Ebook Elections, Macroeconomic Preferences and International Financial Market Constraints
Despite the strong pressures from international financial markets on governments’ ability to choose freely among different economic policy options, political parties, at least nominally, continue to offer very distinct policy solutions. Parties, when running for office, often pretend that they will implement economic policies that differ significantly from those of their competitors and sometimes also succeed in convincing voters that they in fact will do so. Distinct nominal party positions in economic policy thus still is an important component of democratic electoral competition, while, at the same time, many observers object that government parties pursue very similar actual economic policies once they assume office.
Although the strategic positioning of parties is not surprising and the concern that parties may implement different policies than those proposed during a campaign is not novel, it is difficult to assess systematically to what extent this is the case, and how it has changed during the past decades. Moreover, a popular, alternative proposition states that governments diverge instead of converge in their economic policies. This is because demands for redistribution increase when rich people and firms (generally) benefit from increasing openness, while poorer citizens and workers are exposed to greater uncertainty. How the relationship between nominal economic positions and actual policies in industrialized countries has developed during the past decades thus is not clear from a theoretical point of view.
This study examines to what extent the difference between nominal macroeconomic positions and actual economic policies of parties in power has increased with financial openness. I do this by assessing how the reaction of domestic stock markets to election outcomes has changed when industrialized economies have become more open to international financial flows. Stock market behavior reflects the aggregate expectations of well-informed actors about actual policies. This allows me to infer to what extent expected economic policies of governments are consistent with their nominal differences. In short, stock markets should respond more strongly to elections if governments’ actual policies have diverged in open economies. In contrast, stock markets reactions to election should decrease if governments’ actual economic policies have converged.
The study also addresses several aspects that previous research has ignored. First, it examines the first and crucial step in the causal chain that connects openness to domestic politics, i.e. the reaction of internationalized financial markets to governments. Second and unlike an analysis of a narrowly defined area, such as tax policy, focusing on stock markets indirectly captures most relevant policy tools that a government has at its disposal to affect major parts of the economy. Third, the study explicitly examines how stock market behavior has changed as countries gradually became more open to international financial flows. And finally, the analysis adds a comparative perspective to the growing research on financial market responses to elections that, with very few exceptions, only examines the financial effects of few and carefully selected cases.
The preliminary results do not support the divergence logic and present weak support for the convergence logic. Stock markets react fairly strongly to the ideology of the elected government, i.e. prices increase when a more right wing government is elected and they drop when a more left-wing government wins the election. Greater financial openness leads to less strong reactions of stocks to the new government’s ideology, but this effect is not that large. One possibility is that the indictor of openness, which measures de jure capital restrictions, does not capture exposure to international financial markets well. In a next version, I will assess the impact of actual cross border capital flows as an alternative measure of a country’s international financial integration.
Besides the results on financial openness, the study also shows that the impact of politics on stock markets is strongly mediated by political constraints. While the effect of ideology on stock market behavior is quite large in countries with a low degree of political constraints, this effect disappears in countries with a high level of political constraints. This result confirms the findings by studies on institutions and policy volatility in a quite remarkable manner.
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