ABSTRACT: Whereas a political budget cycle was once thought to be a phenomenon of less developed economies, some recent studies find such a cycle in a large cross-section of both developed and developing countries. We find that this result is driven by the experience of “new democracies”, wherefiscal manipulation may be effective because of lack of experience with electoral politics or lack of information that voters in more established democracies use. The strong budget cycle in those countries accounts for the finding of a budget cycle in larger samples that include these countries. Once these countries are removed from the larger sample, the political budget cycle disappears. Ourfindings may reconcile two contradictory views of pre-electoral manipulation, one arguing it is a useful instrument to gain voter support and a widespread empirical phenomenon, the other arguing that voters punish rather than reward fiscal manipulation. JEL Classification: D72, E62, D78 Keywords: political budget cycle, new democracy, fiscal manipulation
*Brender: Bankof Israel, firstname.lastname@example.org; Drazen: Tel Aviv University, University of Maryland, CEPR and NBER, email@example.com . We wish to thank Amir Marchak for superb research assistance. We have benefitted from the comments of Alessandra Casella, Marcela Eslava, Zvi Hercowitz, Ken Rogoff, Rob Sauer, Jakob Svensson, and seminar participants at the Bank of Israel and the 2003 International Seminar onMacroeconomics. The second author wishes to thank the Yael Chair in Comparative Economics, Tel Aviv University and the Israel Science Foundation for financial support, as well as the Research Department of the Bank of Israel for its hospitality. The views expressed in the paper do not necessarily reflect those of the Bank of Israel.
1 1. Introduction The common perception is that incumbents oftentry to use expansionary economic policy before elections to increase their re-election chances. Most politicians and non-politicians alike would probably subscribe to this view, and the term “electionyear economics” or its equivalent is common in many countries.1 In the political economy literature, this view is summarized as the “political business cycle”, that is, the possibility of amacroeconomic cycle induced by the political cycle. Models of the political business cycle are motivated by the finding that good macroeconomic conditions prior to the elections help an incumbent to get re-elected, a finding that has wide support in studies (conducted mainly in developed economies).2 The strength of this finding was an important factor generating formal modeling of how opportunisticincumbents may manipulate economic policy to induce economic expansions before elections. However, notwithstanding both common perceptions and the substantial evidence that a “strong economy” helps incumbents get re-elected, empirical studies – especially in developed economies – provide little evidence of a regular and statistically significant increase in economic activity before elections.3 In short,voters care about the economy but this does not appear to translate into econometrically verifiable cycles in aggregate economic activity. Given the lack of evidence for political cycles in economic outcomes, a literature examining possible cycles in policy instruments has developed. More specifically,
Tufte (1978, p.3) begins his famous book on the political business cycle with a quote from1814, “A Government is not supported a hundredth part so much by the constant, uniform, quiet prosperity of the country as by those damned spurts which Pitt used to have just in the nick of time.” 2 The most influential work was probably that of Fair (1978) (updated in Fair [1982, 1988]), who found similar results for the U.S. In his original article, Fair looked at presidential elections from 1916...