Elections cause fiscal waste in weak and strong democracies alike

A typical argument in the fiscal manipulation literature is that incumbents engage in hidden fiscal spending to convince uninformed voters of their competence. Theoretically, such government manipulation should occur and work particularly well in developing countries with weak democracies, but not in developed and democratic countries with strong institutions. Nevertheless, the empirical literature continues to observe such cycles in strong democracies as well, albeit to a lesser extent.

The study by KOF economist Lamar Crombach and Frank Bohn (Radboud University) describes how fiscal manipulation can be effective in two ways. First, fiscal spending must be able to convince some of the electorate that the incumbent is more competent than is actually the case. Such voters, often denoted as uninformed voters, are necessary for any degree of fiscal manipulation to be effective. Conversely, informed voters are able to distinguish between fiscal manipulation and actual competence. If all voters were informed, fiscal manipulation would incur costs without achieving any electoral gain. The proportion of uninformed voters thus represents the reach of fiscal manipulation. The greater the reach, the more effective the manipulation.

The optimal level of fiscal manipulation depends crucially on a country’s economic stability
The second type of effectiveness, unique to this study, is the persuasiveness of fiscal manipulation. While uninformed voters are susceptible to fiscal manipulation, a given level of manipulation may not be sufficient to persuade an uninformed voter to vote for the incumbent. The study argues that the level of fiscal manipulation needed to persuade an uninformed voter depends crucially on a country’s economic stability. Incumbents in unstable environments have difficulty differentiating themselves from their opponents because voters find it difficult to assess the incumbent’s economic merits compared with their challengers. Incumbents can only stand out by engaging in relatively higher levels of fiscal manipulation.

Conversely, an incumbent in a stable environment can appear more competent with only minor manipulation. As such, the more stable a country’s economic situation, the more persuasive the incumbent’s manipulation. Fiscal spending during elections is thus most effective if it can strongly persuade a large number of voters, which occurs when many voters are uninformed and, as a consequence of instability, are uncertain about the incumbent’s competence.

The degree to which an electorate is uninformed is traditionally measured using indicators such as education, government transparency and, as in this study, the level of press freedom. The persuasiveness of fiscal spending is more complex and without empirical precedent. The researchers argue that voters care greatly about economic conditions and take this as a proxy for government competence. To measure persuasiveness, the researchers therefore use the historical volatility of economic growth. Voters in countries with volatile growth rates have difficulty assessing the incumbent’s relative economic merits. An incumbent would need exceptional levels of fiscal manipulation to differentiate themselves.

Although democratic countries with strong institutions have relatively few uninformed voters, spending is relatively persuasive
In stable countries, on the other hand, a small improvement beyond the status quo convinces many uninformed voters. This means that although developed and democratic countries with strong institutions have relatively few uninformed voters, a low level of spending will be relatively persuasive owing to their stability. Conversely, while developing countries with weak democracies have many uninformed voters, a volatile environment creates problems for an incumbent looking to differentiate themselves.

Chart G 6 below summarises the empirical result based on 70 democracies during the 1986 to 2015 period. The vertical axis measures the share of GDP that is saved (+) or spent (-) additionally during an election year relative to a non-election year. The horizontal axis measures the relative degree of volatility in countries’ economic growth. For instance, -2σ shows the result for all countries that are two standard deviations less volatile than the average country (µ). The blue line shows the effect that an election has on the budget balance for varying levels of volatility in countries without full press freedom, while the green line shows the same for all countries with full press freedom.

The authors conclude that an increase in the share of uninformed voters (moving from the green line, i.e. the effect of elections on the budget balance in countries with press freedom, to the blue line, i.e. the effect of elections without press freedom) exacerbates fiscal spending in more volatile macroeconomies, yet more limited press freedom diminishes such spending in stable macroeconomies. Press freedom has no impact on fiscal manipulation in the average macroeconomy.

Having more informed voters will not necessarily result in fiscal prudence
In sum, the study shows that having a more informed electorate will not always ensure fiscal prudence during election years. Such fiscal spending is very persuasive in democracies with stable growth rates. It takes only minor manipulation to strongly convince an uninformed voter of the incumbent’s economic merits. If the share of uninformed voters were to increase, therefore, an incumbent might deem it optimal to lower fiscal spending because they could achieve the same probability of re-election with more uninformed voters and less spending. Finally, although theory shows that an increase in the share of uninformed voters causes less wasteful spending in stable democracies, it also allows an incompetent incumbent to achieve re-election: an unattractive feat.