By Raphaelle G. Coulombe, Queen’s University

The ratio of government expenditure to output fluctuated considerably after WW2. As shown in Figure 1, many countries experienced rapid decreases or increases in the share of central government expenditure in output at different points in time. For example, there were instances of sharp decreases in Canada, Italy, and Denmark since the mid-1990s, while the United States and United Kingdom experienced the opposite trend over that same time period.

Figure 2 shows that a pattern emerges when examining the change in the ratio of central government expenditure to output during a party’s time in office (in percentage points) against the same party’s ideology on the left-right scale for the twelve OECD countries in the sample since 1945. The color blue denotes right-wing parties (parties with ideological scores greater than zero) while the color red denotes left-wing parties (parties with ideological scores smaller than zero). When in office both right- and left-wing parties tend to turn the ratio of government expenditure to output in their preferred direction. The negative relationship between right-wing parties and the change in the G-to-Y ratio is statistically significant at the 1% level. In addition, while right- (left-) wing parties tend to decrease (increase) the ratio of government expenditure to output, it also seems that the decrease (increase) in the ratio becomes more pronounced the more right- (left-) wing the party is.

The focus of my recent research is to model and document the origins of the variations in fiscal policy stance both across countries and time and to provide a deeper understanding of government decisions towards spending, which amounted to 38% of GDP on average in advanced economies in 2018 (IMF estimates, 2019). To that end, I relax a common assumption in traditional Keynesian and neoclassical macroeconomic models that government spending is an exogenous process (for example see Woodford 2011 or Baxter and King 1993).

I first develop a theoretical model of the joint determination of economic and electoral outcomes in which government decisions towards spending and taxation vary according to the ideology of the ruling party and the state of the economy. The model introduces heterogeneous parties and voters into a one-sector neoclassical model extended with repeated elections at fixed intervals. The key assumption of this model, which is motivated by the empirical evidence, is that the left-wing party wants a higher share of public consumption in output than the right-wing party. In my framework, the ruling party follows a fiscal rule for expenditure that operates like a ratchet mechanism by gradually turning the government spending-to-output ratio in its preferred direction.

I then exploit the large variations in the domestic political environment across twelve OECD countries in North America and western Europe as well as variations in the business cycle and in the stance of fiscal policy since 1945. To capture key differences in ideology and voting behaviour across countries, I use a rich dataset from the Manifesto Project database that documents electoral outcomes and time-varying ideological party positions estimated from electoral platforms.

The model shows that an important part of the variance in government spending can be linked to the political sector for most countries studied (54% on average). Overall, I find that elections are often a precursor to government spending shocks in countries like the United States and the United Kingdom with high political polarization and persistent government ideology. Intuitively, in these countries, an election that leads to a change in government tend to be followed by larger and more persistent government spending shocks.

Questions remain about why the political sector is more important for the variations in government spending in some countries. For instance, the differences in political polarization and in the persistence in government ideology can ultimately stem from a difference in political systems. In fact, the countries for which most of the variations in government spending is linked to the political environment are countries with a smaller number of dominant parties.

References

[1] Baxter, M. and King, R. (1993). Fiscal policy in general equilibrium. American Economic Review, 83(3):315–334.

[2] Volkens, A., Lehmann, P., Matthieß, T., Merz, N., Regel, S., and Werner, A. (Version 2018a). The manifesto data collection. Manifesto Project (MRG/CMP/MARPOR). 

[3] Woodford, M. (2011). Simple analytics of the government expenditure multiplier. American Economic Journal: Macroeconomics, 3:1–35.