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The political cost of reforms

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  • Alessandra Bonfiglioli
  • Gino Gancia

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Abstract

This paper formalizes in a fully-rational model the popular idea that politicians perceive an electoral cost in adopting costly reforms with future benefits and reconciles it with the evidence that reformist governments are not punished by voters. To do so, it proposes a model of elections where political ability is ex-ante unknown and investment in reforms is unobservable. On the one hand, elections improve accountability and allow to keep well-performing incumbents. On the other, politicians make too little reforms in an attempt to signal high ability and increase their reappointment probability. Although in a rational expectation equilibrium voters cannot be fooled and hence reelection does not depend on reforms, the strategy of underinvesting in reforms is nonetheless sustained by out-of-equilibrium beliefs. Contrary to the conventional wisdom, uncertainty makes reforms more politically viable and may, under some conditions, increase social welfare. The model is then used to study how political rewards can be set so as to maximize social welfare and the desirability of imposing a one-term limit to governments. The predictions of this theory are consistent with a number of empirical regularities on the determinants of reforms and reelection. They are also consistent with a new stylized fact documented in this paper: economic uncertainty is associated to more reforms in a panel of 20 OECD countries.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1250.

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Date of creation: Jan 2010
Date of revision: Jun 2011
Handle: RePEc:upf:upfgen:1250

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Web page: http://www.econ.upf.edu/

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Keywords: Elections; Reforms; Asymmetric Information; Uncertainty.;

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Cited by:
  1. Giacomo Ponzetto & Ugo Troiano, 2014. "Social Capital, Government Expenditures, and Growth," Working Papers 612, Barcelona Graduate School of Economics.
  2. Ghatak, Maitreesh & Aney, Madhav S & Morelli, Massimo, 2013. "Can Market Failure Cause Political Failure?," CAGE Online Working Paper Series, Competitive Advantage in the Global Economy (CAGE) 122, Competitive Advantage in the Global Economy (CAGE).
  3. Alessandra Bonfiglioli & Gino Gancia, 2014. "Growth, Selection and Appropriate Contracts," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(1), pages 21-38, January.
  4. Turrini, Alessandro & Koltay, Gabor & Pierini, Fabiana & Goffard, Clarisse & Kiss, Aron, 2014. "A Decade of Labour Market Reforms in the EU: Insights from the LABREF Database," IZA Policy Papers 88, Institute for the Study of Labor (IZA).

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