JAN FIDRMUC DAVID G MAYES Crises, Reforms and Ideology

Introduction Why do reforms take place when they do? What determines their scope, depth and direction? Important economic and political changes often follow after economic crises  New Deal in the US, Nazism in Germany  Communism in Russia and China  Latin American hyperinflations  End of communism in China and Eastern Europe  Arab Spring and the Occupy Movement

Crises Beget Reforms Alesina and Drazen (1991) Moderate crises costly but often sustained over long periods  War of attrition about distributional implications of reform During major crises, all agree on the need for change Empirical evidence supporting this relationship: Bruno and Easterly (1996), Drazen and Easterly (2001), Pitlik and Wirth (2003), Pitlik (2011), Fidrmuc and Tichit (2012).

Ideology and Reform Parties have an ideological bias for certain policies  E.g. deregulation in the UK under Thatcher Cukierman and Tommasi (1998): reform proposals more likely to succeed if made by unlikely politicians  E.g. deregulation in NZ under Labour  Voters cannot tell whether policy proposals motivated by shocks to state of nature or ideological shocks  Politicians observe state of nature but their pronouncements are not credible  Unlikely politicians can credibly signal the need for costly reform

Motivation Do crises affect probability that reform takes place? Does government’s ideology play a role? Do right and left wing governments respond to crises differently? Do right and left wing governments implement reform following different kinds of crises?

What We Do? Effect of crises on reform  Economic liberalization and deregulation  Democratization Different types of crises  Economic contractions  High inflation episodes Effect of ideology Interaction of ideology and crisis

Data Economic data (World Development Indicators)  GDP per capita growth, inflation  Economic Freedom of the World (Fraser Institute)  Every 5 years , every years thereafter  Summary index and 5 sub-indexes Democracy (Freedom House)  Political rights and civil liberties,

Ideology Niklas Potrafke’s Index, University of Konstanz  Originally 1-5 scale (right to left): 1 (over 2/3 right wing), 2 (1/3-2/3 right wing), 3 (centrist or mixed), etc  Reformatted as 1-2 (right), 4-5 (left) and 3 (centrist/mixed)  OECD ( ) and CEE ( ) Comparative Political Data Set III (CPDS), University of Berne  Share of cabinet seats held by right wing, left wing and centrist/independent politicians  OECD and EU countries,

Definitions of Crises Economic contraction  Growth lower by 2/3/4/5% than the average of preceding 4 years  Average growth during preceding 4 years 0/-1/-2/-3 % or less High inflation  Inflation higher by 5/10/20/30% than the average of preceding 4 years  Average inflation during preceding 4 years 10/20/30/40% or higher

Methodology Economic freedom (  ):  t -  t-5 =  1  t-5 +  2  t-5 +  3  t-1 +  4  t +  5 t +  6  t-1  t +  7  t-1 t Democracy (  ):  t -  t-5 =  1  t-5 +  2  t-1 +  3  t +  4 t +  5  t-1  t +  6  t-1 t

Results: Economic Freedom Negative effect of lagged EFW, lagged FH positive Crises: no or negative effect on economic freedom  Crises do not beget reforms (in this sample)  Crisis effect conditional on level of economic freedom: not significant RW parties associated with greater liberalization Crises and ideology:  Positive for RW and/or negative for LW  Only after high-inflation episodes, no effect after contractions  EFW sub-indexes: effect mainly on EFW3 – sound money

Economic Freedom Growth Crises & Potrafke Index Grdev2Grdev3Grdev4Grdev5Grav0Grav-1Grav-2Grav-3 EFW index (5 th lag)(0.035)** (0.034)** FH index (5 th lag)(0.010)**(0.011)** (0.009)** (0.010)** Crisis (0.123)(0.125)(0.145)(0.180)(0.164)**(0.232)**(0.234)**(0.346)** Right wing (0.031)** (0.030)** (0.029)** Left wing (0.017) (0.016) Right*crisis (0.077)(0.094)(0.144)(0.205)(0.111)(0.146)(0.171)(0.241) Left*crisis (0.042)(0.060)(0.062)(0.068)(0.050)(0.069)(0.084)(0.106) Constant (0.246)**(0.254)** (0.242)**(0.246)** (0.249)** R2R N295

Economic Freedom Inflation Crises & Potrafke Index Infld5Infld10Infld20Infld30Infla10Infla20Infla30Infla40 EFW index (5 th lag)(0.034)** (0.045)**(0.038)**(0.035)**(0.034)** FH index (5 th lag)(0.010)**(0.011)** (0.009)** Crisis (0.175)**(0.351)**(0.354)** (0.133)*(0.183)*(0.236)**(0.341)** Right wing (0.030)**(0.029)**(0.030)** (0.032)**(0.031)**(0.029)** Left wing (0.017)(0.016) (0.017) (0.016) Right*crisis (0.101)(0.184)**(0.186)** (0.070)(0.097)(0.124)(0.175)** Left*crisis (0.060)(0.093)* (0.039)(0.055)(0.069)(0.090)* Constant (0.258)**(0.254)**(0.258)** (0.330)**(0.276)**(0.258)**(0.253)** R2R N295

Economic Freedom Growth Crises & CPDS Index Grdev2Grdev3Grdev4Grdev5Grav0Grav-1Grav-2Grav-3 EFW index (5 th lag)(0.041)** (0.040)** FH index (5 th lag)(0.012)**(0.013)** (0.012)** Crisis (0.205)(0.261)(0.284) (0.251)(0.828)(0.829)(0.858) Right wing (0.099)(0.096) (0.095)(0.092)(0.093) Left wing (0.099) (0.096)(0.093) (0.094) Right*crisis (0.246)(0.316)(0.363) (0.451)(0.965)(1.129)(1.850) Left*crisis (0.259)(0.377)(0.402) (0.357)(1.156)(1.168)(1.263) Constant (0.288)**(0.293)**(0.295)** (0.297)**(0.299)**(0.298)** R2R N266

Economic Freedom Inflation Crises & CPDS Index Infld5Infld10Infld20Infld30Infla10Infla20Infla30Infla40 EFW index (5 th lag)(0.041)**(0.043)** (0.050)**(0.044)**(0.041)** FH index (5 th lag)(0.016)**(0.018)** (0.012)** Crisis (0.270)(0.292) (0.232)(0.259)(0.256) Right wing (0.095)(0.096) (0.098)(0.095)(0.093) Left wing (0.099) (0.101)(0.098)(0.096) Right*crisis (0.350)(0.465) (0.317)(0.407)(0.400) Left*crisis (0.379)**(0.483)** (0.314)(0.414)(0.430)* Constant (0.307)**(0.328)** (0.357)**(0.323)**(0.311)** R2R N266

Results: Economic Freedom (cont’d) Relevance:  Crisis management and recovery: RW parties more averse to inflation than LW parties  Long-term effect: EFW important determinant of economic growth (de Haan and Sturm, 2000; Doucouliagos and Ulubasoglu, 2006)

Results: Democracy Negative effect of lagged FH Crises: mixed/weak results Ideology:  RW parties  greater democratization (CPDS)  LW parties  less democratization (Potrafke) Crises and ideology: mixed  Potrafke index: positive for RW, negative for LW  CPDS: negative for both RW and LW  centrist/independent politicians tend to foster democratization after crises  Little difference between inflation and growth crises

Democracy Growth Crises & Potrafke Index Grdev2Grdev3Grdev4Grdev5Grav0Grav-1Grav-2Grav-3 FH index (5 th lag)(0.014)** Crisis (0.236)(0.280)(0.336)(0.404)(0.306)(0.348)(0.382)(0.419) Right wing (0.075)(0.073)(0.071)(0.070)(0.071) (0.070)(0.069) Left wing (0.041)*(0.040) (0.039)*(0.040)*(0.039) Right*crisis (0.145)(0.175)(0.213)(0.268)(0.194)(0.216)(0.236)(0.259)** Left*crisis (0.080)(0.098)(0.121)(0.140)(0.102)(0.120)(0.136)(0.147) Constant (0.262)** (0.261)**(0.266)**(0.268)** (0.266)** R2R N1,089

Democracy Inflation Crises & Potrafke Index Infld5Infld10Infld20Infld30Infla10Infla20Infla30Infla40 FH index (5 th lag)(0.016)** (0.015)** (0.016)** Crisis (0.326)**(0.325)**(0.331)** (0.222)**(0.275)(0.288)(0.298) Right wing (0.071)(0.070) (0.082)(0.077)(0.074)(0.073) Left wing (0.040)(0.039) (0.045)(0.042)(0.041)(0.040) Right*crisis (0.173)**(0.174)**(0.176)** (0.129)(0.151)(0.157)(0.160) Left*crisis (0.095)*(0.096)**(0.097)** (0.069)**(0.082)**(0.088)**(0.090)** Constant (0.301)**(0.300)**(0.297)** (0.298)**(0.302)**(0.301)**(0.306)** R2R N1,089

Democracy Growth Crises & CPDS Index Grdev2Grdev3Grdev4Grdev5Grav0Grav-1Grav-2Grav-3 FH index (5 th lag)(0.011)** (0.012)**(0.013)**(0.012)** Crisis (0.218)(0.285)(0.333) (0.335)(0.458)**(0.482)**(0.529)** Right wing (0.168)(0.160)(0.157) (0.158)*(0.157)*(0.153)*(0.149)** Left wing (0.163)(0.156)(0.154) (0.153) (0.149)(0.145)* Right*crisis (0.294)(0.371)(0.462) (0.445)**(0.579)**(0.688)**(0.734)** Left*crisis (0.311)(0.421)**(0.524)** (0.442)**(0.572)**(0.589)**(0.648)** Constant (0.225)**(0.223)**(0.225)** (0.234)**(0.251)**(0.249)**(0.243)** R2R N682

Democracy Inflation Crises & CPDS Index Infld5Infld10Infld20Infld30Infla10Infla20Infla30Infla40 FH index (5 th lag)(0.013)** (0.012)**(0.013)** Crisis (0.341)**(0.339)**(0.338)**(0.337)**(0.310)(0.319)(0.321)(0.323) Right wing (0.152)*(0.149)* (0.161)*(0.159)*(0.158)* Left wing (0.151)(0.148) (0.160)(0.159)(0.158)(0.157) Right*crisis (0.443)(0.450)(0.452)(0.451)(0.381)*(0.416)**(0.423)** Left*crisis (0.434)(0.439)*(0.440)*(0.438)*(0.375)*(0.410)*(0.417)*(0.419)* Constant (0.257)**(0.259)**(0.255)**(0.249)**(0.260)**(0.263)**(0.266)**(0.270)** R2R N682

Are Reforms Preceded by Crises? So far: Crises do not beget reforms  Explanation (1): Crises occur but are not followed by reforms  Explanation (2): Reforms are not preceded by crises When observe discrete changes in EFW (positive or negative), are they preceded by recessions/booms?  Estimate growth regression with lead reform  EFW increase: (EFW t -EFW t-5 )≥.5/.75/1.0  EFW reversal: (EFW t -EFW t-5 ) ≤-.5/-.75/-1.0

Are Reforms Preceded by Crises? Results EFW increases not correlated with preceding growth EFW reversals preceded by low growth  Similar results for growth with 1 st /2 nd /3 rd leads of reform EFW increases or reversals not correlated with preceding inflation (not reported)  Crises beget reform reversals (in this sample)  With crises, be careful what you wish for

Growth Performance before Reforms  EFW≥.5  EFW≤-.5  EFW≥.75  EFW≤-.75  EFW≥1  EFW≤-1 Investment/GDP (log) (0.006)** n + g +  (log) (0.009)** GDP pc (5 th lag, log) (0.005)*(0.005)**(0.005)* (0.005)**(0.005)* Reform (lead) (0.003)(0.005)**(0.004)(0.007)**(0.005)(0.010)** Constant (0.048)**(0.047)**(0.049)**(0.048)**(0.049)**(0.048)** R2R N 1,070

Conclusions Crises can have important effects on economic policy making and political developments alike Crises can induce tightly regulated countries to embrace reform and deregulation Or they can cause backlash against economic freedom and capitalism Ideology of the incumbent government may play a role

Conclusions Right-wing parties associated with greater economic freedom in general RW parties liberalize economy more after crises Especially if crisis associated with high inflation Mixed results for crisis effect on democratization Reforms implemented by unlikely politicians seem exception rather than rule Political motives important: political clientelism after crises

Conclusions Little consistent evidence of crises begetting reforms  Mainly relatively liberal countries analysed Crises beget change: reform or reform reversal  Latin America and Eastern Europe in 1980s-90s vs Greece and Occupy Movement today