Political economy in macroeconomics

Originally, economics was called political economy, and those studying it readily accepted that economic decisions are made in a political world. But economics eventually separated itself from politics to pursue rigorous methods of analyzing individual behavior and markets. Recently, an increasing number of economists have turned their attention to the old question of how politics shape economic outcomes. To date, however, this growing literature has lacked a cogent organization and a unified approach. Here, in the first full-length examination of how political forces affect economic policy decisions, Allan Drazen provides a systematic treatment, organizing the increasingly influential "new political economy" as a more established field at the highly productive intersection of economics and political science.

Although he provides an extraordinarily helpful guide to the recent explosion of papers on political economy in macroeconomics, Drazen moves far beyond survey, giving definition and structure to the field. He proposes that conflict or heterogeneity of interests should be the field's essential organizing principle, because political questions arise only when people disagree over which economic policies should be enacted or how economic costs and benefits should be distributed. Further, he illustrates how heterogeneity of interests is crucial in every part of political economy. Drazen's approach allows innovative treatment--using rigorous economic models--of public goods and finance, economic growth, the open economy, economic transition, political business cycles, and all of the traditional topics of macroeconomics.

This major text will have an enormous impact on students and professionals in political science as well as economics, redefining how decision makers on several continents think about the full range of macroeconomic issues and informing the approaches of the next generation of economists.

Author Notes

Allan Drazen is the William Hiber Professor of Economics at the Hebrew University of Jerusalem and Professor of Economics and Co-Director of the Center of International Economics at University of Maryland.

Preface	p. xi
Introductory Note	p. xiii
Part I Basic Issues and Tools of Analysis	p. 1
Chapter 1 What is a Political Economy?	p. 3
1.1. Introduction	p. 3
1.2. Politics and Economics	p. 5
1.3. Types of Heterogeneity	p. 9
1.4. An Illustration of Approaches	p. 12
1.5. Plan of the Book	p. 18
Chapter 2 Economic Models for Political Analysis	p. 20
2.1. Introduction	p. 20
2.2. The Principal-Agent Problem	p. 22
2.3. Discrete Time Dynamic Models--Dynamic Programming	p. 31
2.4. The Overlapping Generations Model	p. 35
2.5. Effects of Uncertain Future Policies	p. 38
2.6. Conclusions	p. 58
Chapter 3 Decisionmaking Mechanisms	p. 60
3.1. Introduction	p. 60
3.2. How Much Political Detail?	p. 61
3.3. Choosing Decisionmaking Mechanisms	p. 64
3.4. Direct Democracy	p. 70
3.5. Representative Democracy	p. 77
3.6. Multiparty Systems	p. 85
3.7. Interest Groups and Lobbying	p. 90
3.8. Transaction Cost Politics	p. 96
3.9. Conclusions	p. 98
Part II Commitment, Credibility, and Reputation	p. 99
Chapter 4 The Time-Consistency Problem	p. 101
4.1. Introduction	p. 101
4.2. Capital Taxation	p. 104
4.3. Time Inconsistency as a Conflict of Interests	p. 110
4.4. The Barro-Gordon Model	p. 113
4.5. Seigniorage Revenue and the Optimum Quantity of Money	p. 121
4.6. Commitment versus Flexibility	p. 126
4.7. Conclusions	p. 130
Chapter 5 Laws, Institutions, and Delegated Authority	p. 131
5.1. Introduction	p. 131
5.2. Laws, Constitutions, and Social Contracts	p. 132
5.3. Delegation of Authority	p. 140
5.4. Central Bank Independence	p. 142
5.5. Fiscal Structures for Time Consistency	p. 157
5.6. Conclusions	p. 164
Chapter 6 Credibility and Reputation	p. 166
6.1. Introduction	p. 166
6.2. Reputation	p. 168
6.3. "Reputation" under Complete Information	p. 169
6.4. Reputation under Incomplete Information--Mimicking	p. 175
6.5. Does Reputation "Solve" the Time-Consistency Problem?--Three Caveats	p. 183
6.6. Signaling	p. 187
6.7. Reputation for Not Reneging on Commitments	p. 195
6.8. Credibility and External Circumstances	p. 201
6.9. Ambiguity, Secrecy, and Imprecise Control	p. 208
6.10. Conclusions	p. 214
Part III Heterogeneity and Conflicting Interests	p. 217
Chapter 7 Elections and Changes of Policymakers	p. 219
7.1. Introduction	p. 219
7.2. Elections and Policymaker Performance	p. 223
7.3. The Opportunistic Political Business Cycle	p. 228
7.4. Partisan Political Cycles	p. 246
7.5. Competence and Prospective Voting	p. 268
7.6. Campaign Promises	p. 278
7.7. Interactions of the Executive and the Legislature	p. 283
7.8. Multiparty Systems and Endogenous Election Dates	p. 293
7.9. Tying the Hands of One's Replacement	p. 300
7.10. Conclusions	p. 308
Chapter 8 Redistribution	p. 309
8.1. Introduction	p. 309
8.2. Redistribution of Income	p. 311
8.3. Differential Transfers	p. 318
8.4. Nonmonetary Redistribution	p. 324
8.5. Rent Seeking and Predation	p. 334
8.6. Intergenerational Redistribution	p. 345
8.7. Redistribution and Mobility	p. 354
8.8. Conclusions	p. 370
Chapter 9 Public Goods	p. 372
9.1. Introduction	p. 372
9.2. Public Goods--The Neoclassical Approach	p. 375
9.3. Provision of Public Goods in Practice	p. 379
9.4. Voluntary Provision of Public Goods--Free Riders and Collective Action	p. 382
9.5. Voluntary Provision of Public Goods--Clubs	p. 391
9.6. The Static Public Goods Game	p. 395
9.7. The War of Attrition in Public Goods Provision	p. 397
9.8. Conclusions	p. 401
Chapter 10 Inaction, Delay, and Crisis	p. 403
10.1. Introduction	p. 403
10.2. Economic Arguments	p. 407
10.3. Vested Interests	p. 411
10.4. Nonadoption Due to Uncertainty about Individual Benefits	p. 414
10.5. "Communication" Failures	p. 423
10.6. Conflict over the Burden of Reform	p. 432
10.7. Common Property Models	p. 439
10.8. Economic Crises	p. 444
10.9. Conclusions	p. 454
Part IV Application to Policy Issues	p. 455
Chapter 11 Factor Accumulation and Growth	p. 457
11.1. Introduction	p. 457
11.2. Basic Models of Fiscal Policy and Capital Accumulation	p. 461
11.3. Imperfect Capital Markets, Externalities, and Endogenous Income Distribution	p. 474
11.4. Political Institutions and Regimes	p. 488
11.5. Socio-Political Instability	p. 500
11.6. Empirical Determinants of Growth	p. 513
11.7. Conclusions	p. 524
Chapter 12 The International Economy	p. 526
12.1. Introduction	p. 526
Part I Exchange-Rate Arrangements	p. 529
12.2. Fixed versus Flexible Exchange Rates	p. 529
12.3. Currency Crises and Contagious Speculative Attacks	p. 536
12.4. Monetary Unions	p. 544
Part II Macroeconomic Interdependence	p. 559
12.5. International Policy Cooperation	p. 559
12.6. Political Responses to External Shocks	p. 579
Part III International Capital and Aid Flows	p. 580
12.7. Capital Controls	p. 580
12.8. Sovereign Borrowing	p. 587
12.9. Foreign Aid	p. 601
12.10. Conclusions	p. 613
Chapter 13 Economic Reform and Transition	p. 615
13.1. Introduction	p. 615
13.2. Defining the Issues	p. 617
13.3. Economic and Political Constraints	p. 621
13.4. The Implications of Magnitude--A Formal Analysis	p. 626
13.5. Heterogeneity and Political Constraints	p. 632
13.6. Labor Reallocation	p. 643
13.7. Privatization	p. 653
13.8. Price Liberalization	p. 663
13.9. Conclusions	p. 674
Chapter 14 The Size of Government and the Number of Nations	p. 675
14.1. Introduction	p. 675
14.2. The Scope of Government	p. 677
14.3. The Size of Government--Government Spending	p. 679
14.4. Government Debt and Deficits	p. 690
14.5. Budgetary Rules and Institutions	p. 697
14.6. The Number of Nations	p. 707
14.7. Conclusions	p. 731
Bibliography	p. 735
Author Index	p. 765
Subject Index	p. 771

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