JAN FIDRMUCDAVID 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

changeEmpirical 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 ideologyInteraction of ideology and crisis

Data

Economic data (World Development Indicators) GDP per capita growth, inflation 1960-2009

Economic Freedom of the World (Fraser Institute) Every 5 years 1970-2000, every years thereafter Summary index and 5 sub-indexes

Democracy (Freedom House) Political rights and civil liberties ,1972-2009

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 (1950-2009) and CEE (1989-2007)

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, 1990-2009

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 lessHigh 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 = 1t-5 + 2t-5 + 3t-1 + 4t + 5t + 6 t-1t + 7t-

1t

Democracy ():t - t-5 = 1 t-5 + 2t-1 + 3t + 4 t + 5 t-1t + 6t-1t

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 significantRW parties associated with greater

liberalizationCrises 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 FreedomGrowth Crises & Potrafke Index

  Grdev2 Grdev3 Grdev4 Grdev5 Grav0 Grav-1 Grav-2 Grav-3EFW index -0.452 -0.459 -0.461 -0.464 -0.489 -0.496 -0.489 -0.480 (5th lag) (0.035)** (0.035)** (0.035)** (0.035)** (0.034)** (0.034)** (0.034)** (0.034)**FH index 0.080 0.079 0.080 0.080 0.083 0.079 0.084 0.079 (5th lag) (0.010)** (0.011)** (0.011)** (0.011)** (0.009)** (0.009)** (0.010)** (0.010)**Crisis -0.012 -0.014 0.104 -0.027 -0.580 -0.835 -0.711 -1.207  (0.123) (0.125) (0.145) (0.180) (0.164)** (0.232)** (0.234)** (0.346)**Right wing 0.106 0.107 0.110 0.105 0.095 0.094 0.097 0.084  (0.031)** (0.031)** (0.030)** (0.030)** (0.029)** (0.029)** (0.029)** (0.029)**Left wing 0.033 0.029 0.032 0.031 0.026 0.029 0.024 0.018  (0.017) (0.017) (0.017) (0.017) (0.017) (0.016) (0.016) (0.016)Right*crisis -0.037 -0.093 -0.131 -0.085 0.107 0.163 0.083 0.349  (0.077) (0.094) (0.144) (0.205) (0.111) (0.146) (0.171) (0.241)Left*crisis -0.082 -0.076 -0.106 -0.074 0.064 0.055 0.056 0.183  (0.042) (0.060) (0.062) (0.068) (0.050) (0.069) (0.084) (0.106)Constant 1.792 1.836 1.825 1.865 2.005 2.124 1.988 2.022  (0.246)** (0.254)** (0.254)** (0.254)** (0.242)** (0.246)** (0.246)** (0.249)**R2 0.49 0.48 0.48 0.47 0.51 0.52 0.50 0.50N 295 295 295 295 295 295 295  

Economic FreedomInflation Crises & Potrafke Index

  Infld5 Infld10 Infld20 Infld30 Infla10 Infla20 Infla30 Infla40EFW index -0.480 -0.467 -0.461 -0.461 -0.588 -0.547 -0.552 -0.516 (5th lag) (0.034)** (0.034)** (0.034)** (0.034)** (0.045)** (0.038)** (0.035)** (0.034)**FH index 0.068 0.066 0.066 0.066 0.088 0.086 0.084 0.078 (5th lag) (0.010)** (0.011)** (0.011)** (0.011)** (0.009)** (0.009)** (0.009)** (0.009)**Crisis -0.531 -1.395 -1.405 -1.405 -0.328 -0.466 -0.950 -1.362  (0.175)** (0.351)** (0.354)** (0.354)** (0.133)* (0.183)* (0.236)** (0.341)**Right wing 0.091 0.092 0.088 0.088 0.091 0.100 0.110 0.105  (0.030)** (0.029)** (0.030)** (0.030)** (0.032)** (0.031)** (0.029)** (0.029)**Left wing 0.021 0.021 0.021 0.021 0.026 0.026 0.025 0.023  (0.017) (0.016) (0.016) (0.016) (0.017) (0.017) (0.016) (0.016)Right*crisis 0.128 0.565 0.600 0.600 0.049 0.081 0.231 0.463  (0.101) (0.184)** (0.186)** (0.186)** (0.070) (0.097) (0.124) (0.175)**Left*crisis -0.013 0.205 0.207 0.207 -0.031 -0.002 0.129 0.234  (0.060) (0.093)* (0.093)* (0.093)* (0.039) (0.055) (0.069) (0.090)*Constant 2.230 2.168 2.140 2.140 2.633 2.362 2.432 2.285  (0.258)** (0.254)** (0.258)** (0.258)** (0.330)** (0.276)** (0.258)** (0.253)**R2 0.51 0.51 0.51 0.51 0.51 0.51 0.53 0.53N 295 295 295 295 295 295 295 295

Economic FreedomGrowth Crises & CPDS Index

  Grdev2 Grdev3 Grdev4 Grdev5 Grav0 Grav-1 Grav-2 Grav-3EFW index -0.657 -0.664 -0.675 -0.675 -0.693 -0.704 -0.696 -0.690 (5th lag) (0.041)** (0.041)** (0.041)** (0.041)** (0.041)** (0.040)** (0.040)** (0.040)**FH index 0.130 0.130 0.131 0.131 0.130 0.120 0.119 0.117 (5th lag) (0.012)** (0.013)** (0.013)** (0.013)** (0.012)** (0.012)** (0.012)** (0.012)**Crisis -0.364 -0.245 -0.333 -0.333 -0.195 -0.741 -0.804 -0.608  (0.205) (0.261) (0.284) (0.284) (0.251) (0.828) (0.829) (0.858)Right wing -0.024 -0.011 -0.014 -0.014 -0.025 -0.036 -0.045 -0.047  (0.099) (0.096) (0.096) (0.096) (0.095) (0.092) (0.093) (0.093)Left wing -0.099 -0.115 -0.104 -0.104 -0.074 -0.073 -0.080 -0.080  (0.099) (0.099) (0.099) (0.099) (0.096) (0.093) (0.093) (0.094)Right*crisis 0.239 -0.056 0.004 0.004 -0.126 0.927 1.783 3.087  (0.246) (0.316) (0.363) (0.363) (0.451) (0.965) (1.129) (1.850)Left*crisis 0.116 0.118 0.240 0.240 -0.233 -0.355 -0.371 -0.800  (0.259) (0.377) (0.402) (0.402) (0.357) (1.156) (1.168) (1.263)Constant 2.448 2.498 2.538 2.538 2.686 2.962 2.923 2.928  (0.288)** (0.293)** (0.295)** (0.295)** (0.297)** (0.299)** (0.298)** (0.298)**R2 0.60 0.59 0.58 0.58 0.59 0.61 0.61 0.61N 266 266 266 266 266 266 266 266

Economic FreedomInflation Crises & CPDS Index

  Infld5 Infld10 Infld20 Infld30 Infla10 Infla20 Infla30 Infla40EFW index -0.619 -0.624 -0.624 -0.624 -0.761 -0.742 -0.729 -0.729 (5th lag) (0.041)** (0.043)** (0.043)** (0.043)** (0.050)** (0.044)** (0.041)** (0.041)**FH index 0.096 0.092 0.092 0.092 0.133 0.128 0.119 0.119 (5th lag) (0.016)** (0.018)** (0.018)** (0.018)** (0.012)** (0.012)** (0.012)** (0.012)**Crisis 0.189 0.119 0.119 0.119 -0.285 -0.201 -0.261 -0.261  (0.270) (0.292) (0.292) (0.292) (0.232) (0.259) (0.256) (0.256)Right wing 0.003 -0.009 -0.009 -0.009 -0.051 -0.043 -0.043 -0.043  (0.095) (0.096) (0.096) (0.096) (0.098) (0.095) (0.093) (0.093)Left wing -0.007 -0.026 -0.026 -0.026 -0.082 -0.071 -0.074 -0.074  (0.099) (0.099) (0.099) (0.099) (0.101) (0.098) (0.096) (0.096)Right*crisis -0.152 0.155 0.155 0.155 0.233 0.144 0.058 0.058  (0.350) (0.465) (0.465) (0.465) (0.317) (0.407) (0.400) (0.400)Left*crisis -1.323 -1.321 -1.321 -1.321 -0.309 -0.701 -1.001 -1.001  (0.379)** (0.483)** (0.483)** (0.483)** (0.314) (0.414) (0.430)* (0.430)*Constant 2.771 2.887 2.887 2.887 3.129 3.081 3.160 3.160  (0.307)** (0.328)** (0.328)** (0.328)** (0.357)** (0.323)** (0.311)** (0.311)**R2 0.60 0.59 0.59 0.59 0.59 0.60 0.62 0.62N 266 266 266 266 266 266 266 266

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 FHCrises: mixed/weak resultsIdeology:

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

DemocracyGrowth Crises & Potrafke Index

  Grdev2 Grdev3 Grdev4 Grdev5 Grav0 Grav-1 Grav-2 Grav-3FH index -0.739 -0.739 -0.739 -0.737 -0.739 -0.740 -0.740 -0.741 (5th lag) (0.014)** (0.014)** (0.014)** (0.014)** (0.014)** (0.014)** (0.014)** (0.014)**Crisis -0.243 -0.092 0.131 -0.074 -0.185 -0.222 -0.296 -0.486  (0.236) (0.280) (0.336) (0.404) (0.306) (0.348) (0.382) (0.419)Right wing 0.003 0.015 0.020 0.004 0.002 -0.011 -0.012 -0.018  (0.075) (0.073) (0.071) (0.070) (0.071) (0.071) (0.070) (0.069)Left wing -0.089 -0.075 -0.072 -0.081 -0.079 -0.071 -0.076 -0.072  (0.041)* (0.040) (0.040) (0.039)* (0.040)* (0.039) (0.039) (0.039)Right*crisis 0.064 0.001 -0.053 0.177 0.124 0.345 0.419 0.701  (0.145) (0.175) (0.213) (0.268) (0.194) (0.216) (0.236) (0.259)**Left*crisis 0.031 -0.074 -0.158 -0.051 -0.034 -0.182 -0.151 -0.206  (0.080) (0.098) (0.121) (0.140) (0.102) (0.120) (0.136) (0.147)Constant 13.656 13.622 13.586 13.583 13.629 13.644 13.647 13.654  (0.262)** (0.262)** (0.262)** (0.261)** (0.266)** (0.268)** (0.268)** (0.266)**R2 0.73 0.73 0.73 0.73 0.73 0.74 0.74 0.74N 1,089 1,089 1,089 1,089 1,089 1,089 1,089 1,089

DemocracyInflation Crises & Potrafke Index

  Infld5 Infld10 Infld20 Infld30 Infla10 Infla20 Infla30 Infla40FH index -0.796 -0.798 -0.802 -0.802 -0.763 -0.766 -0.773 -0.776 (5th lag) (0.016)** (0.016)** (0.016)** (0.016)** (0.015)** (0.015)** (0.015)** (0.016)**Crisis -1.582 -1.565 -1.682 -1.682 -0.605 -0.477 -0.497 -0.559  (0.326)** (0.325)** (0.331)** (0.331)** (0.222)** (0.275) (0.288) (0.298)Right wing -0.050 -0.048 -0.038 -0.038 -0.056 -0.007 0.009 -0.001  (0.071) (0.070) (0.070) (0.070) (0.082) (0.077) (0.074) (0.073)Left wing -0.024 -0.020 -0.019 -0.019 -0.030 -0.017 0.000 -0.003  (0.040) (0.039) (0.039) (0.039) (0.045) (0.042) (0.041) (0.040)Right*crisis 0.725 0.711 0.696 0.696 0.172 0.147 0.161 0.221  (0.173)** (0.174)** (0.176)** (0.176)** (0.129) (0.151) (0.157) (0.160)Left*crisis -0.216 -0.260 -0.268 -0.268 -0.195 -0.301 -0.460 -0.457  (0.095)* (0.096)** (0.097)** (0.097)** (0.069)** (0.082)** (0.088)** (0.090)**Constant 14.735 14.776 14.840 14.840 14.254 14.153 14.255 14.304  (0.301)** (0.300)** (0.297)** (0.297)** (0.298)** (0.302)** (0.301)** (0.306)**R2 0.76 0.76 0.76 0.76 0.75 0.75 0.75 0.75N 1,089 1,089 1,089 1,089 1,089 1,089 1,089 1,089

DemocracyGrowth Crises & CPDS Index

  Grdev2 Grdev3 Grdev4 Grdev5 Grav0 Grav-1 Grav-2 Grav-3FH index -0.787 -0.790 -0.792 -0.792 -0.801 -0.797 -0.806 -0.808 (5th lag) (0.011)** (0.011)** (0.011)** (0.011)** (0.012)** (0.013)** (0.012)** (0.012)**Crisis 0.033 0.228 0.166 0.166 0.564 1.325 1.615 2.789  (0.218) (0.285) (0.333) (0.333) (0.335) (0.458)** (0.482)** (0.529)**Right wing 0.238 0.241 0.208 0.208 0.354 0.381 0.372 0.425  (0.168) (0.160) (0.157) (0.157) (0.158)* (0.157)* (0.153)* (0.149)**Left wing 0.133 0.173 0.134 0.134 0.195 0.233 0.232 0.293  (0.163) (0.156) (0.154) (0.154) (0.153) (0.153) (0.149) (0.145)*Right*crisis -0.170 -0.361 -0.094 -0.094 -1.526 -2.293 -3.692 -5.158  (0.294) (0.371) (0.462) (0.462) (0.445)** (0.579)** (0.688)** (0.734)**Left*crisis -0.515 -1.414 -1.728 -1.728 -1.607 -2.693 -3.124 -4.828  (0.311) (0.421)** (0.524)** (0.524)** (0.442)** (0.572)** (0.589)** (0.648)**Constant 15.142 15.184 15.237 15.237 15.351 15.245 15.411 15.410  (0.225)** (0.223)** (0.225)** (0.225)** (0.234)** (0.251)** (0.249)** (0.243)**R2 0.89 0.89 0.89 0.89 0.89 0.89 0.89 0.90N 682 682 682 682 682 682 682 682

DemocracyInflation Crises & CPDS Index

  Infld5 Infld10 Infld20 Infld30 Infla10 Infla20 Infla30 Infla40FH index -0.853 -0.870 -0.865 -0.862 -0.813 -0.815 -0.821 -0.825 (5th lag) (0.013)** (0.013)** (0.013)** (0.013)** (0.012)** (0.013)** (0.013)** (0.013)**Crisis -1.093 -1.151 -1.113 -1.152 -0.120 0.009 -0.110 -0.129  (0.341)** (0.339)** (0.338)** (0.337)** (0.310) (0.319) (0.321) (0.323)Right wing 0.311 0.340 0.338 0.335 0.364 0.327 0.337 0.337  (0.152)* (0.149)* (0.149)* (0.149)* (0.161)* (0.159)* (0.158)* (0.158)*Left wing 0.066 0.081 0.090 0.083 0.136 0.094 0.086 0.092  (0.151) (0.148) (0.148) (0.148) (0.160) (0.159) (0.158) (0.157)Right*crisis -0.161 -0.450 -0.503 -0.452 -0.850 -1.296 -1.349 -1.334  (0.443) (0.450) (0.452) (0.451) (0.381)* (0.416)** (0.423)** (0.423)**Left*crisis -0.570 -0.915 -0.920 -0.923 -0.932 -0.879 -0.840 -0.919  (0.434) (0.439)* (0.440)* (0.438)* (0.375)* (0.410)* (0.417)* (0.419)*Constant 16.431 16.741 16.628 16.582 15.668 15.702 15.807 15.869  (0.257)** (0.259)** (0.255)** (0.249)** (0.260)** (0.263)** (0.266)** (0.270)**R2 0.90 0.90 0.90 0.90 0.89 0.89 0.89 0.89N 682 682 682 682 682 682 682 682

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: (EFWt -EFWt-5)≥.5/.75/1.0 EFW reversal: (EFWt -EFWt-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 1st/2nd/3rd 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≤-1Investment/GDP (log) 0.027 0.024 0.027 0.025 0.027 0.025

(0.006)** (0.006)** (0.006)** (0.006)** (0.006)** (0.006)**

n + g + (log) 0.092 0.090 0.092 0.088 0.093 0.085(0.009)** (0.009)** (0.009)** (0.009)** (0.009)** (0.009)**

GDP pc (5th lag, log) -0.012 -0.013 -0.012 -0.012 -0.013 -0.011(0.005)* (0.005)** (0.005)* (0.005)* (0.005)** (0.005)*

Reform (lead) -0.000 -0.025 -0.001 -0.033 -0.007 -0.052(0.003) (0.005)** (0.004) (0.007)** (0.005) (0.010)**

Constant 0.277 0.287 0.279 0.274 0.287 0.253(0.048)** (0.047)** (0.049)** (0.048)** (0.049)** (0.048)**

R2 0.15 0.17 0.15 0.16 0.15 0.17

N 1,070 1,070 1,070 1,070 1,070 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