Political Economy.pdf

1. LECTURES 1-3
1. From Social Choice to Political Economics
2. Electoral Models: Downs (1957) Majority
Voting Model
ECN305: Political Economy

2. Introduction and Motivation
• Economic policy = f(economic reasoning, politics).
• Political economics = 𝜕𝑒𝑐𝑜𝑛𝑜𝑚𝑖𝑐 𝑝𝑜𝑙𝑖𝑐𝑦/𝜕𝑝𝑜𝑙𝑖𝑡𝑖𝑐𝑠 keeping
economic reasoning constant.
• Method: Often, but not always, formal models, state of the
art quantitative empirics
• Established names to look for: Alesina (Harvard), Besley(LSE),
Torsten Persson (IIES, Stockholm), Tabellini (IGIER, Milan),
Acemoglu (MIT) & Robinson (Harvard).

3. Introduction and Motivation
• What the course is not
It is not the history of economic thought: Sometimes,
courses on Marx and Ricardo are called Political
Economy
• What the course is
Purpose: to analyze policy choice in representative
democracy
Work-horse models: median voter model, Probabilistic
voting model, Political agency, partisan politics

4. Introduction and Motivation
• why is the size of government so different across
countries? UK vs. US!
0
5
10
15
20
25
30
35
40
45
50
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Expenses
(%
of
GDP)
US UK
Source: World Development Indicators

5. Introduction and Motivation
• Political regimes and the size of the public sector.
The UK Reform act of 1884.
Source: Flora et al. (1983) Vol 1
6.34
7.75
5.00
5.50
6.00
6.50
7.00
7.50
8.00
Expenses
(%
of
GDP)
1870-1884
1885-1900

6. Introduction and Motivation
• is public policy different in election and non-
election years?
39.85
41.43
39.00
39.50
40.00
40.50
41.00
41.50
42.00
Expenses
(%
of
GDP)
Fiscal policy in the UK in election and non-election years
Non-election years
Election years
Source: Banks (2003)

7. 1. From Social Choice to Political
Economics
• Pure majority rule (50%+1) :
A1. Direct democracy. The citizens themselves make the
policy choices via majoritarian voting.
A2. Sincere voting. Individuals vote “truthfully” rather
than strategically.
 A3. Open agenda. vote is sequential and on pairs of
alternatives.
• Well this is not exactly democracy as we know it, but we
can analyse it !

8. Majority Rule
• Condorcet Winner-An option that beats all other options in
pairwise voting (Marquis de Condorcet (1743-1794)).
• Consider 3 Voters(A, B and C) and 3 Alternative Policies (tl,
tm and th).
• The preferences of the voters are as follows:
UA (tl)> UA (tm)> UA (th)
UB (th)> UB (tl)> UB(tm)
UC (tm)> UC (th)> UC(tl)
• Individual voter preferences are transitive.

9.  Round 1: tl vs tm
Majority Rule

10. Voting cycle
• Group preferences may not be transitive even if individual
preferences are transitive.
• Condorcet's paradox: Majority-vote often fails to produce
a winner.
Source: Riker, W. H. (1982). Liberalism against populism: A confrontation between the theory of
democracy and the theory of social choice. San Francisco: W.H. Freeman.

11. Arrow's (1951) Impossibility Theorem
• When choosing among more than two options, there exists no
collective decision-making process that satisfies the following 5
conditions:
 Transitivity
 Independence of irrelevant alternatives
 Universal Domain
 Unanimity
 Non-Dictatorship

12. • Restricting the number of voting rounds. Let’s assume 2 rounds!
• The order in which votes are taken changes matters
• The agenda-setter can influence the outcome of voting
↓ ↓ ↓
If the agenda is tl
vs tm, with the
winner against th:
If the agenda is tm
vs th, with the
winner against tl:
If the agenda is tl vs
th, with the winner
against tm:

13. Power of the Agenda Setter
• The agenda setter has the power to determine the final result.
→ Voter A will set the agenda so that policy platform tl win.
• If this is true, stability has been achieved at the sacrifice of
fairness…since the agenda setter is acting like a dictator…
• Examples in the Real world
 Committee systems
 Open vs. closed rules
 Agenda power for parties

14. Strategic Voting
• Strategic voting takes place when a voter votes for a policy
that is not his or her preferred choice, with an aim of
changing the final electoral outcome.
• If the agenda is vote tl vs tm and then the winner vs th.
With sincere voting we saw in the previous slide that
policy th is the winner.
 However, agent A might be better of by changing his vote
from tl vs tm in the first round.

15. Restricting Preferences
• Preferences are single-peaked if the individual has an
optimal value and the utility declines monotonically the
further one goes from the optimum.

16. Which voter does not have
single peaked preferences?
A. Voter A
B. Voter B
C. Voter c

17. Restricting Preferences
• Let’s assume now single-peaked preferences for all Agents.
UA (tl)>

18.  Round 1: tl vs tm
A prefers tl, B prefers tm and
C prefers tm → tm winner
 Round 2: tm vs th
Restricting Preferences

19. Single-peaked preferences: A simple
theoretical example
• Agents: i has utility
𝑈𝑖= 𝑙𝑛𝑐𝑖 + 𝛼𝑖𝑙𝑛g (1)
where 𝑐𝑖 is consumption, g the public good and 𝑎𝑖 captures the
preferences of the voter for the provision of g.
• Budget constraint
𝑐𝑖 = (1 − 𝜏)𝑌𝑖 (2)
Where 𝑌𝑖 is income and 𝜏 the tax rate
• Agents choose their consumption taking as given (i) the budget
constraint, (ii) policy choices 𝜏 and g.

20. Single-peaked preferences: A simple
theoretical example
The government budget constraint has the following form:
g =
σ𝑖=1
𝑛
𝑡𝑌𝑖
𝑛
=
𝜏𝑛𝑌
𝑛
= 𝜏𝑌 (3)
• Indirect utility function (IUF) : (2)+ (3) →(1)
(4)
• IUF tells us what agent I’s maximal utility, given policy and
preferences.
• IUF determines agent’s preferences over policies.
( ) ln((1 ) ) ln
i i i
W a
  
    

21. Single-peaked preferences: A simple
theoretical example
• We can show analytically that W(𝜏) is a concave function with
respect to 𝜏.
F.O.C
(5)
S.O.C.

22. W(τ)
τ
τ*
0 1
Single-Peaked
preferences
Single-peaked preferences: A simple
theoretical example
• The indirect utility is single-peaked and the maximum is at 𝜏*.
• The bliss point represents that policy level at which individual
utility is maximized.

23. Single-peaked preferences: A simple
theoretical example
• The optimal tax rate (𝜏∗
=
𝛼𝑖
1+𝛼𝑖
) depends on the agent’s
preferences for the provision of the public good 𝑎𝑖.
• Because of differences in 𝑎𝑖 different individuals typically
have conflicting policy preferences! → Poor vs Rich
agents!
• The Median voter wins!

24. U
t
tm
tl th
A
B
C
Single-peaked preferences and
the Median Voter Theorem
Suppose that there is an odd number of voters and that the policy
space is one-dimensional. If all voters have single-peaked preferences,
then the median of the distribution of voters’ preferred options is a
Condorcet winner.

25. Median Voter Theorem: Example
Preferred Levels of Public Spending
• Public spending<1000 vs Public Spending=1000
• Public spending>1000 vs Public Spending=1000

26. Multidimensional politics, Unidimensional
conflict
• The stability found in Median Voter Theorem depends a
great deal the assumption that politics is "unidimensional".
• In the real world, politics has more than one dimension
(immigration, size of government).
• Poole, K., & H., Rosenthal. (1991). “Patterns of
Congressional Voting.” American Journal of Political Science
35(1): 228 – 278.
• Until 1960s, US politics was roughly two-dimensional: size
of government and civil rights. After 1980, these have
collapsed into one.

27. Multidimensional politics, Unidimensional
confl‡
ict
• Their model reflects the fact that legislators’ positions on a
wide variety of public policies are interrelated.

28. Where does this leave us?
• There is a tension between stability, fairness, and the
freedom of actors to form their own preferences. If you
want stability you either have to:
 Place restrictions on preferences (i.e. make sure actors
don’t have the kinds of preferences that would lead to
cycling).
 Place restrictions on who is allowed to make
proposals.
 Place restrictions on who gets to participate in the
decision

29. Readings
Acemoglu, D. & Robinson, J. (2005). Economic
Origins of Dictatorship and Democracy,
Cambridge: Cambridge University Press. Chapter
4.1 - 4.3.1.
Persson and Tabellini (2000). Political Economics:
Explaining Economic Policy, MIT Press, chapter 2
(only relevant sections)
Stiglitz and Rosengard (2015). Economics of the
Public Sector, chapter 9 (only relevant sections)

30. Example
b a c a d
c d b c b
d c d b c
a b a d a
Consider five people with the preferences ranking over four
projects a, b, c and d as follows:
(i)Draw the preferences by ranking the projects by alphabetical
order from left to right.
(ii) Who has single-peaked preferences and who has not?

31. Who has single-peaked preferences?
A. 1st ,2nd and 3rd
B. 2nd and 3rd
C. 1st and 3rd
D. 3rd , 4th and 5th
E. None

32. 2. Electoral Models: Downs (1957)
Majority Voting Model
• Downs (1957). An Economic Theory of Political Action in a
Democracy, Journal of Political Economy, 65(2): 135-150.
• Moving away from Direct Democracy  towards
Representative Democracy.
• Main question: size of public sector (govt spending)
• Basic Assumptions
Two office seeker candidates (A and B)
Each party once in power receives an exogenous rent
(R).
• Denote the policy platform of party A (B) with gA ( gB).

33. Electoral Competition
• Stage 1: The two candidates simultaneously and non-
cooperatively announce their electoral platforms: gA and gB.
• The behaviour of the two parties can be represented by the
following pair of maximization problems:

34. Electoral Competition
• Stage 2: Elections are held in which voters choose between
two candidates.
• Voter i will vote for party A if Wi(gA)>Wi(gB).
• If the majority of voters vote for Party A (B) then P(gA,gB) =1
(P(gA,gB) =0)
• If the same number voters votes for both parties P(gA,gB)
=1/2.
• Voter’s have single-peaked preferences The Median Voter
Theorem applies!

35. Electoral Competition
• This implies the following probability of winning for candidate A:

36. Electoral Competition
• Stage 3: Winner implements announced policy. gA if Party A
wins or gB if Party B wins.
• We solve with backward induction: Stage 3  Stage 2 
Stage 1.
• More specifically Party A choses policy platform gA in order to
maximise equation (1a), taken as given the policy platform of
Party B and equation (2).
• This implies that each Party knows that the median is the
pivotal voter.

37. Electoral Competition
• Policy platform gm, the platform preferred by the median
voter, is a dominant strategy for both Parties.
• The Nash equilibrium is as follows: g𝐴
∗
= g𝐵
∗
= g𝑚
• Result: the MVT and the Downsian Policy Convergence
Theorem together enable us to simplify the process of
aggregating the heterogeneous preferences of individuals
over policies.
• Implication: “Policy moderation”

38. Example
Ideal Policy Quantity of g Percentage
of voters
g1 10 8.0%
g2 20 14.0%
g3 30 26.0%
g4 40 24.0%
g5 50 20.0%
g6 60 8.0%
Κατανομή Bliss Points
8.0%
14.0%
26.0%
24.0%
20.0%
8.0%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
g1 g2 g3 g4 g5 g6
• Which policy prevails in a political environment with two
office seeking politicians?

39. Which policy prevails in a political environment
with two office seeking politicians?
A. Policy g1
B. Policy g2
C. Policy g3
D. Policy g4
E. Policy g5
F. Policy g6

40. What do the data say?
• Some unconditional evidence on British politics based on
the Comparative manifesto project (CMP) database.
• The general purpose of the project is to measure political
preferences of parties across time
• Based on 7 domains (e.g., External relationships, Economy
etc…) the variable rile depicts the Right-left position of
parties on a scale from -100(extreme left) to 100 (extreme
right).
• Conservatives vs Labour party since 1945.

41. What do the data say?
-60
-50
-40
-30
-20
-10
0
10
20
30
40
1945 1950 1951 1955 1959 1964 1966 1970 1974 1974 1979 1983 1987 1992 1997 2001 2005 2010
Conservative Party Labour Party

42. What do the data say?
• Given the availability of party position estimates, it would
certainly be convenient if they could also be used to estimate
the independent variable – median opinion!
• Kim, H. M. & Fording, R. C. (2003) Voter ideology in Western
democracies: an update. European Journal of Political
Research, 42(1), pp. 95–105.
• Kim and Fording (2003) use these party positions from the
CMP to estimate the position of the median voter.
• Essentially, the position of the median voter is computed from
vote shares for the ideologically ranked parties.

43. What do the data say?
-60
-50
-40
-30
-20
-10
0
10
20
30
40
1945 1950 1951 1955 1959 1964 1966 1970 1974 1974 1979 1983 1987 1992 1997 2001 2005 2010
Conservative Party Labour Party Median Voter

44. Empirical Evidence
• Adams et al. (2004) "Understanding Change
and Stability in Party Ideologies: Do Parties
Respond to Public Opinion or to Past Election
Results?" British Journal of Political Science
34(4):589-610.
• Adams et al. (2004), re-scale the CMP codings
of the party ideology, which run from -100 to
100, to a 1–10 left–right scale.

46. Adams et al. (2004)
• The time period covered in the analysis is 1976 to 1998.
Empirical specification (OLS):
 b1 : constant term
 Party’s ideological shift: the change in party J’s left–right position in
election t compared with its position at election t-1.
 harmful public opinion shift = Shift in the mean voter ideology between
elections t and t-1, if public opinion shifted away from the party’s position.
 benign public opinion shift = Shift in the mean voter ideology between
elections t and t-1, if public opinion moves towards the party’s position.
 b4, b5, b6 : other important determinants of the dependent variable.

48. Readings
Acemoglu, D. & Robinson, J. (2005). Economic Origins of
Dictatorship and Democracy, Cambridge: Cambridge
University Press. Chapter 4.3.2
Adams et al. (2004) "Understanding Change and Stability in
Party Ideologies: Do Parties Respond to Public Opinion or to
Past Election Results?" British Journal of Political Science
34(4):589-610.
Persson and Tabellini (2000), Political Economics: Explaining
Economic Policy, MIT Press, chapter 3.1-3.3