Politics through the Lens of Economics

Lecture 10: Political Agency Model

Masayuki Kudamatsu

6 December, 2017

Discussion Time

What evidence is needed

for the Legislative Bargaining Model to explain 

Minimum-wage policy in South Korea?

Background information

Minimum-wage policy in South Korea

Introduced in 1988 ($0.50 per hour)

As of 2016, $5.80 per hour (similar to Israel and Poland)

Lower than Japan ($7.40) and most other OECD countries

In 2015, 12% of workers received the minimum wage or lower

(Source: Korea Labor Institute)

(Sources: Bloomberg, The Economist)

Background information

Minimum wage across countries in 2016

US dollars (PPP) per hour

Source: OECD Stat

Background information

Minimum-wage policy in South Korea (cont.)

May 2017 Presidential Election

Every major candidate pledged a 10,000-won ($8.83) wage floor

Winner, Moon Jae-in, promised to reach the target by 2020

Next year it'll be 7530 won ($6.65), an increase by 16.4%

Trade Unions support the policy

A survey shows

90% of small companies prefer a rise of below 5%

55% say they will be bankrupt if the policy goes ahead

(Sources: Bloomberg, The Economist)

Basic economics of minimum wage

Wage

# of employees

Supply

Demand

Equilibrium

Equilibrium

Background information

Basic economics of minimum wage

Wage

# of employees

Supply

Demand

Equilibrium

Equilibrium

Minimum wage

Minimum wage does not have any impact

Background information

Basic economics of minimum wage

Wage

# of employees

Supply

Demand

Equilibrium

Minimum wage

Minimum wage reduces employment

Discussion Time

What evidence do we need to say

the legislative bargaining model (assumptions / predictions)

explains South Korea's minimum wage policy?

Aim to come up with a wrong answer

Motivation for today (& next week)

Conflict of interest

between

citizens and politicians

Examples

Corruption of politicians

Common interest policies requiring politicians' costly effort

e.g. Disaster relief

Today's Road Map

Evidence on citizens' voting behaviour

Political agency model

Evidence on politicians' behaviour

Model ingredient #1: Players

Citizens

Act as one person:

any conflict of interest among themselves is assumed away

Politicians

Incumbent

(chooses a policy in period 1 and, if re-elected, in period 2)

Opposition candidate

(chooses a policy in period 2 if defeating the incumbent)

Model ingredient #2: Policies

Provide public goods

Benefit politician rather than citizens

Preferred by citizens

Use the fixed amount of government revenue to: 

Put public money into pocket

Target-spending on interest groups

Pursue his/her own ideological agenda

Model ingredient #3: Politician type

Prefer a policy that benefits themselves

Congruent politicians

Prefer a policy that citizens prefer (i.e. public good provision)

Dissonant politicians

Model ingredient #4: Information

Citizens do not know each politician's type

Expect a politician to be congruent with probability P

Citizens observe policy choice in period 1

e.g. through mass media

Model ingredient #5: Timing of Events

Step 1: Period 1 Policy-making

Step 2: Election

The incumbent chooses a policy

Citizens vote for the incumbent or for the opposition

Step 3: Period 2 Policy-making

Winner of the election chooses a policy

cf. Results are the same with multiple periods

Period 2 politician's optimization

Congruent politician

Provide public goods

Dissonant politician

Benefit himself / herself

Citizens want a congruent politician to be in office in period 2

Citizens' optimization at the election

Vote for the candidate who is more likely to be congruent

Probability of being congruent

Incumbent

Opposition

P
PP
?
??

Probability that incumbent is congruent

Congruent

Dissonant

P

1 - P

Citizens' initial belief

Probability that incumbent is congruent

Congruent

Dissonant

P

1 - P

Citizens' initial belief

public good

Congruent politicians always provide public good

Incumbent's policy choice

Probability that incumbent is congruent

Congruent

Dissonant

P

1 - P

Citizens' initial belief

public good

Incumbent's policy choice

Q

1 - Q

public good

Suppose the dissonant incumbent

provides public good with probability Q

Later we will derive Q as the dissonant politician's optimal behaviour 

Probability that incumbent is congruent

Congruent

Dissonant

P

1 - P

Citizens' initial belief

public good

Incumbent's policy choice

Q

1 - Q

public good

The dissonant incumbent

benefits himself with probability 1-Q

benefit himself

Congruent

Dissonant

P

1 - P

Citizens' initial belief

If public good is observed...

Congruent

P

Dissonant

(1 - P) * Q

public good

Q

1 - Q

public good

benefit himself

Citizens' updated belief

Probability that incumbent is congruent

Citizens' optimization at the election

Vote for the incumbent if public good was observed

Probability of being congruent

Incumbent

Opposition

P
PP
\frac{P}{P+(1-P)*Q}
PP+(1P)Q\frac{P}{P+(1-P)*Q}
>
>>

Congruent

P

Dissonant

(1 - P) * Q

Citizens' updated belief

Congruent

Dissonant

P

1 - P

Citizens' initial belief

Dissonant

(1 - P) * (1 - Q)

Incumbent is dissonant for sure

public good

If no public good is observed

Q

1 - Q

public good

benefit himself

Citizens' updated belief

Probability that incumbent is congruent

Citizens' optimization at the election

Vote for the opposition if no public good was observed

Dissonant

(1 - P) * (1 - Q)

Incumbent is dissonant for sure

Citizens' updated belief

Probability of being congruent

Incumbent

Opposition

P
PP
0
00
<
<<

Period 1 congruent politician's optimization

Provide public good

Get re-elected and benefit from public good in both periods

Provide no public good

Get kicked out of office and no benefit from public good at all

Optimal behaviour: Provide public good

Period 1 dissonant politician's optimization

Provide public good

Get re-elected & benefit from period 2 policy

Provide no public good

Benefit from period 1 policy & get kicked out of office

Benefit from period 1 policy

Expectedperiod 2 benefit

0

Period 1 dissonant politician's optimization

Provide public good

Get re-elected & benefit from period 2 policy

Provide no public good

Benefit from period 1 policy & get kicked out of office

Benefit from period 1 policy

Expectedperiod 2 benefit

Provide public good

0

Period 1 dissonant politician's optimization

Provide public good

Get re-elected & benefit from period 2 policy

Provide no public good

Benefit from period 1 policy & get kicked out of office

Benefit from period 1 policy

Expectedperiod 2 benefit

Provide no public good

Provide public good

0

Period 1 dissonant politician's optimization

Benefit from period 1 policy

Expectedperiod 2 benefit

Provide no public good

Provide public good

0

Q

1 - Q

Probability:

Political Agency Model in a nutshell

Incumbent Politician type

Good

Bad

Cost of pleasing citizens

Low

High

Period 1 policy

Please citizens

Please citizens

Ignore citizens

Election

Re-elected

Re-elected

Kicked out

Period 2 policy

Please citizens

Ignore citizens

New politician type

Good

Bad

Please citizens

Ignore citizens

Good

Bad

Zero

Voters reward politicians for good behavior

Incumbent politician type

Good

Bad

Cost of pleasing citizens

Low

High

Period 1 policy

Please citizens

Please citizens

Ignore citizens

Election

Re-elected

Re-elected

Kicked out

Period 2 policy

Please citizens

Ignore citizens

Winning politician type

Good

Bad

Please citizens

Ignore citizens

Good

Bad

Zero

Political Agency Model's implication #1

Voters punish politicians for misbehaving

Incumbent politician type

Good

Bad

Cost of pleasing citizens

Low

High

Period 1 policy

Please citizens

Please citizens

Ignore citizens

Election

Re-elected

Re-elected

Kicked out

Period 2 policy

Please citizens

Ignore citizens

Winning politician type

Good

Bad

Please citizens

Ignore citizens

Good

Bad

Zero

Political Agency Model's implication #1

Re-election incentive disciplines the incumbent

Incumbent politician type

Good

Bad

Cost of pleasing citizens

Low

High

Period 1 policy

Please citizens

Please citizens

Ignore citizens

Election

Re-elected

Re-elected

Kicked out

Period 2 policy

Please citizens

Ignore citizens

Winning politician type

Good

Bad

Please citizens

Ignore citizens

Good

Bad

Zero

Political Agency Model's implication #2

Election improves the quality of policy-makers

Incumbent politician type

Good

Bad

Cost of pleasing citizens

Low

High

Period 1 policy

Please citizens

Please citizens

Ignore citizens

Election

Re-elected

Re-elected

Kicked out

Period 2 policy

Please citizens

Ignore citizens

Winning politician type

Good

Bad

Please citizens

Ignore citizens

Good

Bad

Zero

Political Agency Model's implication #3

Summary

Implications of Political Agency Model

Citizens observe

incumbent's performance

before election

Better-than-expected

performance

Re-election

of incumbent

Incumbent delivers

what citizens need

Today's Road Map

Evidence on citizens' voting behaviour

Political agency model

Evidence on politicians' behaviour

Implication of Political Agency Model

to be tested

Citizens observe

incumbent's performance

before election

Better-than-expected

performance

Re-election

of incumbent

Incumbent delivers

what citizens need

Testing ground: Mayors' corruption in Brazil

Mayor was given an apartment worth 600,000 real

cf. 1 US dollar = 2 to 4 Brazilian real

Example #1: Over-invoicing

Building 9km of roads

Cost is estimated to be 1,000,000 Brazilian real

Municipal govt paid 5,000,000 real to a firm with no experience

Another firm subcontracted for 1,800,000 real

Fiscal transfer from Ministry of Health: 321,700 real

Municipal govt used fake receipts worth 166,000 real

as the proof of purchasing medical equipments

Testing ground: Mayors' corruption in Brazil

Example #2: Diversion of public funds

cf. 1 US dollar = 2 to 4 Brazilian real

Construction of a sports complex

Bidding firms required to have 100,000+ real in capital

Only one firm qualifies, which gave kickbacks to mayor 

Testing ground: Mayors' corruption in Brazil

Example #3: Illegal procurement

Random auditing of municipal govt expense

Starting from May 2003...

50-60 municipalities per month (out of 5,000+ in total)

randomly chosen for auditing by public lottery

Lottery: witnessed by citiznes, the press, and political parties

Image source: Foreign Policy (2015)

Random auditing of municipal govt expense

Starting from May 2003...

50-60 municipalities per month (out of 5,000+ in total)

randomly chosen for auditing by public lottery

10-15 auditors sent to each chosen municipality

Trained, well-paid, hired by competitive examination

Report is published to the press and on the Internet

Random auditing of municipal govt expense

By the way, the political reasons for randomization were:

Nobody could accuse the auditing agency

of picking their targets through political calculation.

It would discipline mayors even without being investigated

(the auditing agency's budget was limited)

according to Foreign Policy (2015)

October 2004

Municipal elections

376 municipalities

audited

300 municipalities

audited

Voters observe

mayor's corruption

before election

Voters don't observe

mayor's corruption

before election

Similar due to random assignment

Difference in

electoral outcomes

Impact of observing

mayor's corruption

=

Measurement of corruption

From the audit report, count # of violations

Source: Figure 1 of Ferraz and Finan (2008)

Source: Figure 3 of Ferraz and Finan (2008)

Finding

Zero corruption

Re-election

more likely

Source: Figure 3 of Ferraz and Finan (2008)

Finding

2+ violations

Re-election

less likely

Source: Figure 3 of Ferraz and Finan (2008)

Finding

1 violation

Re-election rate

does not change

Citizens expect opposition's violation to be 1

Today's Road Map

Evidence on citizens' voting behaviour

Political agency model

Evidence on politicians' behaviour

Citizens observe

incumbent's performance

before election

Better-than-expected

performance

Re-election

of incumbent

Incumbent delivers

what citizens need

Implication of Political Agency Model

to be tested

Testing ground: Brazilian mayors (again)

Each term: 4 years long

Term limit (2 terms) introduced from the 2000 election

Those re-elected in 2000 cannot seek re-election in 2004

Local govt receive 35b US dollars per year

Mayors in Brazil have large discretion over public spendings

Measurement of corruption

_____________________________________________________________

Amount of municipal govt budget audited

Amount of municipal govt budget related to corruption

Data source:

Corruption audit reports on 476 municipalities

Average: 0.79

Regression Discontinuity Design (cf. Lecture 4)

Compare mayor's corruption during 2001-2004 between

Municipalities where 

 incumbent barely won 

in 2000 

& term-limited in 2004

 Municipalities where

 opposition barely won

 in 2000

& re-elected in 2004

Similar on average

Difference in corruption = Impact of term limit

Term limits increase corruption

0.04

Term-limited

First-term

Next lecture #1

Term limit

Oct 26, 2016:

LDP's presidential term limit

was extended from 6 to 9 years

Is this a good thing?

Next lecture #2

Freedom of Press

Press Freedom

across countries

in 2016

This lecture is based on the following academic articles and books:

Sections 3.3 and 3.4.3 of Besley (2006)

 

Political Agency Model

Evidence on citizens' voting behaviour

Evidence on politicians' behaviour

Politics through the Lens of Economics (2017): Lecture 10 Political Agency Model

By Masayuki Kudamatsu

Politics through the Lens of Economics (2017): Lecture 10 Political Agency Model

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