Spending Biased Legislators: Discipline Through Disagreement Facundo Piguillem EIEF

Alessandro Riboni Polytechnique

Tinbergen Institute September 2014

1/29

Motivation

I

Bias toward current spending appears as an important problem I

I

Policies become time inconsistent (generic case, Jackson and Yariv, 2012)

And typically policies are decided through dynamic bargaining (endogenous status quo)

What is the role of the endogenous status quo? How the details affect the outcomes?

2/29

This Paper

I

All politicians want high spending today and low in the future I

time inconsistent preferences: when tomorrow comes, temptation to postpone spending cuts

I

Politicians differ on temptation’s strength

I

Spending is decided through legislative bargaining 1) Default option (status quo) in case of disagreement is endogenous 2) Proposals approval is uncertain

3/29

Findings I

Endogenous default option ⇒ commitment device I

Policy persistence: it only arises if there is disagreement

I

Disagreement has a positive value as commitment device

I

Equilibrium can be characterized by Strategic: 1. Complementarities: future and present responsibility reinforce each other or 2. Substitutabilities: future responsibility crowds out the present one

I

Very different impact of the same institutional changes I I

It could be better to add irresponsible legislators or appoint an executive for life 4/29

Findings I

Endogenous default option ⇒ commitment device I

Policy persistence: it only arises if there is disagreement

I

Disagreement has a positive value as commitment device

I

Equilibrium can be characterized by Strategic: 1. Complementarities: future and present responsibility reinforce each other or 2. Substitutabilities: future responsibility crowds out the present one

I

Very different impact of the same institutional changes I I

It could be better to add irresponsible legislators or appoint an executive for life 4/29

Findings I

Endogenous default option ⇒ commitment device I

Policy persistence: it only arises if there is disagreement

I

Disagreement has a positive value as commitment device

I

Equilibrium can be characterized by Strategic: 1. Complementarities: future and present responsibility reinforce each other or 2. Substitutabilities: future responsibility crowds out the present one

I

Very different impact of the same institutional changes I I

It could be better to add irresponsible legislators or appoint an executive for life 4/29

Literature I

Laibson, (1997), Donoghue & Rabin (1999), etc: single decision maker

I

Bowen et al. (2013): time consistent preferences

I

Jackson & Yariv (2012) and Hertzberg (2012): time inconsistency is the generic case in political decisions

I

Halac & Yared (2013): similar mechanism

I

Battaglini & Coate, (2007, 2008): indirect link through debt

I

Majority rule (Aghion et al, 2004, etc)

I

Alesina & Tabellini, 1990, Persson & Svensson, 1989, and Azzimonti, 2011, Cukierman et al, 1992)

5/29

Outline

1. The economy 2. Basic legislative bargaining model 3. Equilibrium, Strategic interactions and its implications 3.1 Distribution in the legislature 3.2 Degree of political turnover

6/29

The Model

Rationalization

I

Spending levels st ∈ {s, s}, with s < s.

I

No debt: τt = st

I

Politicians order stream of spending according to: Ui,t = ai st − βst+1 − β 2 st+2 − ....

I

Optimal policy with commitment : s, s, s, ...

I

but tomorrow, Ui,t+1 = ai st+1 − βst+2 − β 2 st+3 − ....

I

ai measures the temptation to raise spending ex post

I

β ∈ [0, 1] is a measure of quality of institutions. 7/29

The Model

Rationalization

I

Spending levels st ∈ {s, s}, with s < s.

I

No debt: τt = st

I

Politicians order stream of spending according to: Ui,t = ai st − βst+1 − β 2 st+2 − ....

I

Optimal policy with commitment : s, s, s, ...

I

but tomorrow, Ui,t+1 = ai st+1 − βst+2 − β 2 st+3 − ....

I

ai measures the temptation to raise spending ex post

I

β ∈ [0, 1] is a measure of quality of institutions. 7/29

The Model

Rationalization

I

Spending levels st ∈ {s, s}, with s < s.

I

No debt: τt = st

I

Politicians order stream of spending according to: Ui,t = ai st − βst+1 − β 2 st+2 − ....

I

Optimal policy with commitment : s, s, s, ...

I

but tomorrow, Ui,t+1 = ai st+1 − βst+2 − β 2 st+3 − ....

I

ai measures the temptation to raise spending ex post

I

β ∈ [0, 1] is a measure of quality of institutions. 7/29

Legislative Bargaining at t Continuum of legislators indexed by ai I

Agenda setter (executive) is randomly selected at t

I

She makes a take it or leave it offer ˆst

I

Legislators say either yes or no. Prob. of acceptance depends on the number of yes votes:

I

If ˆst passes, it becomes spending for the current period, st = ˆst .

I

If rejected, the status quo is implemented st = qt

I

New default option: qt+1 = st

I

At t + 1 agenda setter stays with probability ρ. 8/29

Equilibrium Characterization

9/29

Basic Model

I

Legislators are sophisticated.

I

Temptation parameter ai uniformly distributed over [0, 1]

I

Acceptance is linear in number of yes votes I

I

Prob of acceptance=proportion of legislators in favor

ρ = 0: no incumbency advantage

10/29

Equilibrium I

Markov Perfect Equilibrium in cutoff strategies

I

All ai > p= proposer’s cutoff, propose high spending

I

All ai > l= legislator’s cutoff accept spending increases (and refuse spending cuts)

I

Because of Uniform assumption, I

p is prob. that s is proposed and l is prob. that s is accepted

 Π=

I

πss πss

πss πss



 =

p + (1 − p)l l p

(1 − p)(1 − l) p(1 − l) + 1 − p



Remark: πss ≥ πss and πss ≥ πss 11/29

Equilibrium I

Markov Perfect Equilibrium in cutoff strategies

I

All ai > p= proposer’s cutoff, propose high spending

I

All ai > l= legislator’s cutoff accept spending increases (and refuse spending cuts)

I

Because of Uniform assumption, I

p is prob. that s is proposed and l is prob. that s is accepted

 Π=

I

πss πss

πss πss



 =

p + (1 − p)l l p

(1 − p)(1 − l) p(1 − l) + 1 − p



Remark: πss ≥ πss and πss ≥ πss 11/29

Trade-off: Voting Legislator I

After proposal, legislator ai favors s over s iff ˆ (s) ≥ ai s + β V ˆ (s) ai s + β V

I

ˆ (s) = continuation value of s V ai (s − s) ≤ (s − s)β(πss − πss )

X∞ t=0

β t (πss − πss )t

I

where πss − πss = p(1 − l) + (1 − p)l=prob of disagreement

I

In short ai ≤ β

(1 − l)p + l(1 − p) 1 − β[(1 − l)p + l(1 − p)]

12/29

Trade-off: Voting Legislator I

After proposal, legislator ai favors s over s iff ˆ (s) ≥ ai s + β V ˆ (s) ai s + β V

I

ˆ (s) = continuation value of s V ai (s − s) ≤ (s − s)β(πss − πss )

X∞ t=0

β t (πss − πss )t

I

where πss − πss = p(1 − l) + (1 − p)l=prob of disagreement

I

In short ai ≤ β

(1 − l)p + l(1 − p) 1 − β[(1 − l)p + l(1 − p)]

12/29

Trade-off: Voting Legislator I

After proposal, legislator ai favors s over s iff ˆ (s) ≥ ai s + β V ˆ (s) ai s + β V

I

ˆ (s) = continuation value of s V ai (s − s) ≤ (s − s)β(πss − πss )

X∞ t=0

β t (πss − πss )t

I

where πss − πss = p(1 − l) + (1 − p)l=prob of disagreement

I

In short ai ≤ β

(1 − l)p + l(1 − p) 1 − β[(1 − l)p + l(1 − p)]

12/29

Trade-off

I

ai is the “present bias” temptation

I

The net gain of going to the next period with a low status quo is β

I

I

(1 − l)p + l(1 − p) 1 − β[(1 − l)p + l(1 − p)]

It is zero if: I

If l = p = 0 (all irresponsible) no gain of low status quo.

I

If l = p = 1 (all responsible) zero cost of high status quo.

Fiscal responsibility only if some (but not all) legislators are irresponsible

13/29

Trade-off

I

ai is the “present bias” temptation

I

The net gain of going to the next period with a low status quo is β

I

I

(1 − l)p + l(1 − p) 1 − β[(1 − l)p + l(1 − p)]

It is zero if: I

If l = p = 0 (all irresponsible) no gain of low status quo.

I

If l = p = 1 (all responsible) zero cost of high status quo.

Fiscal responsibility only if some (but not all) legislators are irresponsible

13/29

Trade-off: Agenda Setter I

Agenda setter proposes s over q if Prob(s)[ai s + βEV (s)]+[1 − Prob(s)][ai q + βEV (q)] ≥ ai q +β EV (q)

I

or, ai s + βEV (s) ≥ ai q + βEV (q)

I

Same trade-off! Then, l = p

I

Equilibrium solves: l =p=β

2(1 − p)p 1 − 2βp(1 − p) 14/29

Equilibrium

p

p

p

β ≤ 1/2

p

β > 1/2 15/29

Equilibrium

Proposition 1: For any β > (1/2, 1] there exists an interior equilibrium with cutoff √ 2β − 1 ∗ p = √ . 2β

16/29

Breaking the link: Exogenous Status quo I

If proposal is rejected: I I

qt = st−1 with Prob = θ, qt = sd with Prob = 1 − θ, for any sd

I

If θ = 1 we are back to Proposition 1.

I

Equilibrium solves: p = θβ

2p(1 − p) 1 − θβ2(1 − p)p

I

Same as before with discounting: βθ

I

Prop. 4. For any exogenous default option sd , when θ < 1/2, high spending is always chosen for all β ∈ [0, 1]. 17/29

Breaking the link: Exogenous Status quo I

If proposal is rejected: I I

qt = st−1 with Prob = θ, qt = sd with Prob = 1 − θ, for any sd

I

If θ = 1 we are back to Proposition 1.

I

Equilibrium solves: p = θβ

2p(1 − p) 1 − θβ2(1 − p)p

I

Same as before with discounting: βθ

I

Prop. 4. For any exogenous default option sd , when θ < 1/2, high spending is always chosen for all β ∈ [0, 1]. 17/29

Strategic Complements 1 β=0.55

l

β=0.65

C’’

0.5

C’

C

0

B

0.5

1

l

18/29

Strategic Substitutes 1 β=0.8 β=0.9

D’ D’’

l

D 0.5

0

B

0.5

1

l

19/29

Transition matrix

I

Markov chain is ergodic.

I

Unconditional prob. of high spending: πs =

I

πss πss + πss

In the best equilibrium   2 √ 2β−1  1− √  2β  2 β > 1/2 √ 2β−1 πs = 1− √ + 2β−1 2β 2β   1 β ≤ 1/2

20/29

Unconditional Probability of ¯s (best equilibrium)

1.2

1

long−run tax

0.8

0.6

0.4

0.2

0

0

0.2

0.4

β

0.6

0.8

1

21/29

Institutional changes

22/29

Introducing more tempted legislators

I

Suppose we allow for legislators with higher temptation:  (1 − λ)ai if 0 ≤ ai < 1, G (ai ) = 1 if ai = 1,

I

For instance expanding enfranchisement

I

Same recognition probabilities

23/29

Introducing more tempted legislators

λ > 0 triggers less discipline (β=0.6)

λ > 0 triggers more discipline (β=0.8) 1

λ=0.4

λ=0.4

λ=0

λ=0

0.5

l

l

1

0.5

0

0 0.5

l

1

0.5

1

l

24/29

Introducing more tempted legislators (best equilibrium) Unconditional probability of s λ=0 λ=0.4

prob. high spending

1

0.5

0

0

0.1

0.2

0.3

0.4

0.5

β

0.6

0.7

0.8

0.9

1

25/29

Fixed Executive

I

Initial executive is never replaced.

p 1 ( 4β 2 + 1 − 1), Proposition Fixed executive with as ≤ p = 2β always proposes low spending, which gets eventually accepted. I

Long run spending depends on initial draw.

I

For any β > 0 at least some executive proposes low spending.

26/29

Turnover vs no Turnover (best equilibrium)

1.2 No Turnover Turnover

long−run spending

1

0.8

0.6

0.4

0.2

0

0

0.2

0.4

β

0.6

0.8

1

27/29

Interior persistence: ρ ∈ (0, 1) long run prob of high spending 1 0.9 0.8 0.7 0.6 0.5 0.4 0.3

ρ=0 ρ=1 ρ=0.25 ρ=0.50 ρ=0.75

0.2 0.1 0

0

0.1

0.2

0.3

0.4

0.5 β

0.6

0.7

0.8

0.9

1

28/29

Conclusions

I

Endogeneity of status quo is key to alleviate the temptation to spend I

It generates endogenous persistence that forces time inconsistent legislator to internalize future costs. (Halac and Yared (2014))

I

Adding some irresponsibility could be beneficial.

I

Reforms that work well in some countries can have the opposite effect in other countries.

29/29

Cutting the extremes

I

So far extreme and centered legislators are equally likely

I

Consider electoral law that keeps extremes out of legislature.

30/29

Cutting the extremes

1

1

0.5

0.5

0

0 0.5

β = 0.75

1

0.5

1

β = 0.8 31/29

Cutting the extremes

1.2 less dispersion more dispersion 1

high spending

0.8

0.6

0.4

0.2

0

0

0.2

0.4

β

0.6

0.8

1

Low β countries benefit from more heterogenous legislatures 32/29

A rationalization I

back

Consumers Vi,t =

I

j=0

β j (1 − st+j ),

Politicians care about spending and consumers. P∞ j 0 = V + α [s + δ Ui,t i,t i t j=1 β (st+j )] I I

I

X∞

αi ∈ [1, 2] is benevolence parameter. δ ∈ [0, 1/2] makes legislators more impatient.

Rewrite politicians utility as Ui,t = ai st − βst+1 − β 2 st+2 − ....

I

where ai ≡

(αi − 1) > 0. (1 − αi δ) 33/29

Simple Majority

Proposition 3: (i) If β ≥ 2/3 there exists a MPE in which the median always rejects spending increases and accepts spending cuts. (ii) If β < 2/3 in all MPE the median always accepts spending increases and rejects spending cuts.

34/29

Simple Majority

1.2

1

prob. high spending

0.8

0.6

0.4

0.2

prob. acceptance simple majority

0

−0.2 0

0.2

0.4

β

0.6

0.8

1

35/29

Spending Biased Legislators: Discipline Through ...

Policy persistence: it only arises if there is disagreement. ▷ Disagreement has a positive value as commitment device. ▷ Equilibrium can be characterized by ...

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