This is the first of two chapters that review the two most prominent models or theories of politics in macroeconomic policymaking: the electoral-cycle theory and the partisanship theory. These theories each capture special features of democratic politics and help us to understand democratic dynamics. In doing so, they abstract from the institutional details through which economic policy is made. Each leaves a great deal about macroeconomic politics unexamined and unexplained. The electoral-cycle model focuses on periodic elections as the democratic institution of interest, and the partisanship model focuses on dual alternatives in these elections. Both types of models connect these features of focal interest to macroeconomic outcomes: unemployment, income growth, and sometimes inflation.

In the real world, the impacts of elections and party differences are mediated through complex institutional structures of fiscal and monetary policies. For example, most of the contemporary models to be considered in these two chapters presume that governments influence macroeconomic performance through monetary policy, that is, through government control of the money supply and interest rates. Monetary policy is controlled by central banks, such as the U.S. Federal Reserve System (“the Fed”). Electoral-cycle and partisanship models often assume that the Fed obediently follows the preferences of politically motivated public officials. In fact, the Fed is considered to be one of the most politically independent of the central banks in the industrialized nations.

Fiscal policy consists of public decisions about government expenditures and revenues. Spending policy and taxation policy have always been of interest in their own right, but at least since the 1930s, spending and taxing and the balance between them have been seen by at least some economists as having controllable consequences for the performance of the macroeconomy. For example, Keynesians have advocated active discretionary manipulation of the size of the budget deficit (or surplus) to stabilize the economy, to reduce unemployment, and to shift the path of economic growth. The Kennedy-Johnson tax cut of 1964 is seen by Keynesians as a successful example of how fiscal policy can increase prosperity by increasing aggregate demand. Supply side economists have acknowledged the success of that tax cut, but explain its success in terms of increasing aggregate supply, rather than demand. They would defend the Economic Recovery Tax Act of 1981 on the same, supply oriented grounds.

Causality goes in the other direction as well. That is, the performance of the economy has an effect on the size of the government's deficit (or surplus). Specifically, when the economy expands, revenues may rise faster than expenditures, thus reducing a deficit. And when the economy goes into a recession, expenditures may rise (e.g., because of increased unemployment compensation claims) while revenues fall, because of declining incomes and reduced economic activity.

Voters are the ultimate authority in a democracy. Their preferences and behaviors are the fundamental sources of legitimacy for policymakers, who get their power through elections. Their preferences and behaviors also place constraints on what elected politicians can do. The electorate is the source for the authority of constitutional rules of procedure and for the authority of official statements of public goals. When there is ambiguity about what goals are appropriate for public policy, voter choices can resolve them at least provisionally. When there is ambiguity about which potential officeholders have correct or appropriate beliefs about the way the economic world works, voter choices can determine which ones will get to test their views against experience.

All this would be true in a world of ideal democratic citizens, but it is true in the real world as well. Yet the effort to maximize one's share of the votes of even ideal citizens can lead to opportunism, according to some of the models of political economy we have reviewed. And whereas ideal citizens may be public-spirited and fully informed, real-world voters may not have either of those qualities. This chapter will assess what we know about how voting behavior is affected by macroeconomic issues, as well as the implications for policy making.

Most real-world voters are not well informed about political issues; they sometimes are characterized as being vulnerable to cynical manipulation by opportunistic politicians.

INTRODUCTION

The model of the American political economy described in chapter 8 has several empirical implications. These are tested in this chapter using United States data for the period 1915 to 1988. We examine the behavior of the annual growth rate of the gross national product and of vote shares in presidential elections and in elections for the House of Representatives.

Throughout this volume we have stressed the interdependence of politics and economics. A basic theme is that partisan politics introduces uncertainty in both the polity and the economy; both the voters and the economic agents need to hedge. Specifically, uncertainty in presidential elections leads economic agents to hedge by expecting an inflation rate equal to an average of the inflation policies that would be followed by the two parties. Similarly, voters adjust their on-year congressional votes so that there is not a decisive tilt towards either party. At midterm, the identity of the party of the president for the next two years is known; thus the voters can complete their balancing of the president.

In other words, expectations about future policies tie the political and economic systems together. Therefore we undertake a simultaneous estimation of four equations: one for GNP growth; one for the vote share in presidential elections; one for House vote shares in on-years; and another for House vote shares in midterms.

Our most general formulation of the GNP growth equation incorporates the two basic determinants of growth highlighted in the previous two chapters: the partisan macroeconomic policies of the two parties and the competence of different administrations.

INTRODUCTION

A primary purpose of this book is to understand how politics affects public policy. In the previous chapter, we considered two possible scenarios. One had politics leading to middle-of-the-road policies as the result of electoral competition between electoralist parties. This approach was refuted both theoretically, because of the inability of candidates to make credible campaign promises, and empirically, because of widespread observations of party polarization. The other scenario had partisan politics with alternation between the relatively extreme policies pursued by two polarized parties.

This second scenario is also likely to be inaccurate because it ignores the institutional structure that leads to policy formation. In the United States, the Constitution provides for “checks and balances”. Legislation, including measures that affect economic policy, requires congressional majorities and a presidential signature. Regulatory agencies, important in policymaking (like the Federal Reserve), are subject to congressional oversight. The need for some degree of concurrence between the executive and legislative branches of government contributes to policy moderation.

In this chapter, we consider the effect of institutional “checks and balances” on policy moderation in a highly stylized manner that is, nonetheless, empirically descriptive. We build on the case of fully divergent and “immobile” parties of section 2.4: if the executive has full control of policy, the two parties implement their ideal policies. We posit, however, that the influence of the executive in policymaking is mediated by the legislature: policy depends on which party holds the presidency and on the composition of the legislature. We view policy as a compromise between the executive and the legislature.

INTRODUCTION

The primary focus of this book is on partisan politics where voters are concerned with policies that can be positioned on a liberal–conservative dimension. An alternative view of American politics is that voters are concerned with how a larger share of the federal pie can be garnered for their state, their congressional district, and, ultimately, themselves. These distributive concerns, coupled with the seniority system in Congress, provide voters with strong incentives to re-elect incumbents. In addition, incumbents, in part through use of the perquisites of office, have strong informational advantages over challengers. As a consequence, “incumbency advantage” is a major determinant of congressional elections. The “incumbency advantage” is particularly evident in the House in the postwar period where, until the wave of retirements in 1992, over 90 percent of incumbents stood for re-election and, of those standing, over 90 percent were reappointed. These high rates of re-election have led recent elections to produce, especially relative to earlier periods of American history, small changes in seat shares.

Thus far this book has ignored incumbency advantage. Instead, we have emphasized the balancing behavior of voters, which generates split-ticket voting and the midterm cycle. In this chapter we discuss how incumbency advantage and balancing behavior coexist.

The model of chapter 4 predicts substantial changes in vote shares as a result of the midterm cycle. While the theoretical prediction of a shift in votes receives overwhelming empirical support (figure 4.1), the shift in thevote has not had much impact on seats. Finding a midterm cycle that is far stronger in votes than in seats raises an important question.

INTRODUCTION

According to a widely held view about American politics, the two parties are indistinguishable and both located in the middle of the political spectrum. We emphatically disagree.

The notion of convergence of party platforms emerges from the initial rational choice models of two-party electoral competition in the contributions of Hotelling (1929), Black (1958), and Downs (1957). These seminal works assumed that although voters care about public policy, candidates care only about winning.' In this situation, the candidates propose identical platforms: one should observe complete convergence of policies toward the middle. Which policy is actually chosen by a candidate depends on the specification of the electoral process: the number of issues involved, the dissemination of information within the electorate, the nature of voters' preferences, and the ability of voters to make decisions consistent with their preferences.

The most famous convergence result is the “median voter theorem” (Black (1958)). It implies that, under a certain specification, the candidates converge to the policy most preferred by the median voter. For other specifications, Hinich (1977), Coughlin and Nitzan (1981), Ledyard (1984), and Tovey (1991) analyze cases of convergence not at the median. For our purposes, the important point is not so much “where” the candidates converge (at which particular point of the political “middle”) but the fact that they fully converge.

A different view of party competition holds that political parties, as well as the voters, care about policy outcomes, in addition to winning per se (Wittman (1977, 1983), Calvert (1985), and Roemer (1992)). According to this view, political parties represent the interests and values of different constituencies.

GENERAL OVERVIEW

Economics and politics deeply interconnect. On the one hand, incumbents are likely to benefit from an expanding economy and challengers to thrive on misery. On the other, the outcomes of elections influence economic policy and the state of the economy. This book studies the joint determination of political and macroeconomic outcomes. It focuses on the United States, but we also briefly discuss how our work sheds light on the political economy of other industrial democracies.

A few basic ideas underlie our work. The first one is that the American political system is “polarized”. Contrary to the widely held view, particularly in the “rational choice” framework, that a two-party system generates convergence of party platforms (Downs (1957)), we posit that, when in office, the two American parties follow different policies. The degree of polarization has varied greatly in American history (Poole and Rosenthal (1991a, 1993b)), but the two parties have never fully converged. What is important for us is not that polarization is constant, but simply that it does not vanish.

The second idea is that policy polarization leads to macroeconomic cycles. The two major parties follow sharply different macroeconomic policies. Whereas the Republicans are relatively more concerned with inflation, the Democrats emphasize reducing unemployment. These distinctive objectives, coupled with uncertainty about the outcome of elections, make macroeconomic policy not perfectly predictable. The actual outcomes of elections then generate economic recessions and expansions even though predictable macroeconomic policies should not influence growth in an economy with rational agents.

INTRODUCTION

This chapter explores three extensions of the basic model presented in chapters 3 and 4. These developments show how our framework is useful for analyzing a variety of issues in voting theory in a rich and realistic institutional setup.

We begin, in section 5.2, by exploring the case of heterogeneous parties. While in chapters 3 and 4 we assumed that both the president and the congressional delegation of a party have the same ideal policy, here we generalize our analysis by considering cases in which the president and the congressional delegatioq of the same party have different preferences. In chapter 3, we showed that, with homogeneous parties, the policy outcome was always in between the ideal policies of the two presidents: it was always the legislature which moderated the president. With heterogeneous parties, once again the voters use the “checks and balances” provided by the Constitution to achieve moderation; however, the president may now play a moderating role. Specifically, if the congressional delegation of a party is more extreme than the president of the same party, the final policy outcome may be in between the two ideal policies of the president and the legislators of the same party. In this case, the president moderates Congress.

In section 5.3 we address another institutional aspect of the American electoral system, namely the staggered terms of office for senators. This feature has important implications for voter behavior, but does not change the nature of our results concerning moderation.

INTRODUCTION

Partisan cycles in economic policy and institutional balancing are not a uniquely American phenomenon. On the contrary, the ideas developed in this volume with specific reference to the United States have a much broader appeal, and illuminate the political economy of other democracies. In different institutional settings political and economic variables interconnect in different ways, but this chapter argues that the concepts of polarization, balancing, and partisan cycles can explain important aspects of the political economy of parliamentary democracies.

First of all, long periods of divided government are hardly an American monopoly. On the contrary, in parliamentary democracies cases of unified government are rare. Laver and Shepsle (1990) appropriately define a government to be unified “whenever a single party both forms the political executive and commands a majority in the legislature”. In the period 1945–82 fewer than 15 percent of the governments of parliamentary democracies satisfied this definition. All the other governments were not unified: at least two parties were needed to participate either in the government or in the parliamentary majority supporting the government. Therefore, if one views coalition government as an example of division of power, divided government is the norm rather than the exception. Based upon this observation, Fiorina (1991) argues that Downs (1957) overplays the contrast between the American two party system and European coalition governments: divided government in America and coalition governments in Europe have much more in common than it would appear at first sight.

In addition, coalition government is not the only possible form of power sharing: an additional one is the balancing of different levels of government.

INTRODUCTION

One of the most important public policy issues is the definition of an economic policy that controls the level of inflation, GNP growth, and unemployment by means of monetary and fiscal stimuli. In order to analyze the effects of partisan politics on the economic cycle, one needs a view of how the economy works, a model linking economic policies to economic outcomes. Our economic model, although very simple, blends two important elements that are widely emphasized in modern macroeconomic theory: the “rational expections” and the “wage–price rigidity” hypotheses.

The mechanism of expectation formation and the extent of price and wage flexibility have been at the core of the macroeconomic debate in the last thirty years. In the fifties and sixties, mainstream Keynesians held that policymakers could easily control real macroeconomic variables, such as GNP growth and unemployment. The crucial relationship in this Keynesian approach is the “Phillips curve”, which relates inflation to unemployment (or GNP growth). A relatively stable inverse relationship between inflation and unemployment was thought to be exploitable for policy purposes: by means of appropriate combinations of monetary and fiscal policies, the policymakers were supposed to be able to choose a point along this macroeconomic trade-off; for instance, by expanding aggregate demand and accepting the costs of some inflation, policymakers could expand economic activity, at least up to a point. Thus, the effects of macroeconomic policies, both fiscal and monetary, were thought to be predictable and stable.