Policy Persistence in Multi-party Parliamentary Democracies

Pohan Fong and Daniel Diermeier
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Pohan Fong: Concordia University
Daniel Diermeier: Northwestern University

No 248, 2007 Meeting Papers from Society for Economic Dynamics

Abstract: Recent empirical studies by Persson and Tabellini show that, in parliamentary countries with proportional representation, government spending as a fraction of GDP goes up during cyclical downturns but does not come down during cyclical upturns, whereas this ratchet effect is not apparent in countries with other constitutional arrangements. This paper presents a dynamic theory of public finance and shows how the institution of legislative bargaining may lead to the asymmetric movement of government spending. A key assumption is that entitlement programs, once enacted, are in effect until they are reformed. When an economy is hit by a temporary negative income shock, the party that controls agenda setting faces a strong resistance on expenditure cuts. This is because a more stringent entitlement program on any socioeconomic group implies a worse status quo in the future and therefore a permanently lower bargaining power of that group. On the other hand, with a temporary positive income shock, the leading party can easily satisfy its coalition partners by their reservation values and pass a more generous entitlement program to benefit the socioeconomic group it represents.

Date: 2007
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