Political Risk, Economic Integration, and the Foreign Direct Investment Decision

In this paper we analyse the impact of policy uncertainty on foreign direct investment strategies. We also consider the impact of economic integration upon FDI decisions. The paper follows the real options approach, which allows investigating the value to a firm of waiting to invest and/or disinvest, when payoffs are stochastic due to political uncertainty and investments are partially reversible. Across the board we find that political uncertainty can be very detrimental to FDI decisions while economic integration leads to an increasing benefit of investing abroad.

Political economics and normative analysis

The approaches and opinions of economists often dominate public policy discussion. Economists have gained this privileged position partly (or perhaps mainly) because of the obvious relevance of their subject matter, but also because of the unified methodology (neo-classical economics) that the vast majority of modern economists bring to their analysis of policy problems and proposed solutions. The idea of Pareto efficiency and its potential trade-off with equity is a central idea that is understood by all economists and this common language provides the economics profession with a powerful voice in public affairs. The purpose of this paper is to review and reflect upon the way in which economists find themselves analysing and providing suggestions for social improvements and how this role has changed over roughly the last 60 years. We focus on the fundamental split in the public economics tradition between those that adhere to public finance and those that adhere to public choice. A pure public finance perspective views failures in society as failures of the market. The solutions are technical, as might be enacted by a benevolent dictator. The pure public choice view accepts (sometimes grudgingly) that markets may fail, but so, it insists, does politics. This signals institutional reforms to constrain the potential for political failure. Certain policy recommendations may be viewed as compatible with both traditions, but other policy proposals will be the opposite of that proposed within the other tradition. In recent years a political economics synthesis emerged. This accepts that institutions are very important and governments require constraints, but that some degree of benevolence on the part of policy makers should not be assumed non-existent. The implications for public policy from this approach are, however, much less clear and perhaps more piecemeal. We also discuss analyses of systematic failure, not so much on the part of markets or politicians, but by voters. Most clearly this could lead to populism and relaxing the idea that voters necessarily choose their interests. The implications for public policy are addressed. Throughout the paper we will relate the discussion to the experience of UK government policy-making.

Do political incentives matter for tax policies? Ideology, opportunism and the tax structure

This paper investigates the importance of political ideology and opportunism in the choice of the tax structure. In particular, we examine the effects of cabinet ideology and elections on the distribution of the tax burden across factors of production and consumption for 21 OECD countries over the period 1970-2000 by employing four alternative cabinet ideology measures and by using the methodology of effective tax rates. There is evidence of both opportunistic and partisan effects on tax policies. More precisely, we find that left-wing governments rely more on capital relative to labor income taxation and that they tend to increase consumption taxes. Moreover, we find that income tax rates (but not consumption taxes) tend to be reduced in preelectoral periods and that capital effective tax rates (defined broadly to include taxes on selfemployed income) are reduced by more than effective labor tax rates.

An Archival Case Study: Revisiting The Life and Political Economy of Lauchlin Currie

This paper forms part of a wider project to show the significance of archival material on distinguished economists, in this case Lauchlin Currie (1902-93), who studied and taught at Harvard before entering government service at the US Treasury and Federal Reserve Board as the intellectual leader of Roosevelt’s New Deal, 1934-39, as FDR’s White House economic adviser in peace and war, 1939-45, and as a post-war development economist. It discusses the uses made of the written and oral material available when the author was writing his intellectual biography of Currie (Duke University Press 1990) while Currie was still alive, and the significance of the material that has come to light after Currie’s death.

The Good, the Bad and the Populist: A Model of Political Agency with Emotional Voters

This paper attempts to extend existing models of political agency to an environment in which voting may be divided between informed and instrumental, informed and ‘expressive’ (Brennan and Lomasky (1993)) and uninformed due to ‘rational irrationality’ (Caplan (2007)). It constructs a model where politicians may be good, bad or populist. Populists are more willing than good politicians to pander to voters who may choose inferior policies in a large-group electoral setting because their vote is insignificant compared with those that voters would choose were their vote decisive in determining the electoral outcome. Bad politicians would ideally like to extract tax revenue for their own ends. Initially we assume the existence of only good and populist politicians. The paper investigates the incentives for good politicians to pool with or separate from populists and focuses on three key issues – (1) how far the majority of voter’s preferences are from those held by the better informed incumbent politician (2) the extent to which the population exhibits rational irrationality and expressiveness (jointly labelled as emotional) and (3) the cost involved in persuading uninformed voters to change their views in terms of composing messages and spreading them. This paper goes on to consider how the inclusion of bad politicians may affect the behaviour of good politicians and suggests that a small amount of potential corruption may be socially useful. It is also argued that where bad politicians have an incentive to mimic the behaviour of good and populist politicians, the latter types of politician may have an incentive to separate from bad politicians by investing in costly public education signals. The paper also discusses the implications of the model for whether fiscal restraints should be soft or hard.

Expressive Political Behaviour: Foundations, Scope and Implications

A growing literature has focussed attention on ‘expressive’ rather than ‘instrumental’ behaviour in political settings - particularly voting A common criticism of the expressive idea is that its myriad possibilities make it rather ad hoc and lacking in both predictive and normative bite. We agree that no single clear definition of expressive behaviour has emerged to date, and no detailed foundations of specific expressive motivations have been provided, so that there are rather few specific implications drawn from the analysis of expressive behaviour. In response, we provide a foundational discussion and definition of expressive behaviour that accounts for a range of factors. We also discuss the content of expressive choice distinguishing between moral, social and emotional cases, and relate this more general account to the specific theories of expressive choice in the literature. Finally, we discuss the normative and institutional implications of expressive behaviour.

Who Ultimately Bears the Burden of Greater Non-Wage Labour costs?

We investigate the effect of a rise in non-wage labour costs (NWLC) on real anufacturing labour costs in OECD countries, taking into account the degree of coordination in the wage bargaining process. We find that, in countries in which wage bargaining is not highly coordinated, 55% of an increase in NWLC appears to be shifted to workers in the long run, whereas in countries operating under a highly coordinated bargaining regime, full shifting occurs. Overall, our results suggest that high NWLC can be associated with a high equilibrium unemployment rate, but only in those OECD countries that do not have highly coordinated wage bargaining.

Transaction Costs and Institutions

This paper proposes a simple framework for understanding endogenous transaction costs - their composition, size and implications. In a model of diversification against risk, we distinguish between investments in institutions that facilitate exchange and the costs of conducting exchange itself. Institutional quality and market size are determined by the decisions of risk averse agents and conditions are discussed under which the efficient allocation may be decentralized. We highlight a number of differences with models where transaction costs are exogenous, including the implications for taxation and measurement issues.

Trade Costs, International Competition and Selection: The Effects of Unionisation on Market Size

Within a two-country model of international trade in which heterogeneous firms face firm-specific unions, we study the effects of different forms of trade liberalisation on market structure and competitive selection in the presence of inter-country asymmetries in size and labour market institutions. For given levels of trade openness, an increase in a country’s relative unions’ strength reduces the average productivity of its domestic producers but increases that of its exporters. Whilst an unfavourable union power differential, by increasing wages, weakens a country’s firms’ competitive position, the higher wages reinforce standard market access mechanisms to give rise to aggregate income effects. When the initial levels of trade openness are sufficiently low, this ‘expansionary’ aggregate effect can attract industry in the country with stronger unions and also result in an increase in the extensive margin of exports. For sufficiently large inter-country differences in the bargaining power of unions, trade liberalization can then result in a pro-variety effect, with an increase in the total availability of varieties to consumers in both countries, regardless of there being inter-country differences in size.

Rationalising ‘Irrational’ Support for Political Violence

This paper provides a rationale for group support for political violence when violence does not provide a material benefi t. A theory of fairness is adopted to demonstrate that although group violence may not be the equilibrium of a material game it may be a fairness equilibrium in a game containing psychological payoffs. For this to happen the material stakes must be perceived as low and psychological payoffs are expressive. Although the material stakes are actually high, members of each group may choose expressively to support the use of violence because the probability of being decisive is low. The paper also considers the possibility of peace emerging as a fairness equilibrium. This can only happen if each group perceives the other as making some sacrifi ce in choosing peace.

FDI, Trade Costs and Regional Asymmetries

We set up a trade model where three countries compete for an exogenous number of firms. Our innovation lies in the geography of the model. Of the three countries, one is the hub through which all trade takes place. First, we establish the natural geography of the region, which is given by the equilibrium distribution of industrial activity in the absence of taxes or subsidies. We then examine the implications for corporate taxes when the countries compete with each other to attract firms. We find that, even when all countries are the same size, the centrality of the hub gives it an advantage in tax setting, such that its equilibrium tax can be larger than that of the spokes and yet it still attracts a disproportionate share of industry. Thus geographic advantage in tax competition has a second dimension, centrality in addition to size.

Picking the Right Budget Constraint for Scotland

This position paper considers the devolution of further fiscal powers to the Scottish Parliament in the context of the objectives and remit of the Smith Commission. The argument builds on our discussion of fiscal decentralization made in our previous published work on this topic. We ask what sort of budget constraint the Scottish Parliament should operate with. A soft budget constraint (SBC) allows the Scottish Parliament to spend without having to consider all of the tax and, therefore, political consequences, of that spending, which is effectively the position at the moment. The incentives to promote economic growth through fiscal policy – on both the tax and spending sides are weak to non-existent. This is what the Scotland Act, 1998, and the continuing use of the Barnett block grant, gave Scotland. Now other budget constraints are being discussed – those of the Calman Commission (2009) and the Scotland Act (2012), as well as the ones offered in 2014 by the various political parties – Scottish Conservatives, Scottish Greens, Scottish Labour, the Scottish Liberal Democrats and the Scottish Government. There is also the budget constraint designed by the Holtham Commission (2010) for Wales that could just as well be used in Scotland. We examine to what extent these offer the hard budget constraint (HBC) that would bring tax policy firmly into the realm of Scottish politics, asking the Scottish electorate and Parliament to consider the costs to them of increasing spending in terms of higher taxes; or the benefits to them of using public spending to grow the tax base and own-sourced taxes? The hardest budget constraint of all is offered by independence but, as is now known, a clear majority of those who voted in the referendum did not vote for this form of budget constraint. Rather they voted for a significant further devolution of fiscal powers while remaining within a political and monetary union with the rest of the UK, with the risk pooling and revenue sharing that this implies. It is not surprising therefore that none of the budget constraints on offer, apart from the SNP’s, come close to the HBC of independence. However, the almost 25% fall in the price of oil since the referendum, a resource stream so central to the SNP’s economic policy making, underscores why there is a need for a trade off between a HBC and risk pooling and revenue sharing. Ranked according to the desirable characteristic of offering something approaching a HBC the least desirable are those of the Calman Commission, the Scotland Act, 2012, and Scottish Labour. In all of these the ‘elasticity’ of the block grant in the face of failure to grow the Scottish tax base is either not defined or is very elastic – meaning that the risk of failure is shuffled off to taxpayers outside of Scotland. The degree of HBC in the Scottish Conservative, Scottish Greens and Scottish Liberal Democrats proposals are much more desirable from an economic growth point of view, the latter even embracing the HBC proposed by the Holtham Commission that combines serious tax policy with welfare support in the long-run. We judge that the budget constraint in the SNP’s proposals is too hard as it does not allow for continuation of the ‘welfare union’ in the UK. We also consider that in the case of a generalized UK economic slow requiring a fiscal stimulus that the Scottish Parliament be allowed increased borrowing to be repaid in the next economic upturn.

Transaction Costs and Institutions: Investments in Exchange

This paper proposes a simple model for understanding transaction costs for their composition, size and policy implications. We distinguish between investments in institutions that facilitate exchange and the cost of conducting exchange itself. Institutional quality and market size are determined by the decisions of risk averse agents and conditions are discussed under which the efficient allocation may be decentralized. We highlight a number of differences with models where transaction costs are exogenous, including the implications for taxation and measurement issues.