Outside the Beltway

Political Business Cycles–Don’t Forget Those Recessions

Steve Verdon · Wednesday, May 11, 2005 · 1 comment

What are political business cycles? They are business cycles that are due to politics. Or more precisely the political parties try to manipulate the economy to their benefit electorally. The work on this kind of economic-political model was first done by Hibbs and extended by Alesina. The basic idea is that policy makers/politicians make policy decisions that will help ensure that they will remain in office. There is an assumption that one party fights inflation (the Republicans) and the other party is concerned about uneployment and growth (the Democrats). You can get a good overview of the evolution of these types of models here.

Kevin Drum has recently taken a look at some new research in this ares. This reasearch is by Larry Bartels at Princeton University (links courtesy of Brendan Nyhan). Bartel’s reasearch looks at growth in the income limits for the various income quintiles. He notes that under the Republicans growth in these income limits is lower than under Democrats when you take an annual average from 1947 to 2001. This graph gives the basic picture.

From this picture one might wonder why Republicans ever get elected. Well Bartel’s claim is that voters are myopic and only look at recent events. There is some support for this. This is similar to Kahneman’s findings that people tend to evaluate uncertain events poorly and tend only look at the most recent data in formulating their perspectives on uncertain events. Further, people tend to overestimate bad outcomes as well as good outcomes. For example, a person applying for a highly competitive job will usually overestimate their chances of getting the job. At the same time people also tend to overestimate the probability of bad events which is why they’ll buy extended warranties. So, if we restrict our averaging to just election years we get the following picture.

Eureka, claims Kevin. Mystery solved. The Republicans are cagey poltical operatives and they are clearly trying to manipulate the economy to their electoral benefit. But is this really the case? While this maybe true, I am doubtful to some degree. The problem is the ignoring of recessions. For example, there are far more recessions during Republican’s tenure in office than with Democrats. The following table demonstrates this quite clearly:

I suppose one could argue that the Republican policies are far more likely to cause recessions than the democratic policies, and this would fit with the political business cycle theory of Hibbs and Alesina and others (causing a recession to reign in inflation). The problem is that models such as the ones developed by Alesina assume that the differences between parties is how they view issues like inflation, unemployment, growth and the policies they put in place in regards to these issues. The primary method for fighting inflation is via monetary policy which neither Republican nor Democratic presidents have much control over. No President wants to ratchet up interest rates and implement restrictive monetary policy if it will mean defeat at the polls (e.g. Jimmy Carter in 1980, President Bush in 1992). Further, recessions are curious things in that nobody really knows when they are going to happen. Most economic forecasts in 2000 were predicting years more of economic growth, not a recession.

Anyhow, if we remove the recession years and recalculate the annual average percentage changes to the income limits we get the following picture.

Suddenly the Republicans don’t look so bad. They just happen to suffer from lots of recessions during their watch.

Another factor that muddies the waters is the oil shock of 1973. Nobody can argue that this event had a profound impact on the U.S. economy and its politics. Let’s also look at our annual growth rates pre/post 1973.

Prior to 1973 the Republicans and Democrats were pretty much indistinguishable in terms of income change for the various quintiles, IMO. After 1973 the Republicans look really bad (although part of the reason is that the post-1973 sample also contains the recession from 1973 to 1975 which really hurts the Republicans). But again we see that the Republicans are also in office during the recessions save for Jimmy Carter in 1980. So the real reason the Republicans look so bad using a simple annual average is that there are more recessions during Republican terms. Is this necessarily their fault? I don’t know, but I tend to doubt it. Another interesting thing is that the Democrats also do worse after 1973 over all income catagories except the top 5% of income earneres! Makes you wonder about this supposed notion of Democrats being the party of the little guy, eh? (Sorry couldn’t resist that little bit of snark there) But for Bartel’s claim that if Democrats had been in office 100% since 1947 that we’d have much less income inequality does not necessarily follow given that the differences in income limit growth rates seems very much to be driven by recessions. For Bartel’s claim about income inequality to hold (and Kevin’s more sinister claim that Republicans are [attempting] controlling the economy to gain electoral advantage) he has to demonstrate that the majority of the last 10 recessions are due to Republicans. Another problem for Bartel is that post 1973 the Democrats pursued policies that would have contributed to increasing income inequality in that those in the higher income quintiles tended to do better as well.

Update: Kevin has a follow up post and needless to say gets it entirely wrong. Clearly when we split the sample at 1973 the Democrats are not good for income inequality, they are merely less bad.
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Hibbs, D. (1977) The Political Parties and Macroeconomic Policy” American Political Science Review, 7, December, 1467-87.
Alesina, A. (1987) “Macroeconomic Policy in a Two-Party System as a Repeated Game” Quarterly Journal of Economics, 101: 651-78.
Alesina, A. (1988a) “Macroeconomics and Politics” NBER Macroeconomics Annuals. Cambridge MIT Press: 13-52.
Alesina, A. (1988b) “Credibility and Policy Convergence in a Two-Party System with Rational Voters” American Economic Review, 78, 796-805.
Alesina, A. (1995) “Elections, Party Structure, and the Economy”, in Bank & Hanushek (eds.), Modern Political Economy. 1995 Cambridge University Press, 145-170.

Update (1430): James Joyner adds, see also yesterday’s post, “Are Republican Presidents Bad for the Economy?“