Nicholas Stern, in his excellent presidential address to the European Economic Association in 2009, said that a big problem in global negotiations to stop or alleviate the consequences of climate change, was that developing countries should perceive as fair the offers by rich countries to reach an agreement. The idea is based on a very simple interaction called the Ultimatum Game, very well known by many social scientists. In this game, a proposer suggests a deal to some subordinate agent. The deal can be to split a given resource in a fair way (say, fifty-fifty) or to split it unequally (say, ten per cent versus ninety per cent). If the second agents accepts the deal, the resource gets splitted as suggested. Otherwise, the resource disappears (as would life in the planet if nothing is done to stop climate change). Given the alternative, the purely rational reaction of the second player should be to accept any deal. However, in practice, as seen in thousands of experiments, the second player almost never accepts utterly unfair proposals. The game has come to my mind after reading one after another article by many economists stressing the need for structural reforms, without saying much or anything about any suggestion to accompany them by a plan to make these proposals acceptable by those who may be the losers from such reforms, and may well be expecting some perceived fairness from the proposers.
The academic journal SERIEs has accepted a paper by Pau Castells (now at the UK Government Economic Service and PhD candidate at the Autonomous University of Barcelona) and myself on the impact of the March 2004 general election on large Spanish firms. As it is well known, in the last days of the electoral campaign for the 2004 general election in Spain, on Thursday March 11th 2004, a series of simultaneous terror attacks caused the death of 191 persons in commuting trains in the capital Madrid. Four days later, the opposition party PSOE won the election, against all predictions that were made prior to the terror attacks. This change in expectations presents a unique opportunity to take advantage of event study techniques (which measure the impact of surprise events on the stock market) to test some politico-economic hypotheses. One of the problems of many event studies is that long event windows run the risk of including effects of events other than those under analysis; the fact that in this case the election result could not have been predicted four days before the election greatly reduces the meaningful length of the event window and hence the potential for event contamination, except for the potential confusion between the attacks themselves and political change. But we isolate the effect of the attacks themselves by looking at the effects on the stock prices of specific economic sectors (such as tourism) on the day of the attacks and the day after, that were more affected by the attacks than by the elections. We use data for 87 firms in Madrid’s continuous market. We use daily returns data from Infomercados, a financial web site specialized in Spanish equity markets.
One of the hypotheses that we test is that political parties tend to converge in the centre of the ideological spectrum (Median Voter Theorem), implying that there are no differences in practice in policy terms. The other is that politicians and managers collude, for example through the presence of former politicians in the Board of Directors of firms. Convergence theories prove quite resilient in our study as, jointly, on average quoted firms were not significantly affected by the election outcome. We find that, in spite of rhetoric, investors did not expect significant differences between both major Spanish political parties. The expectation was that the degree of convergence in policies affecting the average profits of firms in the overall market would be high. The overall results are consistent with no partisanship (so no effect on expected macro policies such as fiscal policy, inflation, public expenditure or unemployment policies that may affect the market as a whole). Parties may indeed diverge in non-economic policy dimensions, such as social, religious and cultural norms, foreign policy, or the degree of institutional decentralization. But the profit expectations of the stock market as a whole remained unaffected.
The results on the impact on politically connected companies and particular economic sectors, however, suggest that particular industries and businesses may be affected by the political structure of Spain and the nature of its business-politicians networks. A number of companies were indeed affected by the election results analysed in this article, and the empirical results provide some support to the hypothesis that the degree of political connectedness of such businesses is at the core of explaining the impact of the surprise election results on their financial returns. Of the 87 firms analyzed, 46 were politically connected, in the sense of having some former politician or a person clearly linked to a political party in the Board of Directors. We find only weak evidence that politically connected firms on average were affected by the surprise results. But firms that were connected to the Popular Party were significantly affected by the result. Interestingly, the impact could be positive or negative. It was negative in the case of Endesa but it was positive for example in the case of Telefónica or Iberia. Firms in the energy sector could be affected by partisan effects beyond those related to political connections, because the sector was in the middle of a merger wave about which political parties held different opinions. The fact that firms linked to the PP could have a positive effect from the Socialist Party victory can be interpreted as the collusion between managers and PP politicians being damaging for shareholders.
Our interpretation of these results is that the impact of one party or another governing in Spain is not that there will be big changes in general economic policies, but that the value of collusive agreements between politicians and firms changes.
The debate about the "Occupy" and related movements is attracting the best minds. No matter what you thing about the particular details of what the participants are demanding, this is a good sign. Yesterday, in Newsnight (BBC2) Jeremy Paxman interviewed Michael Moore, and the interview reflected both the great potential and the limits of the movement. On Sunday, Eugenio Sclafari in La Repubblica urged the participants in these movements to get organized and influential in the political arena. "The Economist" did something similar when comparing the "Occupiers" with the Tea Party. In Italian, from Scalfari, it sounds much better:
Gli "indignati" sono indignati perché tutto ciò manca e il futuro gli è stato rubato. Sono d'accordo con loro anche perché a me e a quelli della mia generazione è stato rubato il presente e la memoria del passato e vi assicuro che non si tratta d'un furto da poco. Ma so che non è con l'utopia che si risolve il problema.
L'utopia è una fuga in avanti alla quale subentra ben presto l'indifferenza.
Il vostro entusiasmo è sacrosanto come la vostra pacifica ribellione, ma dovete utilizzarlo per la progettazione concreta del futuro, altrimenti da indignati finirete in rottamatori e quando tutto sarà stato rottamato - il malfatto insieme al benfatto - sarete diventati "vecchi e tardi" come i compagni di Ulisse quando varcarono le Colonne d'Ercole e subito dopo naufragarono.
Last Thursday, I presented at my university a paper on independence and the ratchet effect, co-authored with Joanne Evans, Neil Rickman and Paul Levine. The paper can be found here. In words, the ratchet effect is the tendency of evaluators to "penalize" efficient behaviour by setting higher standards for future evaluations. In the relationship between a regulator and a firm, if a firm is efficient, the regulator may demand more effort in future periods. Anticipating this, the firm may be tempted not to behave as efficiently as it could in the first place. This could be alleviated if the regulator could commit not to "penalize" the firm. One way that this could be done would be to delegate into a type of regulator that is not bothered about the firm enjoying efficiency rents. Of course, the solution implies that the political system is able to commit to respecting the independence of this regulator, something that many countries have found difficult to do. If committing to the institution is possible, then governments should find a regulator with exactly the "right" preferences. This is because a regulator could be too pro-firm, and then allow regulated firms to enjoy too high rents from a social welfare point of view. An interesting result of the paper, although it is established by simulations and not analytically, is that pro-firm (conservative) governments have more to gain from delegation than pro-consumer egalitarian governments, because the latter will resent more the relatively high rents enjoyed by firms. And the paper further discusses the recent never ending "independence debate".
I thought of Masahiko Aoki as a Japanese economist trained in the US that was expert in the corporate governance of Japanese firms. Now that I am reading his book "Towards a Comparative Institutional Analysis" (The MIT Press, 2001), I see that he is much more than that. In his analysis, he explains how different domains of social life (economic, political, socio-cultural) interact to sustain stable socio-political arrangements. For example, he sees the co-determination of German firms as complementary of what he calls social-compact corporatist states. Beyond particular examples, he sees institutions as equilibria of social games that constrain the behavior of agents in other games. Then reform proposals in particular societies have to be made in reference to these equilibria. It is useless to recommend policy changes that are not equilibria of any game. Institutions, preferences and beliefs coevolve and the role of policy is to advise on how is it possible to coordinate on equilibria that are both fairer and more efficient.