1. Political Economics Riccardo Puglisi Lecture 1 Content: The Political Economics Approach Methodological Tools Majoritarian Elections

2. The Political Economics Approach MARKET POLITICAL INSTITUTIONS Economic Policy Individual Preferences over Economic Policy  Focus on the Welfare State  Analyze how Political Institutions affect Economic Policies

3. Novelty of this approach Economic AgentsPolitical Agents Political InstitutionsMarkets Economic Policy Economic Aggregates & Prices POLITICO-ECONOMIC EQUILIBRA Individuals as ECONOMIC and POLITICAL Agents:  ECONOMIC Agents take Labor, Savings, Consumption Decisions  POLITICAL Agents (Voters) decide over Economic policies (Redistribution, Public Goods, etc)

4.  Economic Agents maximize their Utility Function (or their profit) w.r.t. an economic variable, subject to some constraints, given the economic policy Example: Given the retirement programs, workers decide when to retire  Political Agents (Voters) maximize their “indirect Utility Function” w.r.t. the economic policy under consideration Example: Given their age, occupation, health status and savings elderly workers decide which early retirement policy they prefer ECONOMIC BEHAVIOUR VOTING BEHAVIOUR

5. OUR GOALS 1.Explain the Rise and Sustainability of different configurations of the WELFARE STATE: Use a simple political institution to aggregate preferences Find “economic” or demographic explanation of the differences 2. Analyze the Impact of Different POLITICAL INSTITUTIONS on ECONOMIC POLICIES Examine Political Regimes and Electoral Rules Economic Policy, Corruption, Political Accountability

6. METHODOLOGICAL TOOLS How are Individual Preferences over an Economic Policy Aggregated in Actual Economic Policy? POLITICAL INSTITUTIONS If political institutions were neutral:  No effect on Economic policy  Different Economic Policy explained only by Economic, Demographic, Sociological Differences

7. However….Political Institutions are not neutral:  ARROW’S IMPOSSIBILITY THEOREM  EXAMPLE OF NON-NEUTRALITY IN ELECTIONS  MAJORITARIAN ELECTIONS: THE MEDIAN VOTER THEOREM

8. ARROW’S IMPOSSIBILITY THEOREM Arrow (1951) showed that there is NO DEMOCRATIC mechanism which allows individual preferences to be aggregated in a consistent way, that is, so that the following properties are satisfied: (1) RATIONALITY (aggregate preferences are complete and transitive) (2) UNRESTRICTED DOMAIN (on individual preferences) (3) WEAK PARETO OPTIMALITY (4) INDIPENDENCE (from irrelevant alternatives) In Political Economics, we usually drop property (2)

9. Example of Non-Neutrality in Elections Consider 7 Voters(1,2,3….,7) and 4 Alternatives Policies (A,B,C,D) Analyze 3 types of elections:  PLURALITY (or MAJORITY) voting  VOTING between two alternatives with AGENDA setting  “BORDA” voting

10. Agents1 2 3 4 5 6 7 Alternatives best worst A A A B B C C B B B C C D D C C C A D A A D D D D A B B 1) MAJORITY/PLURALITY voting: A = 3 votes B = 2 votes C = 2 votes A winner 2) VOTING between two alternatives  AGENDA I a vs b -- vs c -- vs d C winner A winner B winner  AGENDA II d vs c -- vs b -- vs a  AGENDA III a vs c -- vs b -- vs d

11. Agents1 2 3 4 5 6 7 Alternatives best worst A A A B B C C B B B C C D D C C C A D A A D D D D A B B 3) “BORDA” voting (k = 1): 1 vote to the first A winner A = 6 votes B = 7 votes C = 6 votes D = 2 votes B winner MAJORITY VOTING (k = 2): 2 votes to the first, 1 vote to the second

12. Why do different voting procedures reach different results? Individual preferences are not SINGLE-PEAKED agents 1,2,3 agent 4 agent 5 agents 6,7 best worst ABCD Do single-peaked preferences make sense for economic policy problems?

13. POLITICAL INSTITUTIONS Electoral Models  Electoral Competition between two Candidates (Median Voter)  Probabilistic Voting (Dixit - Londregan, 1996)  Citizen Candidate (Besley - Coate, 1997, Osborne - Slivinski, 1996) Legislative Models (Post-Electoral Politics)  Agenda Setting (Baron - Ferejohn, 1998)  Allocation of Policy Jurisdiction (Shepsle, 1979) Lobbying Models (Becker, 1983, Grossman - Helpman, 1994) Additional Dichotomy on the MOTIVATION of politicians: Opportunistic (office or rent-seeking) or Partisan

14. MAJORITARIAN ELECTIONS Main Features:  Direct democracy: voters choose a one-dimensional economy policy (e.g. the size of the welfare state, degree of flexibility in the labor market)  Each voter has single-peaked preferences over the economic policy  Bliss point: most preferred economic policy  Median voter divide the distribution of votes in half  Commitment over economic policy

15. MEDIAN VOTER THEOREM If preferences are single-peaked along a one-dimensional economic policy, the median voter’s bliss point represent the equilibrium outcome of the majoritarian voting game  Intuition: All voters to the left of the median voter – i.e., whose bliss point is lower than the median voter’s – prefer the median voter’s (MV’s) bliss point to any point chosen by voters to the right of the median voter, and vice versa.  Hence, 50% of the voters prefer the MV’s bliss point to any lower level [the voters to the right of the MV]. While 50% prefer the MV’s bliss point to any higher level [voters to the left of the MV]

16. U x X*X’xaxa xcxc A B C B is the median voter x* is the equilibrium outcome of the voting game MEDIAN VOTER THEOREM

17. Applications of the Median Voter Theorem Election: majority voting for political candidates (or parties) Two opportunistic candidates who chose political platform (or ideology) Voters care about the ideology/political platform Political outcome: both candidates select as their platform the ideology of the median voter

18. DOWNS - HOTELLING MODEL Ideology Proportion of voters left right ImIm IbIb IaIa  Result: Party A & B converge towards I m - the ideology of the median voter  Implication: “Policy moderation” - both parties move towards moderate positions (ideology) and away from extreme  Evidence: In two candidates (parties) systems, moderate and “similar” positions.