How does national election affect the economy?
Mustafa K. Mujeri | November 29, 2018 00:00:00
According to available reports, the Election Commission (EC) has prepared a Tk. 7.02 billion budget for holding the 11th JatiyA Sangsad (JS) election, an overall increase of over 40 per cent over the 10th parliamentary election in 2014. Almost 57 per cent of the budget is allocated for maintaining law and order during the national polls. The above, however, excludes the amount of over Tk.38 billion for expenses for purchasing the electronic voting machines (EVM) for use during the polls.
There exists a general consensus that the election period witnesses a slowdown in economic activity in almost all countries. Uncertainty is identified as a key variable that affect the economic indicators and lead to the economic slowdown through different channels.
Election-related spending by the government (and the EC) includes both material expenses as well as expenses incurred for ensuring security and employing human resources for conducting the election. Private spending is the result of costs incurred by the candidates for their election campaign.
High expenditures may cause imbalances in aggregate demand and supply thereby fuelling demand side inflation. The impact on the share market is somewhat unpredictable as election induces volatility and market instability. The market may be subject to speculations based on the economic policies endorsed by the contesting parties. New investments tend to get postponed during the election period. Investors prefer to wait for election results as the payback on their investments is subject to the policies rolled out by the winning party.
Election causes sporadic upsurges in the production and consumption of commodities which are needed during the elections. On the other hand, construction business may recede during the election period. There may be a decline in business activities as funds are injected to finance political campaigns. At the same time, the pace of industrial credit growth usually decelerates as there are fewer investors lining up for bank loans ahead of elections. The government intervention (e.g. in fiscal policy) may also be opportunistic in an election year to cater to special interest groups rather than to provide a boost to the overall economy.
There are theories which predict an ‘opportunistic political business cycle’ through which politicians induce temporary economic expansions in the pre-election period. But empirical studies have generally failed to find significant evidence of opportunistic cycles in the real world. While politicians may succeed in manipulating budgetary expenditures and other policy instruments, these efforts do not produce real changes in outcomes such as gross domestic product (GDP).
However, several recent works argue that there exists an additional electoral business cycle that could help explain the dearth of evidence for opportunistic cycles. This alternative theory suggests that as elections approach, macroeconomic performance should actually decline due to the policy uncertainty induced by the elections. In particular, the policy uncertainty encourages the delay of ‘costly-to-undo’ investments, such as capital expenditures, but not other types of private spending. Empirical studies find that growth in nongovernment fixed capital formation experiences decline significantly in the pre-election period. This pattern is termed as ‘reverse electoral business cycle’. Indeed, as political uncertainty is generally higher in countries like Bangladesh having lower levels of political and economic development, reverse electoral investment cycles should be stronger if the theory is correct.
Under the canonical opportunistic business cycle (OBC) model, incumbent politicians enact policies that expand the economy in the pre-election period. The original Nordhaus model, as well as many subsequent theories, assumes that elected politicians can affect money supply via the monetary policy. Other theories focus on fiscal policies, particularly ones that have an immediately noticeable impact on voters such as transfer payments and tax cuts. Theoretically, either type of policy instrument is associated with pre-election growth in GDP. The inflation-based models assume non-prospective actors respond to unexpected inflation by boosting wages and hiring, thereby spurring economic growth. Personal consumption, in particular, rises as wages and employment increase.
The impact of fiscal adjustments such as increased transfer payments on GDP is somewhat straightforward. First, because government spending is a significant component of GDP, economic growth should increase with budgetary expenditures in the short-term if all other components are held constant. Second, if voters believe that the transfers or tax cuts will not necessarily require them to forgo future consumption, then personal consumption should rise. The opportunistic models thus suggest that at least two portions of GDP that should increase as elections approach: personal consumption and government spending.
On the other hand, the reverse electoral investment (REI) cycle theory focuses on the portions of GDP involving ‘costly-to-undo’ investments, known as irreversible investments. These investments are ones that would be impossible or quite expensive to reverse, once undertaken. According to the REI theory, the policy uncertainty that inherently arises from an election can induce the firms to postpone the decision over whether to undertake such investments. For instance, if the major parties hold different positions on specific investments, and there is uncertainty about who will win the election, the investors might rationally choose to delay the decision.
As is well known, GDP includes several types of private irreversible investment, including gross fixed capital formation and consumer durables. Gross fixed capital formation encompasses the net acquisitions of fixed assets such as new construction, equipment, and machinery. Consumer durables consist of goods expected to last longer. It is not clear how the purchases of these goods will be affected due to the policy uncertainty associated with an upcoming election.
Taken together, the opportunistic and reverse electoral cycle theories suggest that the impact of elections will vary across different components of GDP. For private gross fixed capital formation, elections will induce a slowdown. For government spending and most of private consumption, elections will encourage a temporary expansion. On the other hand, for private consumption on durable goods, countervailing pressures may operate. The opportunistic theory predicts personal consumption should rise while the reverse electoral investment cycle theory predicts that consumption of durable goods should fall. Theoretically, it is not clear which effect should dominate. However, if both theories are correct, a distinction should emerge between nondurable and durable goods. Elections should induce a greater increase in private consumption of nondurables than in durables.
Additionally, the level of democracy should affect the magnitude of the electoral cycle. In countries that are less democratic, incumbent governments have fewer institutionalised checks and balances and they can easily manipulate fiscal and monetary policy. Moreover, fiscal manipulation can be more easily rewarded due to lower fiscal transparency. Several studies show that opportunistic cycles in budgets and/or deficits are higher in countries with less democratic experience and lower levels of economic development.
If the elections are not democratic enough and the election is nothing but a sham, the government does not need to manipulate the economy in order to enhance its chances of staying in office. But, even if the elections are partially democratic so that the election result is not a foregone conclusion, smaller opportunistic cycles are likely to operate not only for government spending but also private consumption of nondurables.
Reverse electoral investment cycles are also likely to vary with the level of political development. Since there exist vastly greater levels of uncertainty in developing democracies as in Bangladesh, policy uncertainty associated with elections will be higher in these countries. Further, political leaders in these countries are less constrained by formal institutions.
Since the policy uncertainty associated with elections is greater in developing democracies, a larger pre-election decline in irreversible investment may be expected. Overall, the size of reverse electoral investment cycle is likely to be inversely correlated with the level of political development.
According to both opportunistic and reverse electoral business cycle theories, electoral competitiveness-closeness of a particular election — influences the strength of the cycles. In a noncompetitive election, where the incumbent government is likely to win by a large margin, manipulation of the economy carries small marginal benefits. Moreover, the negative post-election effects of the manipulation could have reputational consequences. As the competitiveness of an election race increases, opportunistic cycles are likely to increase, regardless of whether the incumbent or opposition is leading.
Electoral competitiveness also influences the magnitude of reverse electoral investment cycles. As the electoral outcome becomes less predictable, the policy uncertainty associated with an election increases. Consequently, the competitiveness of a race enhances the incentive to delay costly-to-undo investments until after the election occurs. Further, policy platforms and voters’ alignments are less stable in emerging than in more consolidated democracies. This fluidity has implications for both opportunistic and reverse electoral investment cycles. The lower predictability of partisan affiliations creates incentives for private firms to hold back on costly-to-undo investments until the political uncertainty associated with the election resolves. Thus in less consolidated democracies, opportunistic and REI cycles will exist even for elections that are relatively uncompetitive.
One must, however, recognise that the election uncertainty affecting economic outcomes has implications beyond electoral cycles. Associated political uncertainty induces a decline in private fixed investment; and the impact is greater in countries with lower level of democratic consolidation. And in countries like Bangladesh, policy uncertainty-induced fall in private investment could be longer-lived and higher in magnitude.
Dr. Mustafa Kamal Mujeri is Executive Director, Institute for Inclusive Finance and Development (InM)