DP9909 Political Competition and the Limits of Political Compromise

Author(s): Alexandre B. Cunha, Emanuel Ornelas
Publication Date: March 2014
Keyword(s): efficient policies, political turnover, public debt
JEL(s): E61, E62, H30, H63
Programme Areas: International Macroeconomics, Public Economics, Development Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9909

We consider an economy where competing political parties alternate in office. Due to rent-seeking motives, incumbents have an incentive to set public expenditures above the socially optimum level. Parties cannot commit to future policies, but they can forge a political compromise where each party curbs excessive spending when in office if they expect future governments to do the same. We find that, if the government cannot manipulate state variables, more intense political competition fosters a compromise that yields better outcomes, potentially even the first best. By contrast, if the government can issue debt, vigorous political competition can render a compromise unsustainable and drive the economy to a low-welfare, high-debt, long-run trap. Our analysis thus suggests a legislative tradeoff between restricting political competition and constraining the ability of governments to issue debt.