems as if each party dogmatically subscribe to an economic ideology. Party r announces that an expansion of the government sector has large adverse effects on private activity and acts accordingly, whereas party l holds the view that government activity has minor effects on economic activity. It is worth emphasizing that in this paper parties’ ideologies stem from strategic considerations, rather than from principled disagreement about the costs of government activity. As discussed in the previous section, a pooling equilibrium can only exist if the benefits from basing policy on an incorrect model exceed the associated costs. Since there are only benefits if parties are at least to some extent constrained in implementing policy and the benefits depend positively on the degree of polarization and the utility policy parties attribute to holding office, dogmatic ideologies are most likely to arise in a somewhat rigid economic system and a polarised political system where the incumbent party has an utmost interest in keeping office. Moreover, a pooling equilibrium requires that voters also think in terms of extreme economic models, in the sense that if a political party departs from its ideology, voters take this as a signal that the ideology held by the opposition party is correct. In the two possible partially pooling equilibria political parties usually subscribe to an economic ideology, but occasionally abandon their ideologies. Since the equilibrium in which an a H -type of party l and an a H -type of party r mimic an a M -type Žcase iii in Section 4. can only exist under very specific voting functions, I restrict attention to case ii, where parties are biased to basing policy on the extreme models. A partially pooling equilibrium arises when the benefits of basing policy on model a L if model a M is correct exceed the costs, while the costs of basing policy on a L if model a H is correct exceed the benefit. Because the costs of basing policy on model a L depend on the squared deviation of a L from the correct a , a partially pooling equilibrium is most likely to occur if a H is much lower than a M , which in turn is only slightly lower than a H . To ensure that there remain benefits from basing policy on an incorrect model, the policy maker must receive high utility from holding office. A distinguishing feature of the partially pooling equilibrium ii is that parties occasionally depart from their ‘normal’ partisan behaviour. Such moves take place when the incumbent’s view of
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how the economy works differs widely from his ideological view, so that the costs of sticking to its ideology exceed the gains. Voters infer information about the working of the economy from the observed policy shift. They know that the correct model of the economy is the model favoured by the opposition party. The resulting change in voters’ beliefs increases the probability that the opposition party will be elected in the next elections. If the opposition party takes office in the next period, it will be in the comfortable position that it can credibly base policy on its ideological model. Thus, the new incumbent will forcefully continue the policy shift initiated by the previous incumbent without being punished for it by voters.
6. Final remarks Party ideologies can be explained in a model in which parties have superior knowledge about the efficacy of policy relative to voters. The role of party ideologies in the conduct of economic policy depends on various features of the economic political system. The political economic model presented in this paper suggests that in rigid economic and polarized political systems, party ideologies are most likely to arise. Conversely, in flexible economic systems with a high degree of cohesion, party ideologies will play a minor role. The model developed in this paper is based on several simplistic assumptions which call for relaxation. First of all, the model employed is basically static. The only link between the two periods is that current policy may affect future policy through its effect on voter behaviour. The static nature of the model has enabled me to focus on the strategic role of ideology. One natural way of introducing dynamics into the model is by assuming that parties attach costs to adjusting policies Ž G) s Gty1 .. The assumption that changing the status quo involves costs can be motivated by uncertainty about the distributive effects of policy Žcf. Fernandez and Rodrik, 1991.. Adjustment costs affect the decision problem the incumbent faces in two ways. First, adjustment costs enable the incumbent in period 1 to affect his successor’s policy. In the model discussed in this paper this causes that party l Ž r . has an incentive to leave a large Žsmall. public sector, in particular if the incumbent is likely to lose the elections. Second, adjustment costs affect voter behaviour. From Eqs. Ž8. and Ž9. it is easy to see that if G) s Gty1 , the probability that party l wins the elections is inversely related to the initial size of the public sector. As a consequence, party l Ž r . may try to attract ‘middle of the road’ voters by choosing a relatively low Žhigh. level of government activities. Since the above two effects on policy are conflicting, the sign of the sum of these effects is ambiguous. Which of the two effects dominates depends among other things on the parties’ chances of winning the elections. For example, if the incumbent party is almost certain to lose the elections, the first effect will dominate. The introduction of adjustment costs into the model does not affect the
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main principles of the role of party ideologies. However, it affects the benefits and costs of the adoption of an ideological view. Most importantly, in the model with adjustment costs the state of the economy affects the costs and benefits of holding a party ideology. For instance, it is easy to derive that the smaller the initial size of the public sector, the more likely it is that party l adopts an ideological view. Second, in my model the election held at the end of period 1 is the last one. As a consequence, reputation does not play a role in the model. The extension to a finitely repeated game is straightforward. In that case, the model describes the last subgame in which the incumbent cannot gain from building a reputation for basing its policy on the correct model. Since reputation is not an issue in the last subgame, the incumbent cannot gain from a reputation in the next to last subgame either, since voters know that in the last subgame, the incumbent may base policy on an incorrect model. This argument can be applied to every subgame, including the first. However, in a infinitely repeated game, parties may gain from building a reputation for always basing their policies on a correct model. Reputational forces become important when the discount factor is high. Another consequence of the two period model is that voters cannot punish political parties for basing policy on an incorrect model. Naturally in a multi-period setting, voters will learn that they are sometimes misled by the government. However, since voters are atomistic, each of them disregards any effect of his vote on policy. As a consequence, it is unlikely that voters collectively engage in strategic behaviour, forcing the political parties always to base policy on the correct model. In fact, the model may explain why in many countries voters are sceptical about politics in general and about policy makers’ faithfulness in particular. Third, the results of this paper would change if I had assumed a continuous strategy set for the incumbent, rather than a discrete strategy set. If the incumbent could base policy on any model he desires, an a L-type of party l could base his policy on a very extreme model so that an a M -type is not tempted to mimic. Thus a continuous strategy space makes a separating equilibrium Žin which policy makers do not always base their actions on the correct model. more likely. However, if unlike the incumbent, voters think in terms of a limited number of ideologies, the incumbent may still have incentives to masquerade the type of the economy. In such a model thresholds are likely to play an important role. If the policy variable exceed a certain threshold, voters consider policy to be in conflict with the incumbent’s ideology. For example, a right-wing party signals the ideological model as long as it does not increase tax rates. Then a rise in tax rates decreases the probability that party r wins the elections. A drawback of such a model is that the choice of the thresholds is not always obvious. Fourth, policies only affect voter behaviour through their effects on voters’ beliefs. A natural extension of the model is that voters also base vote decisions on the past economic performance Žretrospective voting behaviour.. Voters may use economic outcomes to evaluate the probability that a certain ideology is correct. For example, in case of a flourishing private sector and an expanding public sector
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party r may have more problems to convince voters that public activity has large adverse effects on private activity than in case of a private sector in decline and an expanding public sector. Fifth, in the present paper, all voters are assumed to be uncertain about the efficacy of economic policy. Recently, Feddersen and Pesendorfer Ž1996. have examined vote abstention when part of the electorate is informed about the costs of a policy innovation and part is not. They show that less informed voters may have an incentive to abstain from voting. Incorporation of this idea in our model is likely to reduce the electoral effects of the adoption of an ideology. For in our model, ideology may increase the chances of reelection as it leaves voters uncertain about the efficacy of economic policy. If this induces the less informed voters to abstain, ideology will not effect election outcomes. Hence, the benefits of the adoption of an ideology will decrease.
Acknowledgements I am indebted to Jos Jansen, Maarten Janssen and an anonymous referee for useful remarks.
References Alesina, A., 1988. Credibility and policy convergence. Am. Econ. Rev. 78, 796–805. Alesina, A., Cukierman, A., 1990. The politics of ambiguity. Q. J. Econ. 60, 829–850. Cho, I.K., Kreps, D., 1987. Signalling games and stable equilibria. Q. J. Econ. 102, 179–222. Downs, A., 1957. An Econ. Theory of Democracy, Harper and Row, New York. Feddersen, T.J., Pesendorfer, W., 1996. The swing voter’s curse. Am. Econ. Rev. 86, 408–424. Ferejohn, J., 1986. Incumbent performance and electoral control. Public Choice 50, 5–26. Fernandez, R., Rodrik, D., 1991. Resistance to reform: status quo bias in the presence of individualspecific uncertainty. Am. Econ. Rev. 81, 1146–1155. Frankel, J., Rockett, K., 1988. International macroeconomic policy coordination when policy makers do not agree on the true model. Am. Econ. Rev. 78, 318–340. Ghosh, A.R., Masson, P.R., 1991. Model uncertainty, learning, and the gains from coordination. Am. Econ. Rev. 81, 465–480. Holtham, G., Hughes Hallett, A., 1992. International macroeconomic policy coordination when policymakers do not agree on the true model. Am. Econ. Rev. 82, 1043–1051. Meltzer, A.H., Richard, S.F., 1981. A rational theory of the size of the government. J. Pol. Econ. 89, 914–927. Roemer, J.E., 1994. The strategic role of party ideology when voters are uncertain about how the economy works. Am. Pol. Sci. Rev. 88, 327–335. Rogoff, K., 1990. Equilibrium political budget cycles. Am. Econ. Rev. 80, 21–36. Swank, O.H., 1994. Partisan views on the economy. Public Choice 81, 137–150.
Towards an economic theory of party ideology Otto H. Swank
)
Erasmus UniÕersity Rotterdam, Tinbergen Institute, OCFEB, Rotterdam, Netherlands
Abstract In this paper a signalling model is used to examine the role of party ideology in the conduct of economic policy. A distinguishing feature of the model is that policy makers have more knowledge about the efficacy of economy policy than voters. This asymmetry of information generates an incentive for the policy makers to adopt an ideological view of how the economy works. It is shown that party ideologies are most likely to arise in rigid economic and polarized political systems. q 1998 Elsevier Science B.V. All rights reserved. JEL classification: D78; E61 Keywords: Party ideology; Signalling model; Economic policy
1. Introduction In this paper I develop a political economic framework to gain insight into the role of party ideology in the conduct of economic policy. Essential features of the framework are that there exist different models of how the economy works and that political parties have better information about the working of the economy than voters. It is argued that in a partisan setting election outcomes depend on voters’ perceptions of the efficacy of alternative policies. For example, the popularity of a political party favouring a small size of the government is relatively high if voters believe that public activity has large adverse effects on
)
Corresponding author. Erasmus University Rotterdam H7-16, P.O. Box 1738, 3000 DR Rotterdam, Netherlands. E-mail: [email protected]. 0176-2680r98r$19.00 q 1998 Elsevier Science B.V. All rights reserved. PII S 0 1 7 6 - 2 6 8 0 Ž 9 8 . 0 0 0 0 5 - 6
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private activity. An important implication of this is that political parties have an incentive to make voters believe in a specific model of the economy. The party in office can credibly do so by basing its policy on that model. However, if that model is invalid, the incumbent incurs costs, because its policy is based on an incorrect model. Naturally, the more the model on which policy is based deviates from the correct model, the higher are these costs. We show that under certain conditions, on average each political party bases policy on a model that is favourable from an electoral point of view. This model may be interpreted as that party’s ideological view of how the economy works. However, occasionally a political party may depart from its ideological model. In that case the costs of basing policy on the ideological model are deemed too high and it seems as if the party has abandoned its traditional political position. In this paper party ideologies refer to parties’ pretended views of how the economy works. A party ideology basically serves as a means to sell partisan policies to incompletely informed voters. I try to gauge under which political and economic conditions Ž1. parties hold dogmatic ideologies and never depart from it, Ž2. parties are completely pragmatic and base policy always on the model they consider as the correct model and Ž3. parties usually base policy on an ideological model but sometimes depart from it. The analysis suggests that party ideologies are most likely to arise in countries with a rigid economic system and a polarized political system. Moreover, the higher is the utility parties receive from holding office, the higher is the probability that party ideologies arise. My paper is related to several earlier studies, in particular those dealing with the strategic role of party ideology ŽRoemer, 1994 and Swank, 1994.. Roemer examines a partisan model in which voters are uncertain about the working of the economy and each political party announces a policy and a theory of the economy. Unlike the model developed here, in Roemer’s model elections outcomes are certain so that the median voter theorem applies and the two parties propose the same policy. Moreover, in Roemer’s paper announcements of theories of the economy directly affects voters’ perceptions of how the economy works, whereas in this paper voters take announcements only seriously if policy makers’ announcements are in accordance with their actions. To put it differently, in Roemer’s model parties are identified with the platforms they are assumed to carry out after the elections. As argued by Ferejohn Ž1986., this approach raises a time-consistency problem, in the sense that once elections are held parties may diverge from their platforms and pursue their own interests or the interests of their core-constituencies. Rational voters recognize this and take parties’ platforms only serious if they are credible. In this paper, attention is restricted to time-consistent policies and announcements of economic theories. Since only the party in office can support its announcements by actions, the opposition party plays a relatively passive role in the model. In spite of the differences between the two approaches, they lead to the same notion that parties ‘use’ theories of the economy to sell their policies to voters.
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My model is also related to various signalling models of economic policy in which voters are uncertain about the type of the government. Alesina and Cukierman Ž1990. have developed a model in which voters are uncertain about the preferences of the incumbent party and Rogoff Ž1990. has examined a model in which voters do not know the policy maker’s competence. In signalling models the order of actions is important. Usually it is assumed that the policy maker moves first and that voters, after observing the policy maker’s action but not his type, move next. This may enable the policy maker to signal his type. In this paper, the types of the government refer to different models of the economy and the government may signal a model of the economy by basing its actions on it. In my model signalling may be useful, since vote decisions depend on voters’ perceptions of how the economy works. As a consequence, political parties have an incentive to make voters believe in a specific model of the economy. As discussed above, voters are assumed to be uncertain about the extent to which private activity is crowded out by government activity. The motivation of this assumption relies on Downs Ž1957., who argued that voters have few incentives to acquire information about policy matters. Rational ignorance creates the possibility for parties to supply information. However, rational voters will recognize that this source of information may be biased. The signalling framework adopted in this paper enables me to reconcile the concepts of voters’ rationality and voters’ ignorance Žcf. Rogoff, 1990.. While the logic of the approach followed in this paper is general, I will use decisions on the size of the government as an example to illustrate the main ideas behind the approach. I think this example is interesting, because economic theories typically differ in their predictions of the effects of government activities on private activities. In the example, all citizens care about government and private activities, but some benefit more from government activities than others. This assumption is in line with models emphasizing the redistributional nature of government activities Žcf. Meltzer and Richard, 1981.. The paper is organised as follows. The next section discusses the basic elements of the model. In Section 3, voter behaviour is analyzed under incomplete information. Section 4 discusses some interesting equilibria and Section 5 discusses the conditions under which these equilibria occur. Section 6 concludes the paper with a discussion of the sensitivity of the results for changes in the main assumptions underlying the model.
2. The model In this section I discuss the main features of a simple two-period political economic model in which citizens have different preferences as to the activities the government should engage in. Differences among voters may be ideological or stem from the distributional consequences of government activities. At the end of
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period 1 elections are held which determine the political colour of the government in period 2. Two parties, each catering to the desires of its core constituency, run for office. Apart from ideological or redistributional considerations, decisions on the size of the government depend on the effects of government activities on private activities. A distinguishing feature of the model is that political parties have superior knowledge about those effects compared with voters. Basically, this paper explores how political parties may use this information advantage. To keep things simple, it is assumed that voters know the preferences of political parties. 2.1. The preferences of Õoters The economy is composed of a large number of voters whose preferences are represented by linear-quadratic utility functions: Ut .i s Tt y g P Ž Gt y Gid .
2
Ž 1.
where Y is the share of Ždisposable. income in potential income, G is the share of government spending in potential income and t is a time index. It is assumed that for each voter i there exists a unique exogenous value of Gt , Gid , such that voter i would benefit from a rise in Gt for Gt - Gid and would suffer from a rise in Gt for Gt ) Gid . I assume that there is a continuum of voters in terms of Gid . The somewhat degenerate nature of the utility function is not responsible for the results. All that is required is that voters differ in their preferences over Y and G. Alternatively, I could have assumed that voters differ in g i instead of G d . The reason for introducing heterogeneity in voters’ preferences through Gid is to economize on notation later. The linear-quadratic specification of the utility function is common in models in which the efficacy of policy is uncertain Žcf. Frankel and Rockett, 1988, Ghosh and Masson, 1991 and Holtham and Hughes Hallett, 1992. and is adopted for mathematical convenience. 2.2. The preferences of the political parties There are two political parties, l and r, each representing the interests of its core constituency. Thus the parties differ in Gid , with G ld ) Grd . The utility functions of political parties deviate from those of voters in two respects. First, the political parties receive direct utility from holding office. Second, the incumbent party attaches costs to deviations of G from a certain benchmark, G). Those costs may be due to an unwilling bureaucracy which has interests in a certain size of the government Ž G). or due to a dichotomy in the political structure of the economy Žthe administration vs. Congress, where Congress aims at Gt s G).. Alternatively, adjustment of the status quo may involve costs Ž G) s Gty1 .. Period t utility of party j Ž j s l,r . is given by: 2
2
Ut , j s Ž 1 y b . P Yt y g P Ž Gt y Gjd . y b P Ž Gt y G) . q l P p t , j
Ž 2.
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where l denotes the utility attached to holding office and p t, j is a shift variable taking the value one if party j is in office and zero otherwise. The parameter b is a measure of the extent to which political parties are constrained in pursuing ideological and electoral goals. If adjustment costs are low and the incumbent party controls the apparatus of the state, b is small. Initially, G) is assumed to be fixed. Later I will elaborate upon the implications of this assumption for the results. In principle, Eq. Ž2. implies that a political party may prefer opposition to office. Throughout this paper, l is assumed to exceed a critical value, ensuring that both parties always prefer office to opposition. 2.3. Uncertainty about the efficacy of policy The relationship between Yt and Gt is described by a simple linear equation: Yt s 1 y a t P Gt .
Ž 3.
Uncertainty about the effects of Gt on Yt is incorporated in a t . I assume that a t can take on three values: a L , a M and a H , with a L - a M - a H . The value of a t evolves according to the following stochastic process: if a 1 s a L , there is a probability r that a 2 s a L and a probability Ž 1 y r . that a 2 s a M ; if a 1 s a M , there is a probability r that a 2 s a M , a probability 1r2 P Ž 1 y r . that a 2 s a L and a probability 1r2 P Ž 1 y r . that a 2 s a H ; if a 1 s a H , there is a probability r that a 2 s a H and a probability Ž 1 y r . that a 2 s a M .
Ž 4. Without affecting the main results of this paper, I assume symmetry in the sense that
a M s 1r2 P a L q 1r2 P a H . Basically, there are two interpretations of Eq. Ž4.. The first is that reality is too complex to be captured by a single model, for example because the economy can be in different stages. Each model describes a different stage. According to Eq. Ž4. there are three stages of the economy, two extreme stages and one normal stage. The stochastic process describes how the economy moves from one stage to another. The second interpretation of Eq. Ž4. is that there exists a correct model of the economy, but has not been discovered yet. The economic literature offers various models which differ in their predictions of the efficacy of policy. The value of a t reflects the state of the art in economics and may change over time when new evidence becomes available. A singular feature of the model is that political parties have better information about a t than voters. It is assumed that political parties know a t , while voters
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only know a ty1. I consider the case in which voters assign the following a priori probabilities to a 1: Prob Ž a 1 s a L . s 1r2 P Ž 1 y r . Prob Ž a 1 s a M . s r
Ž 5.
Prob Ž a 1 s a H . s 1r2 P Ž 1 y r . . The above a priori probabilities amount to the assumption that a t s a M in period 0. The specification of the stochastic process of a t is clearly an ad hoc one. For this reason, it is worth elaborating on it. One assumption underlying Eq. Ž4. is crucial. This is that a t is treated as a discrete parameter, rather than a continuous parameter. This assumption is made for tractability reasons. One way of looking at it is that political parties, like voters, are basically ignorant about alternative economic theories. Due to this, policy makers find it difficult to make subtle distinctions between various models, but are able to divide them into types. 1 For example, policy makers know that according to some models effects of Gt on Yt are small, median or large. Later on, I will discuss the implications of restricting the strategy space for the results. Two other assumptions underlying Eq. Ž4. are relatively innocuous. First, the imposed symmetry is only to reduce notation. Second, the simple stochastic process according to which a t evolves can be replaced with a more sophisticated one. What matters is that there is some persistence in the relationship between Yt and Gt , so that information about a 1 leads to a more precise forecasts of a 2 . 2.4. The order of actions Before the game starts Žstage 0., the incumbent party gathers information about the state of the art in economics. Next, in stage 1 the party in office chooses policy. At the end of period 1, before Y1 is observed Žstage 2., elections are held. When casting their ballots voters know policy in period 1, but do not know which model is correct. They update their prior beliefs about the efficacy of policy on the basis of the information captured by policy in period 1. Each voter casts his ballot for the party that offers him highest expected utility. At the beginning of the second period, nature determines how the efficacy of policy evolves. At the end of
1 In this paper there are three types of advisers which is the minimum to explain the phenomena discussed in the introduction. Assuming more than three type of advisors does not affect the main ideas behind the model.
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Fig. 1. The order of actions.
the game Žstage 3., the party which has won the elections implements policy. Fig. 1 summarizes the order of actions of the players in more formal terms.
3. Policy in period 2 and the voting function In period 2, only the party that has won the elections chooses an action. Let G 2, j denote policy in period 2 if party j has won the elections. In the second period, the incumbent party does not face an election constraint. As a consequence, G 2, j follows from maximizing period 2 utility with respect to G 2, j , subject to Eq. Ž3., yielding: G 2, j s
g P Ž 1 y b . P Gjd q b P G) y 1r2 P Ž 1 y b . P a 2 gP Ž1yb . qb
Ž 6.
Since by assumption G ld ) Grd , G 2,l ) G 2, r . Note that in period 2 the party in office has no incentive to base policy on an economic model that deviates from the correct model. Thus a 2 in Eq. Ž6. refers to party j’s actual view of the economy. Let us now consider the decision problem voters face. Voters are assumed to be rational and forward-looking. Each voter casts his ballot for the party that offers him highest expected utility. Voters know that in period 2 the party in office chooses Eq. Ž6. and bases policy on the correct model Ž a 2 .. However, voters are uncertain about a 2 , because they observe neither a 1 nor a 2 . Since in period 1 policy may convey information about a 1 , and through Eq. Ž5. about a 2 , expectations of a 2 are formed conditional on G1. Let E A < G 14 denote the expectation of
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A given that G 1 is implemented in period 1. Eq. Ž1. implies that voter i casts his ballot for party l, Õi s l, if: 2
E Ž 1 y a 2 P G 2,l . y g P Ž G 2,l y Gid . < G 1 ) E Ž 1 y a 2 P G 2, r .
½
5
½
2
yg P Ž G 2, r y Gid . < G 1
5
Ž 7.
where G 2, j is given by Eq. Ž6.. Eqs. Ž6. and Ž7. show that a 2 affects vote decisions along two channels. First, a 2 affects voters’ expectations of policies in period 2 Žsee Eq. Ž6.. and second, a 2 affects the evaluation of those policies Eq. Ž7.. By substituting Eq. Ž6. into Eq. Ž7. for j s l,r and rearranging the terms, Eq. Ž7. can be rewritten as: b Gij) E a 2 < G1 4 2Pg gP Ž1yb . qb q
g P Ž 1 y b . P Ž G ld q Grd x q 2 P b P G) 2P gP Ž1yb . qb
[T
Ž 8.
Eq. Ž8. shows that every voter i with Gid ) T votes for party l. Since in this model voters’ preferences are single peaked, to determine the election outcomes it suffices to establish for which party the median voter casts his ballot. Following Alesina Ž1988. it is assumed that the position of the median voter Ž Gmd . is uncertain and randomly distributed on the interval w0, ` ) according to a continuous density function f Ž Gmd .. The probability that party l wins the elections Ž Pl . is given by: `
Pl s Prob Ž Õm s l . s T H f Ž Gmd . dGmd .
Ž 9.
4. Equilibria The game described above is a signalling game in which the incumbent sends a message to voters about the type of the economy through G1. As it is usual in signalling games, various types of Žperfect Bayesian. equilibria may exist, including separating, pooling and partially pooling equilibria. In this section, I discuss some interesting equilibria, restricting attention to pure strategies. I consider the case in which party l is the incumbent in period 1, and I show that party l may have an incentive to make voters believe that the working of the economy is characterised by a L . The case that party r is in office in period 1 is analogous, save that it is in the interest of party r that voters believe that the working of the economy is characterised by a H . For the presentation of the equilibria, it is convenient to identify party l with the type of the economy. I pretend that there exist three types of party l: an a L-, an a M - and an a H -type. Each type of party l refers to an economic model. Thus the statement ‘an a H -type of party l mimics an
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a L-type’ means that party l bases policy on the economic model characterised by a L , while the correct economic model is characterised by a H . 4.1. A separating equilibrium In a separating equilibrium, the three types of party l choose three different actions in the first period. Here this means that party l always bases policy on the correct model of the economy. As a consequence, G 1 fully reveals the incumbent’s type and voters have complete information when casting their ballots. Let m k denote voters’ posterior belief that a 1 s a k , k g L,M,H4 and G 1 Ž a k . s argmax U1,l Ž G1 , a k . k e L,M,H 4 .
Ž 10 .
In a separating equilibrium, voters’ posterior beliefs are given by:
m k s Prob Ž a 1 s a k < G1 Ž a k . . s 1 for k e L,M,H 4 .
Ž 11 .
A necessary condition for a separating equilibrium is that the strategy to base policy always on the correct model is optimal given voters’ beliefs about how the economy works. Basing policy on an incorrect model affects the utility of party l in two ways. First, it decreases period 1 utility, since policy is based on an incorrect model. I refer to this decrease in utility as the costs of basing policy on an incorrect model ŽC.. Let a 1 refer to the correct model of the economy. The costs of basing policy on an incorrect model can be written as: C Ž a k , a 1 . s U1,l Ž G 1 Ž a 1 . , a 1 . y U1,l Ž G 1 Ž a k . , a 1 . 2
2
Ž 1 y b . P Ž a k y ya 1 . s . gP Ž1yb . qb
Ž 12 .
Eq. Ž12. shows that the costs of basing policy on an incorrect model Ž a k / a 1 . are increasing in the deviations of a k from a 1 and decreasing in b and g . Note that G 1Ž a k . and G 1Ž a 1 . are evaluated on the basis of the correct model, a 1. Second, basing policy on an incorrect model affects voters’ beliefs about a 1 and accordingly affects the probability that party l wins the elections. In a separating equilibrium, the incumbent can decrease E a 2 < G 1Ž a k .4 by basing its policy on a model that is characterised by a lower a 1 than the correct model Žsee Eq. Ž11... Given Eq. Ž11., it is easy to derive from Eqs. Ž8. and Ž9. that a lower value of E a 2 < G 1Ž a k .4 increases the probability that party l wins the election. The intuition behind this is straightforward. A rise in E a 2 < G 1Ž a k .4 increases the costs of government spending in terms of Yt and therefore decreases voters demand for government activity. The supply of government activity also decreases, but less than demand, because the policy maker is constrained. As a consequence, the policy most desired by each voter moves Žrelatively speaking. towards the policy proposed by the party favouring a small size of the government. Hence, the probability that party l wins the election increases. The increase in expected
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period 2 utility resulting from basing policy on a model that is characterised by a lower a 1 than the correct model is referred to as the benefits Ž Bs . from basing policy on an incorrect model in a separating equilibrium. In period 1, expected period 2 utility is given by the utility party l attaches to G 2, l plus the utility that party l receives from G 2, r weighted by the probabilities that those policies are implemented Ž Pl and 1 y Pl , respectively.: e U2,l s s P Pl Ž E a 2 < a 1 s a k 4 . P U2,l Ž G 2,l .
q Ž 1 y Pl Ž E a 2 < a 1 s a k 4 . . P U2,l Ž G 2, r .
Ž 13 .
where s is the discount factor Žtotal utility Uj s Ý2ts1 s ty1 P Ut, j .. Eq. Ž11. indicates that if G 1 is based on a k , rather than on a 1 , voters’ beliefs change from a 1 to a k . Hence the benefits from basing policy on a k are equal to: Bs Ž a k , a 1 . s s P Pl Ž E a 2 < a k 4 . y Pl Ž E a 2 < a 1 4 . P U2,l Ž G 2,l . y U2,l Ž G 2, r . s s P Pl Ž E a 2 < a k 4 . y Pl Ž E a 2 < a 1 4 . 2
P
½
g 2 P Ž 1 y b . P Gld y Grd gP Ž1yb . qb
2
q l q b Ž G 2, r y G) .
2
5 Ž 14 .
Clearly, if a k - a 1 , then Bs ) 0. 2 Furthermore, Eq. Ž14. shows that the benefits from basing policy on an incorrect model are increasing in l and Gld . A separating equilibrium occurs if BsŽ a k , a 1 . CŽ a k , a 1 . for k g L,M,H4 and all possible values of a 1. Under this condition, party l has no incentive to base policy on an incorrect model, given voters’ posterior beliefs. Furthermore, voters’ beliefs are optimal given the policies implemented by party l. 4.2. A pooling equilibrium In a pooling equilibrium the three types of party l choose the same policy in the first period. Here this means that party l chooses G1 s G 1Ž a L ., because party l cannot benefit from basing policy on an incorrect model if a 1 s a L . Since in the first period, policy is independent of the incumbent’s type, voters cannot infer 2
Recall the assumption that both political parties prefer office to opposition, implying that wU2, l Ž G 2,l .-U2,l Ž G 2,r .x ) 0.
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information from G1. Hence on the equilibrium path voters’ posterior beliefs are equal to their prior beliefs: m L s Prob Ž a 1 s a L < G 1 Ž a L . . s 1r2 P Ž 1 y r .
m M s Prob Ž a 1 s a M < G 1 Ž a L . . s r m H s Prob Ž a 1 s a H < G 1 Ž a L . . s 1r2 P Ž 1 y r .
Ž 15 .
so that E a 2 < G 1Ž a L .4 s a M . To check whether party l benefits from deviating from its strategy given Eq. Ž15., voters’ beliefs have to be specified when G 1Ž a M . and G 1Ž a H . are observed. Since there are no types of party l that benefit from basing policy on a model being characterised by a k for which a k ) a 1 Žsee Eqs. Ž8. and Ž9.., irrespective of voters’ beliefs, voters are assumed to assign zero probabilities to those events, implying: Prob Ž a 1 s a H < G 1 Ž a H . . s 1 and Prob Ž a 1 s a L < G 1 Ž a M . . s 0. These assumptions which are based on the intuitive criterion of Cho and Kreps Ž1987. do not determine exactly how voter beliefs’ are updated when G 1Ž a M . is observed. It restricts the corresponding expectation of a 1 to: a H G E a 1 < G1Ž a M .4 GaM. Necessary conditions for a pooling equilibrium are that both an a H -type and an a M -type increase utility by mimicking an a L-type given the above posterior beliefs. Let me first consider an a H -type. The costs of mimicking are given by Eq. Ž12. with a k s a L and a 1 s a H . The benefits of mimicking are Ž Bp Ž a H , a M ..: Bp Ž a H , a M . s s P Pl Ž a M . y Pl Ž E a 2 < a H 4 . 2
P
½
g 2 P Ž 1 y b . P Gld y Gtd gP Ž1yb . qb
2
q l q b Ž G 2, r y G) .
2
5
.
Ž 16 . If Bp Ž a H , a M . ) C Ž a k s a L , a 1 s a H . an a H -type benefits from mimicking an a L-type. Now let me consider an a M -type. The costs of implementing G 1Ž a L . are given by Eq. Ž12. with a k s a L and a 1 s a M . The benefits from mimicking are given by Eq. Ž16. after replacing E a 2 < a H 4 with E a 2 <Ž E a 1 < G 1Ž a M .4.4 where a H G E a 1 < G 1Ž a M .4 G a M . Clearly, if E a 1 < G1Ž a M .4 approximates a M , the benefits from mimicking go to zero. In this case, party l benefits from deviating from its strategy and a pooling equilibrium does not exist. In contrast, if E a 2 < G 1Ž a M .4 approximates a H , mimicking an a L-type may be fruitful. Thus a pooling equilibrium can only exist if voters assign a high probability to the event that the economy is described by a H , when G 1Ž a M . is observed. The intuition behind these results is straightforward. In a pooling equilibrium, party l cannot decrease the conditional expectation of a 2 below a M . If a H is the correct model of the economy there are benefits from mimicking, so that party l trades off the costs of basing policy on an incorrect model against increasing its chances of reelection. However, in case that a M represents the correct model, the incumbent would like
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to implement G 1Ž a M . rather than G 1Ž a L ., because G 1Ž a L . raises costs through Eq. Ž12., but does not reduce voters’ belief about a 1 below a M . Only if G 1Ž a M . makes voters believe that a 1 is higher than a M , the incumbent may benefit from implementing G1Ž a L .. 4.3. Partially pooling equilibria In a partially pooling equilibrium two types of party l choose the same policy in period 1 and the third type chooses a different policy. In principle, there are three possible partially pooling equilibria. i. Both an a L-type and an a H -type choose G 1Ž a L . and an a M -type chooses Ž G 1 a M .. On the equilibrium path voters’ beliefs are given by:
m L s Prob Ž a 1 s a L < G 1 s G 1 Ž a L . . s 1r2 m M s Prob Ž a 1 s a M < G 1 s G 1 Ž a M . . s 1
Ž 17 .
m H s Prob Ž a 1 s a H < G 1 s G1 Ž a L . . s 1r2. Clearly, the above set of strategies and beliefs are not an equilibrium. Suppose that in period 1 an a H -type is in office. By mimicking an a L-type, the conditional expectation of a 2 is a M . The beliefs on the equilibrium path Eq. Ž17. imply that this value can also be reached by mimicking an a M -type. Since the costs of mimicking an a M -type are lower than the costs of mimicking an a L-type, the latter action is dominated by the former one. Thus given Eq. Ž17., it is optimal for an a H -type not to base policy on a L . This rules out the above strategies and beliefs as an equilibrium. ii. Both an a M -type and an a L-type choose G 1Ž a L . and the a H -type chooses Ž G 1 a H .. On the equilibrium path voters’ beliefs are given by:
m L s Prob Ž a 1 s a L < G 1 s G 1 Ž a L . . s
1yr
1qr 2Pr m M s Prob Ž a 1 s a M < G 1 s G 1 Ž a L . . s 1qr
Ž 18 .
m H s Prob Ž a 1 s a H < G 1 s G1 Ž a H . . s 1. Necessary conditions for these strategies and beliefs to be an equilibrium are that an a M -type increases utility and an a H -type decreases utility by mimicking an a L-type:
s P Pl Ž E a 2 < G 1 Ž a L . 4 . y Pl Ž E a 2 < G 1 Ž a M . 4 . 2
P
½
g 2 P Ž 1 y b . P Gld y Grd gP Ž1yb . qb
) C Ž ak s a L , a1 s a M .
2
q l q b Ž G 2, r y G) .
2
5 Ž 19 .
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and
s P Pl Ž E a 2 < G 1 Ž a L . 4 . y Pl Ž E a 2 < a H 4 . 2
P
½
g 2 P Ž 1 y b . P Gld Grd
2
gP Ž1yb . qb
q l q b Ž G 2, r y G) .
2
5
- C Ž ak s a L , a1 s a H . .
Ž 20 .
In order to check whether the above strategies and beliefs are an equilibrium if Eqs. Ž19. and Ž20. are satisfied, I have to specify voters’ beliefs when G 1Ž a M . is observed. Since an a L-type and an a M -type choose G 1Ž a L ., I assume ProbŽ a 1 s a H < G 1Ž a M .. s 1. 3 In that case, Eqs. Ž19. and Ž20. are sufficient conditions for the above strategies and beliefs to be a partially pooling equilibrium. iii. Both an a M -type and an a H -type choose G1Ž a M . and the a L-type chooses G 1Ž a L .. On the equilibrium path voters’ beliefs are given by:
m L s Prob Ž a 1 s a L < G 1 s G 1 Ž a L . . s 1. m M s Prob Ž a 1 s a M < G 1 s G 1 Ž a M . . s m H s Prob Ž a 1 s a H < G 1 s G1 Ž a M . . s
2Pr 1qr 1yr
Ž 21 .
1qr
The basic idea behind the necessary conditions for an equilibrium is similar to that behind the previous case. Now an a H -type has to benefit from mimicking an a M -type, whereas an a M -type must decrease utility by basing its policy on a L :
s P Pl Ž E a 2 < G 1 Ž a M . 4 . y Pl Ž E a 2 < a H . 4 . 2
P
½
g 2 P Ž 1 y b . P Gld y Grd
2
q l q b Ž G 2, r y G) .
gP Ž1yb . qb
2
5
) C Ž ak s a M , a1 s a H .
Ž 22 .
and
s P Pl Ž E a 2 < G 1 Ž a L . 4 . y Pl Ž E a 2 < G 1 Ž a M . 4 . 2
P
½
g 2 P Ž 1 y b . P Gld y Grd gP Ž1yb . qb
- C Ž ak s a L , a1 s a M . .
2
q l q b Ž G 2, r y G) .
2
5 Ž 23 .
The above conditions can only hold if the effect of a rise in E a 2 4 on the 3
The motivation of this assumption is that an a H -type may have an incentive to masquerade its type, while an a M -type has no incentive to reveal its type if Eq. Ž19. is satisfied.
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probability that party l is reelected is much lower for high values of a 2 than for low values of a 2 . It is easy to derive that given Eq. Ž21.: E a 2 < G1 Ž a M . 4 y E a 2 < G1 Ž a L . 4 ) E a 2 < G1 Ž a H . 4 y E a 2 < G1 Ž a M . 4 .
Ž 24 . Eq. Ž24. shows that the effect of mimicking on E a 2 4 is higher if an a M -type mimics an a L-type than if an a H -type mimics an a M -type. This implies that if the effect of a 2 on Pl is independent of the value of a 2 , 4 and an a H -type increases utility by mimicking an a M -type, an a M -type increases utility by basing its policy on a L . 5 Then the above strategies and beliefs can be ruled out as an equilibrium. One might think that this way of reasoning also rules out the strategies and beliefs under ii, because the fact that an a M -type increases utility by implementing G 1Ž a L . implies that an a H -type must benefit from implementing G 1Ž a M .. However, in that case, an a M -type mimics an a L-type, so that an a H -type can only masquerade its type by basing its policy on a L . As a consequence, the costs of mimicking are lower for an a M -type than for an a H -type. 5. Evaluation of the equilibria In Section 4, I have discussed four pure strategy perfect Bayesian equilibria. Which of those equilibria arises depends on the parameters of the model and in two cases on voters’ beliefs about the incumbent’s type when out-of-equilibrium behaviour is observed. 6 As mentioned earlier, the analysis of the equilibria when party r is in office in the first period is analogous to the above analysis, except that party r has an incentive to base policy on a H in the first period. Since the political economic model is highly symmetric in its treatment of the political parties, I presume that if a certain equilibrium occurs if party l is in office, a similar equilibrium would occur if party r were in office. 7 In a separating equilibrium, political parties always base policy on the correct model of the economy. As a consequence, the outcomes of the model are the same as the outcomes of the model if voters were assumed to have full information. A 4 This occurs, for example, if the position of the median voter, Gmd Žsee Eq. Ž9.. is uniformly distributed. 5 Note that Eq. Ž12. indicates that the corresponding costs of mimicking are equal for an a H -type and an a M -type. 6 In the model there is also a multiplicity of hybrid equilibria in which in the first period parties randomize between basing policy on different models. As in the pooling and partially pooling equilibria, in hybrid equilibria, party l Ž r . is biased to base policy on a model that is characterized by a low Žhigh. value of a 1. 7 If the voting function, PlŽP., is a linear function of E a 2 < G1 4 and voters assign the same beliefs to out off equilibrium behaviour when party l is in office and party r is in office, so that the model is completely symmetric Žsee also Footnote 4..
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separating equilibrium arises when the costs of basing policy on an incorrect model exceed the benefits. Eqs. Ž8., Ž9. and Ž14. indicate that the benefits from mimicking are low when the political parties give low utility to holding office and there is a low degree of political polarization Ž G ld y Grd .. Furthermore, since the costs of basing policy on an incorrect model fall in period 1, while the benefits are reaped in period 2, a separating equilibrium is more likely to arise when the discount factor is low. Finally, note that if political parties are unconstrained in implementing policy there are no benefits from mimicking. In that case, election outcomes are independent of the costs of government activity in terms of private activity and a separating equilibrium occurs. In a pooling equilibrium, party l bases policy always on a L and party r always bases policy on a H . As a consequence, it seems as if each party dogmatically subscribe to an economic ideology. Party r announces that an expansion of the government sector has large adverse effects on private activity and acts accordingly, whereas party l holds the view that government activity has minor effects on economic activity. It is worth emphasizing that in this paper parties’ ideologies stem from strategic considerations, rather than from principled disagreement about the costs of government activity. As discussed in the previous section, a pooling equilibrium can only exist if the benefits from basing policy on an incorrect model exceed the associated costs. Since there are only benefits if parties are at least to some extent constrained in implementing policy and the benefits depend positively on the degree of polarization and the utility policy parties attribute to holding office, dogmatic ideologies are most likely to arise in a somewhat rigid economic system and a polarised political system where the incumbent party has an utmost interest in keeping office. Moreover, a pooling equilibrium requires that voters also think in terms of extreme economic models, in the sense that if a political party departs from its ideology, voters take this as a signal that the ideology held by the opposition party is correct. In the two possible partially pooling equilibria political parties usually subscribe to an economic ideology, but occasionally abandon their ideologies. Since the equilibrium in which an a H -type of party l and an a H -type of party r mimic an a M -type Žcase iii in Section 4. can only exist under very specific voting functions, I restrict attention to case ii, where parties are biased to basing policy on the extreme models. A partially pooling equilibrium arises when the benefits of basing policy on model a L if model a M is correct exceed the costs, while the costs of basing policy on a L if model a H is correct exceed the benefit. Because the costs of basing policy on model a L depend on the squared deviation of a L from the correct a , a partially pooling equilibrium is most likely to occur if a H is much lower than a M , which in turn is only slightly lower than a H . To ensure that there remain benefits from basing policy on an incorrect model, the policy maker must receive high utility from holding office. A distinguishing feature of the partially pooling equilibrium ii is that parties occasionally depart from their ‘normal’ partisan behaviour. Such moves take place when the incumbent’s view of
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how the economy works differs widely from his ideological view, so that the costs of sticking to its ideology exceed the gains. Voters infer information about the working of the economy from the observed policy shift. They know that the correct model of the economy is the model favoured by the opposition party. The resulting change in voters’ beliefs increases the probability that the opposition party will be elected in the next elections. If the opposition party takes office in the next period, it will be in the comfortable position that it can credibly base policy on its ideological model. Thus, the new incumbent will forcefully continue the policy shift initiated by the previous incumbent without being punished for it by voters.
6. Final remarks Party ideologies can be explained in a model in which parties have superior knowledge about the efficacy of policy relative to voters. The role of party ideologies in the conduct of economic policy depends on various features of the economic political system. The political economic model presented in this paper suggests that in rigid economic and polarized political systems, party ideologies are most likely to arise. Conversely, in flexible economic systems with a high degree of cohesion, party ideologies will play a minor role. The model developed in this paper is based on several simplistic assumptions which call for relaxation. First of all, the model employed is basically static. The only link between the two periods is that current policy may affect future policy through its effect on voter behaviour. The static nature of the model has enabled me to focus on the strategic role of ideology. One natural way of introducing dynamics into the model is by assuming that parties attach costs to adjusting policies Ž G) s Gty1 .. The assumption that changing the status quo involves costs can be motivated by uncertainty about the distributive effects of policy Žcf. Fernandez and Rodrik, 1991.. Adjustment costs affect the decision problem the incumbent faces in two ways. First, adjustment costs enable the incumbent in period 1 to affect his successor’s policy. In the model discussed in this paper this causes that party l Ž r . has an incentive to leave a large Žsmall. public sector, in particular if the incumbent is likely to lose the elections. Second, adjustment costs affect voter behaviour. From Eqs. Ž8. and Ž9. it is easy to see that if G) s Gty1 , the probability that party l wins the elections is inversely related to the initial size of the public sector. As a consequence, party l Ž r . may try to attract ‘middle of the road’ voters by choosing a relatively low Žhigh. level of government activities. Since the above two effects on policy are conflicting, the sign of the sum of these effects is ambiguous. Which of the two effects dominates depends among other things on the parties’ chances of winning the elections. For example, if the incumbent party is almost certain to lose the elections, the first effect will dominate. The introduction of adjustment costs into the model does not affect the
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main principles of the role of party ideologies. However, it affects the benefits and costs of the adoption of an ideological view. Most importantly, in the model with adjustment costs the state of the economy affects the costs and benefits of holding a party ideology. For instance, it is easy to derive that the smaller the initial size of the public sector, the more likely it is that party l adopts an ideological view. Second, in my model the election held at the end of period 1 is the last one. As a consequence, reputation does not play a role in the model. The extension to a finitely repeated game is straightforward. In that case, the model describes the last subgame in which the incumbent cannot gain from building a reputation for basing its policy on the correct model. Since reputation is not an issue in the last subgame, the incumbent cannot gain from a reputation in the next to last subgame either, since voters know that in the last subgame, the incumbent may base policy on an incorrect model. This argument can be applied to every subgame, including the first. However, in a infinitely repeated game, parties may gain from building a reputation for always basing their policies on a correct model. Reputational forces become important when the discount factor is high. Another consequence of the two period model is that voters cannot punish political parties for basing policy on an incorrect model. Naturally in a multi-period setting, voters will learn that they are sometimes misled by the government. However, since voters are atomistic, each of them disregards any effect of his vote on policy. As a consequence, it is unlikely that voters collectively engage in strategic behaviour, forcing the political parties always to base policy on the correct model. In fact, the model may explain why in many countries voters are sceptical about politics in general and about policy makers’ faithfulness in particular. Third, the results of this paper would change if I had assumed a continuous strategy set for the incumbent, rather than a discrete strategy set. If the incumbent could base policy on any model he desires, an a L-type of party l could base his policy on a very extreme model so that an a M -type is not tempted to mimic. Thus a continuous strategy space makes a separating equilibrium Žin which policy makers do not always base their actions on the correct model. more likely. However, if unlike the incumbent, voters think in terms of a limited number of ideologies, the incumbent may still have incentives to masquerade the type of the economy. In such a model thresholds are likely to play an important role. If the policy variable exceed a certain threshold, voters consider policy to be in conflict with the incumbent’s ideology. For example, a right-wing party signals the ideological model as long as it does not increase tax rates. Then a rise in tax rates decreases the probability that party r wins the elections. A drawback of such a model is that the choice of the thresholds is not always obvious. Fourth, policies only affect voter behaviour through their effects on voters’ beliefs. A natural extension of the model is that voters also base vote decisions on the past economic performance Žretrospective voting behaviour.. Voters may use economic outcomes to evaluate the probability that a certain ideology is correct. For example, in case of a flourishing private sector and an expanding public sector
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party r may have more problems to convince voters that public activity has large adverse effects on private activity than in case of a private sector in decline and an expanding public sector. Fifth, in the present paper, all voters are assumed to be uncertain about the efficacy of economic policy. Recently, Feddersen and Pesendorfer Ž1996. have examined vote abstention when part of the electorate is informed about the costs of a policy innovation and part is not. They show that less informed voters may have an incentive to abstain from voting. Incorporation of this idea in our model is likely to reduce the electoral effects of the adoption of an ideology. For in our model, ideology may increase the chances of reelection as it leaves voters uncertain about the efficacy of economic policy. If this induces the less informed voters to abstain, ideology will not effect election outcomes. Hence, the benefits of the adoption of an ideology will decrease.
Acknowledgements I am indebted to Jos Jansen, Maarten Janssen and an anonymous referee for useful remarks.
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