General Equilibrium Effects and Voting into a Crisis

Hans Gersbach and Beilharz, Hans-Jörg

No 4454, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We show that in democracies insufficient recognition of general equilibrium effects can lead to a crisis. We consider a two-sector economy in which a majoritarian political process determines governmental regulation in one sector: a minimum nominal wage. If voters recognize general equilibrium feedbacks, workers across sectors form a majority and will favour market-clearing wages. If voters only take into account direct effects in the regulated sector, workers in the other sector are willing to vote for wage rises in each period since they also reckon with higher real wages for themselves. The political process leads to constantly rising unemployment and tax rates. The resulting crisis may trigger new insights into economic relationships on the part of the voters and may reverse bad times.

Keywords: Democracy; Unemployment; Crises; Awareness of general equilibirum effects; rise and fall of market distortions (search for similar items in EconPapers)
JEL-codes: D72 D83 E24 J30 (search for similar items in EconPapers)
Date: 2004-06
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Citations: View citations in EconPapers (9)

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