Session 10: Political Economic Theory

We study the spontaneous emergence of power alternation from the need for cooperation by developing a model in which two parties repeatedly cooperate and negotiate the position of power, defined as the control right of a productive regime. Unless the party in power, “incumbent,” compromises, the party out of power, “opposition,” would withdraw from cooperation. Central to our analysis are two impediments: the incumbent’s hold-up problem and information asymmetry. We establish a recursive structure of the model, taking into account the endogenous roles—incumbent or opposition—the two parties play. We find that alternation of power is necessary to sustain cooperation in the long run, while within-period compromise is essential for efficiency. Two norms are inherent in efficient self-enforcing agreements, prescribing an implicit bargaining protocol and the persistence of power. We characterize the implied dynamics of compromise, legitimacy, and power alternation and illustrate the results in context of the Whig-Tory alternation in England from 1688 to 1830.

We present a moral hazard model of electoral accountability that challenges the common view of the populist vote as mere frustration with the elite. Rational voters use the threat of electing outsiders to incentivize more competent insiders whose policy preferences diverge from those of voters. Their optimal retention strategy involves differentiated punishment for failing incumbents, replacing them either with other elite politicians or with outsiders. The latter only occurs when the incumbent’s policy is both perceived as a failure and as benefiting the elite. This strategic voting behavior explains why outsider electoral success is often volatile: rational voters may back an outsider in one election and an establishment candidate in another, without changing their fundamental preferences.

We propose an approach to two-candidate competition with electoral uncertainty in which elections are both competitive (in the sense that each candidate wins with positive probability) and meaningful (in the sense that the candidates adopt distinct platforms).  Candidates may place positive weight on policy and office; these weights may differ across parties; and one party may have an electoral advantage.  Existence of equilibria in pure strategies holds in any number of dimensions, even if the extent of electoral uncertainty is arbitrarily small.  We characterize  equilibria and demonstrate their tractability in simple examples applied to distributive politics, progressive taxation, and cultural and economic policy.

I study partisan gerrymandering whendistrict composition affects candidates’ policy positions and, consequently, voters’ behavior. In the U.S., primary elections determine which candidates compete in general elections, with a district’s ideological composition shaping who emerges as the nominee. Thus, redistricting affects not only which party wins but also the ideology of competing candidates. I find that classical gerrymanderingstrategies can backfirewhencandidatesemergeendogenously, particularly in districts where extreme voters may select non-viable candidates. However, when properly designed to account for both voter affiliation and preference intensity, gerrymandering can be a more powerful instrument than traditional approaches that consider only party affiliation. I show how methods from optimal transport theory can be used to characterize the optimal redistricting plan, which creates districts that maximize ideological distance between competing candidates. Using these findings, I analyze two implications for the U.S. House of Representatives: how gerrymandering contributes to political polarization and its consequences for minority representation.

This paper introduces a model of group communication, in which a group of senders with conflicting interests collectively communicate with a receiver through the disclosure or non-disclosure of information about a relevant state. Collective disclosure decisions are reached via the aggregation of group members’ disclosure recommendations via a pre- determined deliberation procedure. In contrast with classic results from single-agent disclosure, (sequential) equilibria of the group disclosure game typically do not involve full disclosure. We investigate the relation between the group’s deliberation procedure and features of equilibrium communication. In particular, we characterize changes in the deliberation procedure that increase a group’s informativeness; and show that the receiver interprets group messages less favorably for group members who have relatively more power.

We investigate the efficiency of agreements with the following features: (i) self-enforcing—any agent can walk away from the agreement at any moment; (ii) dynamic—payouts occur stochastically while the agreement is in force; (iii) risky—one agent is more favored by the agreement but the favored agent is unknown ex-ante. These features appear in international economic agreements, such as the WTO. Such arrangements have formal or informal mechanisms to resolve disputes that may be more favorable to one agent, but who is favored is learned only as disputes arise. To model these features we assume each agent has access to a risky arm of a Poisson bandit and a safe outside option. The agreement is in force only if both agents are pulling their respective risky arms. Risky arms are negatively correlated, reflecting the fact that only one agent is favored by the agreement. If one agent quits, then the agreement is dissolved and both agents receive their safe payoff. Agents will enter the agreement only if they are sufficiently optimistic that they are favored and will quit when sufficiently convinced they are not favored. Agreements are, thus, in force for an interval of beliefs. This implies some efficient agreements are never started, and efficient agreements in force end with certainty. We find that under some conditions welfare is non-monotonic in the agreement’s informativeness, and is maximized for interior priors. This suggests that slow judgments and agreement ambiguity can improve welfare under some conditions. We further show that a mild asymmetry between the speed of judgments for each player, can improve welfare for some starting beliefs.

We examine receiver-optimal mechanisms for aggregating information that is divided across many biased senders. Each sender privately observes an unconditionally independent signal about an unknown state, so no sender can verify another’s report. A receiver has a binary accept/reject decision which determines players’ payoffs via the state. When information is divided across a small population and bias is low, the receiver-optimal mechanism coincides with the sender-preferred allocation, and can be implemented by letting senders confer privately before reporting. However, for larger populations, we can benefit from the informational divide. We introduce a novel incentive-compatibility-in-the-large (ICL) approach to solve the high-dimensional mechanism design problem for the large-population limit. We use this to show that optimal mechanisms converge to one that depends only on the accept payoff and punishes excessive consensus in the direction of the common bias. These surplus burning punishments imply payoffs are bounded away from the first-best level.

We examine how the political polarization of individual investors, particularly regarding Environmental, Social, and Governance (ESG) issues, is reflected in institutional investor proxy voting and in corporate decision-making. We develop a theoretical model with two types of investors: those who value ESG factors (activists) and those who do not (skeptics). We find that large funds, seeking to attract investors of all ideologies, tend to adopt moderate stances on ESG, which they can impose on corporations, while small funds cater to investors’ polarized positions. We then explore counterfactual settings where individual investors vote directly or delegate their vote to individuals and organizations of their choice (political entrepreneurs), like in a representative democracy, and show that more-extreme corporate ESG policies are likely to be implemented in these cases, reflecting the underlying polarization among investors. In such set- tings, self-confirming multiple equilibria can arise since share ownership is endogenous to the firm’s ESG stance. Additionally, we explore share-holder abstention and the role of investors as citizens.

Both income inequality and political polarization have been steadily increasing in recent decades. Perhaps surprisingly, over the same period elections have increasingly centered around culture war issues that are largely peripheral to inequality. We develop a theoretical framework to explain this pattern. When parties compete over taxes, the Left party has an advantage in numbers because the poor are a majority, whereas the Right party has an advantage in raising money for campaigns because it draws its support from the rich. Culture wars shift some poorer voters toward the Right, and some richer donors toward the Left, resulting in a transfer of popular support to Right and campaign funds to Left. We predict the emergence of culture wars, and which party drives them, based on a country’s inequality, the importance of money in campaigns, and the breadth and depth of cultural polarization.

How should society allocate policy-making between the legislative and the executive branches of government? We analyze a model in which biased and polarized policymakers set policy in response to shocks. We show that policy issues for which the policy-maker bias is small relative to the degree of polarization should be delegated to the legislature, while policy issues where the bias is large should be delegated to the executive. Moreover, when executive delegation is preferred, it is optimal to leave little discretion and impose a narrow mandate. This finding contrasts with conventional wisdom that executive delegation allows for greater flexibility. The main difference between the two institutional settings is the ability to restrict ex post bargaining under executive delegation. Thus, when the bias is large, executive delegation is preferred because it can effectively constrain policymakers’ choices. In contrast, when the bias is small, the ability to bargain ex post allows for flexible responses to severe shocks while limiting political risk. We also study the credibility of these institutions and show that while delegating to the legislature is typically credible, executive delegation is typically not when the bias is exogenous but can be when the bias arises from time inconsistency problems.