Comment on Mark J. Roe and Travis Coan, Financial Markets and the Political Center of Gravity (May 3, 2015) June 6, 2015 Hideki Kanda University of Tokyo 1

Theme The paper discusses whether, and how, politics is relevant to the level of development of the financial market (which, in the paper, means the capital market, or primarily the stock market, I think). In contrast to the past literature, the paper submits the argument that left or right of the polity is less relevant in the determination of the level of development of the capital market, because political parties shift their economic views over time. Political orientation (measured by the median voter in the absolute scale over time, which the paper calls "political center of gravity") is more important. The paper attempts a data analysis for 40 countries in , and also includes a careful discussion on the relevance of the median voter theorem. The paper is very carefully written, and the argument has intuitional appeal. 2

Data Analysis Using stock market capitalization as a percentage of GDP ("StockCap/GDP") (as a dependent variable) seems natural (the "Buffett indicator"). It appears to show mean reversion. Indeed, the result of the regression analysis in the paper shows that GDP (which does not have stationarity) is not statistically significant and GDP Growth (which is stationary) is statistically significant (see Table 3 on page 21 and Table 4 on page 23). This also suggests, for instance, that it is probably not odd that R-squared is higher when taking both variables of "Pro-market Economic Orientation" and "Median Voter Position" (see Table 3 on page 21). However, I have some troubles in understanding the analysis in the paper. Taking up both of the two variables, "Log(GDP/capita)" and "GDP Growth" (see Table 2 on page 20), seems a bit strange. Using "GDP Growth" only would seem to be enough. As to the variable of "Log (Inflation)", logarithm is usually not taken. Taking the logarithm might disrupt the result of the analysis. Also, other popular variables such as interest rates should perhaps be considered. 3

OLS versus GLM In general, if the number of samples is large, OLS or GLM should not show a big difference. Why in the paper is GLM with gamma distribution (of measurement errors) used, and not other distributions? If GLM shows a better result (as it does in the paper), why gamma distribution is used and whether the number of samples matters should be explained more explicitly. Robustness does not seem to be shown in the paper. With respect to p-value, there seem to be discrepancies between Table 3 (on page 21) and the corresponding text, and between Table 4 (on page 23) and the corresponding text (although I might be wrong). It would seem better if p-values or t-values themselves are explicitly shown in the paper. Also, in addition to R-squared, it seems better to show so-called Durbin-Watson ratio, which is unknown from the paper. 4

Causality We are all interested in causalities rather than correlations. The paper does not seem to show the causality between politics and the level of development of the capital market. This is because the annual data over 45 years cannot escape from the simultaneity problem. Although it is generally thought that politics affects capital market development, reverse causality is possible: that is, the level of deployment of the capital market affects politics. One way worth pursuing may be that taking the variable concerning political orientation one year before the corresponding variable concerning the capital market. Needless to say, if this is done, the analysis would be to see the causality between political orientation in a given year and the capital market in the following year. 5

A Few General Comments Many things may matter in the development of capital markets. First, the paper's analysis of manifesto data and the discussion concerning the median voter theorem are quite interesting. I wonder if they apply to a country where ruling political party does not change over time. There are quite a few such (and yet democratic) countries on our planet. Second, as noted above, I am interested in whether it is possible that capital market development affects political orientation or politics in general. My intuition is yes. Finally, what if we take a different view as to important economic indicators in the developed nations? Just for instance, one popular view in Japan today is that by Thomas Piketty, Capital in the Twenty-First Century (Harvard University Press, 2014) (original in French). Piketty argues that in modern economies, wealth is accumulated in a quite unbalanced way and return on investment is higher than rate of growth. He thus argues that it is more important for the society to deal with wealth imbalance. If so, tax policy and other distribution measures should be given more attention, and from this perspective, it would be interesting to examine the relationship between politics and return on investment, not a more traditional figure concerning capital market development. 6