Political Institutions, Policymaking Processes and Policy Outcomes: A Political Transactions Framework

1. Political Institutions, Policymaking Processes and Policy Outcomes:A Political Transactions Framework Pablo Spiller Ernesto Stein Mariano Tommasi

2. Motivation • Natural inclination of economists is to emphasize policy recipes as a way of improving the well-being of people in developing countries. • In Latin America during the 1990s, this has led to the adoption of a wide variety of reforms, grouped under the “Washington Consensus” • The outcome of these efforts has been disappointing. • This project is based on the belief that the potential of policy recipes depends on the quality of the policymaking process through which those recipes are discussed, approved, implemented and enforced. • Improvements in the policymaking processes – and a better understanding of these processes when policies are designed – are key in order to improve the quality of public policies, and achieve development objectives.

3. Motivation • Comparison across countries – even within LAC – reveals very substantial differences in the quality of public policies. • While some countries can sustain policies long enough to create a stable and predictable environment, others experience sudden changes in policies with every change in government. • While some are able to adjust their policies in response to shocks, or when previous policies fail, others seem unable to adjust, or get stuck in bad policies for long periods of time. • While some are able to adequately implement and enforce policies once they have been enacted, others seem unable to do so effectively. • What determines the capacity of countries to design, approve and implement effective public policies? • In this project, we try to provide some answers to this question.

4. The project • This paper is part of an IDB research network project on Political Institutions, Policymaking Processes and Policy Outcomes. • The project covers 9 countries in Latin America, in addition to the original work on Argentina by Spiller and Tommasi. • The purpose of this paper (as well as a companion paper by Scartascini and Olivera) was to provide a “blueprint” so that other authors could (loosely) replicate the methodology developed by Spiller and Tommasi for Argentina, and apply it to their respective countries. • We are now in the process of writing an overview chapter, which will complete the book.

5. The project Argentina Brazil Chile Colombia Ecuador Mexico Paraguay Peru Uruguay Venezuela

6. The objectives • To improve our understanding of the process by which policies get enacted, approved and implemented (the PMP). • To improve policy recipes, by adapting them to (political) institutional capabilities • Countries have different political institutions. Policies that may work under one institutional context may not be adequate under another one. • To contribute to the debate about (possibly) reforming political institutions, shedding some light on their effects on policy. • To foster institutional political analysis in Latin America • To foster interdisciplinary collaboration • All country chapters were written by interdisciplinary teams, including economists as well as political scientists.

7. The framework • We draw extensively on pre-existing literature on “Positive Political Theory” • Most of the extant literature on effects of political institutions on policy outcomes tends to focus on a single institutional dimension, and explores its impact on some policy outcome. • Example: impact of proportional representation on government size. • This literature is very useful but… • …it is mostly “partial equilibrium” • …it is mostly “forward looking” • …it is not (directly) useful for analyzing specific political reforms in specific countries at specific points in time. • For this, one needs to take into account • Interactions • Country specificities • Historical dynamics

8. General equilibrium approach • We believe the workings of the PMP (and the impact on policy outcomes) do not depend on single-factor explanations but rather on a multiplicity of factors, and their interaction. • For this reason, we adopt a GE approach with a country focus. • We believe the GE approach is more appropriate to • understand why reforms that work under certain institutional environments may not work under others • think about the design of political reform. • Our approach is very demanding in terms of the knowledge of the institutional details of the countries under study. • Our approach is also “backward looking” or “consequential” • starting from dependent variable (common features of policy outcomes) and looking backwards to find their institutional determinants. • Complex methodology, implementing it is as much an art as a science • Complements other approaches such as Tsebelis (2002) or Cox and Mc Cubbins (2001). Ours is more intertemporal.

9. Outer features of public policies • The focus of the approach is in explaining not the content or substance of policies (such as whether tariffs are high or low), but rather certain common features or qualities of public policies, characterized as“outer features” • Stability vs. volatility: • Adaptability vs. rigidity • Coordination / coherence • Quality of implementation and enforcement • Public vs. private regardedness • How can the authors characterize these outer features in each of the countries? • By combining first hand knowledge of key policy areas with secondary country sources, and with different indices that may help place the countries in comparative perspective.

10. Policy volatility (based on Fraser index)) Belgium Finland Switzerland Australia Austria Germany Canada Netherlands Colombia Denmark Sweden Uruguay Italy Jordan Jamaica Spain United States Japan Hong Kong SAR Panama Honduras Singapore United Kingdom Sri Lanka France Israel Greece Hungary Trinidad and Iceland India Mauritius Egypt Portugal China Thailand Chile Norway Ireland South Africa Malaysia Costa Rica Mexico Turkey Paraguay Ecuador New Zealand Dominican Republic Nigeria Guatemala Philippines Indonesia Brazil El Salvador Bolivia Venezuela Argentina Peru Nicaragua Zimbabwe 0.00 0.25 0.50 0.75 1.00

11. Legal or political changes over the past few years have (1=severely undermined your firm's planning capacity, 7=had no effect)

12. Policy stability vs. Growth 10 5 GDP growth CHL DOM CRI PAN COL 0 MEX PAR GTM BRA ECU PER SLV ARG UGY JAM VEN -5 -2 -1 0 1 2 Policy stability Controlling for GDP per capita. Significant at the 5% level

13. The minimum wage set in your country is (1=never enforced, 7=strongly enforced)

14. Tax evasion in your country is (1=rampant, 7=minimal)

15. Environmental regulation in your country is (1=not enforced or enforced erratically, 7=enforced consistently and fairly)

16. Quality of Enforcement vs. Growth 10 5 GDP growth CHL DOM CRI PAN COL 0 MEX PAR GTM BRA ECU PER SLV ARG UGY JAM VEN -5 -1.5 -1 -.5 0 .5 1 Quality of Enforcement Controlling for GDP per capita. Significant at the 10% level

17. The Policymaking Process (PMP) • Within our framework, the PMP takes center stage. A lot of effort is spent in each of the papers characterizing the PMP: • Which are the key actors that participate in it? • What powers and roles do these actors have? • What preferences, incentives and capabilities do these actors bring to the table? • What are the characteristics of the arenas in which they interact? • How frequent are these interactions? • What is the nature of the transactions they engage in? • We believe that certain key characteristics of the PMP play an important role in determining some important features of policy outcomes (link PMP  PO) • In turn, the workings of the PMP can be traced back to political institutions (link PI  PMP)

18. The framework FUNCTIONING OF POLITICAL INSTITUTIONS (rules of policymaking game) X General Equilibrium Interactions POLICY- MAKING GAME XxZ→Y (features of) PUBLIC POLICIES Y BASIC INSTITUTIONS & HISTORY features of specific policy issues Z

19. The framework FUNCTIONING OF POLITICAL INSTITUTIONS (rules of policymaking game) X General Equilibrium Interactions POLICY- MAKING GAME XxZ→Y (features of) PUBLIC POLICIES Y BASIC INSTITUTIONS & HISTORY features of specific policy issues Z

20. PMP  Policy Outcomes • We view public policies as the outcome of intertemporal political transactions among political actors. • Key insight: important features of public policies depend crucially on the ability of political actors to achieve cooperative outcomes – that is, their ability to strike and enforce intertemporal political agreements. • In political environments that facilitate such deals, public policies will tend to be of higher quality, less sensitive to the realization of political shocks, and at the same time more adaptable to changing economic conditions. • In environments that hinder cooperation, policies will be of lower quality, either too unstable (subject to political swings) or too inflexible (unable to adapt to socioeconomic shocks), poorly coordinated, etc. • Key question: what determines cooperation?

21. What determines cooperation? • Number of actors with substantial impact on the policymaking game (related to number of veto players). • Discount rate of actors (related to their tenure in office). • Frequency of their interactions. • Extent of convergence or divergence of preferences. • Availability of credible enforcement technologies (such as an independent judiciary, or a strong bureaucracy to which certain public policies can be delegated). • Link between PMP and characteristics of public policies modeled by Spiller and Tommasi (2003)

22. ST Model: Games of political cooperation • Motivation for the link between PMP and outer features of PP • Imagine set of political actors making collective decisions • Players have a common interest in having policy respond to economic shocks, but there is conflict due to different preferences (or distributive nature of politics). • Random political shocks shift the relative power of the players. • The political game starts with period in which players can reach some agreements regarding the way in which they will restrict their actions in the future. • The set of feasible agreements that can be reached will depend on the institutional environment (for example, on observability of moves, verifiability of states of nature, availability of enforcement technologies).

23. ST Model: Games of political cooperation • First best policies: those that would be agreed upon in a complete contract before the world starts running -- or equivalently, those that would be chosen by social planner. • Spiller and Tommasi show that optimal policies are invariant to the realization of political shocks (i.e., do not depend on the party in power) but contingent on economic shocks. • If political actors are patient enough, optimal policies can emerge as a Nash equilibrium of the infinitely repeated game. • But if their discount rate is high enough, full cooperation will not be achieved and policies will depend on the realization of the political shock. • The existence of credible enforcement technologies (such as an independent court) which bound the players to their agreements may contribute to generate cooperative outcomes.

24. ST Model: Games of political cooperation • If there is third-party enforcement, but economic shocks are not verifiable, it may not be possible to enforce state-contingent rules. Simple rules may be agreed upon, but these will imply inflexible policies, where actors tie their opponents and their own hands in order to prevent political opportunism. • When discount rates are high, and enforcement of intertemporal political agreements is relatively weak, we may observe highly volatile policies, or highly inflexible policies.

25. q Y * ( ) ˆ d q m Y ( , ) first best Y Games of political cooperation: summary • First best function of economic shock (θ) but not political shock (μ) • Attained for low discount rate (large δ). • Non-cooperative equilibrium policies depend on μ (as well as θ). • Actors might impose rigid rules to prevent political opportunism. • Result: In “bad transactions environments”, some policies are too volatile, others too rigid. • Simple extensions: bad transaction environments also lead to lack of coordination, and to inability to pass welfare improving reforms.

26. Why focus on outer features? • Common features of policies such as stability or volatility are more naturally linked to the institutional environment than the content of policies. • For example, in an institutional environment that makes cooperation difficult, the content of policies may shift frequently with the realization of the political shock, while the institutional environment remains the same (for example, trade policy may shift from closed to open, to closed again, depending on the preferences of the party in power). • Features such as stability or adaptability, however, will remain the same. • Focus on outer features also allows comparability across policy issues, which would not be possible with the contents of policies.

27. The framework FUNCTIONING OF POLITICAL INSTITUTIONS (rules of policymaking game) X General Equilibrium Interactions POLICY- MAKING GAME XxZ→Y (features of) PUBLIC POLICIES Y BASIC INSTITUTIONS & HISTORY features of specific policy issues Z

28. Policy outcomes may differ across issues • Different policy issues may differ in their transaction characteristics. • Some (such as social security) may be more demanding than others in terms of the enforcement of intertemporal deals. • Some may have special outside enforcement mechanisms (such as international trade agreements for the case of trade policy). • They may involve key specific actors (such as the Central Bank for monetary policy, or the teachers union for education) • They may be played in different arenas. • They may differ on the degree of divergence of preferences. • These differences across issues is being exploited in several of the country studies • Uruguay, Brazil, Chile, Colombia

29. Characterizing countries’ PMP • How did authors go about characterizing their PMPs? • By combining first hand knowledge of key policy actors and their interactions with secondary sources and, in some cases, with new empirical work. Examples: • In Brazil, the team discusses in detail several episodes in which the supreme court ruled against the executive on issues of vital importance, and present evidence from a previous study (Castro, 1997) examining more than 1200 judgments by the Supreme Court in 1997, in order to back up their claim that the SC was independent. • In Colombia and Paraguay, the authors illustrate their claims about the changing role of the legislature in the PMP by carrying out empirical analysis of legislative activity in the different periods they consider. • In Brazil, authors present empirical evidence about the connection between votes for the government in Congress and the appropriation of legislator’s budget amendments on the part of the executive, providing support for their story that the key exchange is one of pork for support. • In Ecuador, team provides detailed account of the mechanics with which the government forms coalitions, the currencies used, etc.

30. The framework FUNCTIONING OF POLITICAL INSTITUTIONS (rules of policymaking game) X General Equilibrium Interactions POLICY- MAKING GAME XxZ→Y (features of) PUBLIC POLICIES Y BASIC INSTITUTIONS & HISTORY features of specific policy issues Z

31. PI  PMP • In turn, key aspects of the PMP are determined (among other things) by the nature of the political institutions. • For example, the number of actors, as well as their preferences, may be shaped by the nature of the electoral rules, which affect the configuration of the legislature. • Constitutional rules (such as agenda setting power of the president) may affect the interaction between the relevant actors. • Once again, authors were encouraged to combine their own knowledge with secondary sources, the extant literature (for example, suggesting that certain electoral rules lead to certain incentives for legislators) as well as international comparative data on political institutions.

32. Tenure of Supreme Court Justices

33. Legislative Powers of Latin American Presidents Budgetary powers Package Partial veto Decree Exclusive Convoke Power to Result of no Total veto powers initiative referenda / define legislative plebiscite action Argentina 2 2 1 0 1 0 1 7 Bolivia 2 0 0 1 0 0 2 5 Brazil 1 1 4 2 0 2 1 11 Chile 2 2 1 2 0 3 2 12 Colombia 1 1 2 2 0 3 2 11 Costa Rica 1,5 0 0 0 0 1 0 2,5 Dominican Rep. 2,5 2,5 0 0 0 2 1 8 Ecuador 3 2,5 1 1 2 3 2 14,5 El Salvador 2,5 0 0 0 0 3 1 6,5 Guatemala 2,5 0 1 0 2 0 1 6,5 Honduras 1,5 0 1 0 0 0 0 2,5 Mexico 2 0 0,5 0 0 0 0 2,5 Nicaragua 1 1 0 0 2 2 2 8 Panama 2,5 2,5 0,5 1 0 2 2 10,5 Paraguay 1 1 0 0 0 0 1 3 Peru 1 1 2 1 3 3 2 13 Uruguay 1 1 0,5 1 0 2 1 6,5 Venezuela 0,5 0,5 1 0 2 2 1 7 Average 1,7 1 0,9 0,6 0,7 1,6 1,2 7,6

34. Variation across time • Several of the studies exploit variation across time in political institutions • Colombia, before and after 1991 Constitution • Venezuela, before and after election of governors • Paraguay, during the Stroessner dictatorship, and thereafter • Mexico, during the PRI hegemony, and thereafter • Not all changes are alike. Some more fundamental than others.

35. Example: Colombia • Exploits variation across time, focusing on two periods: • Frente Nacional (1958-1974), with many features extending into the late 1980s. Agreement between the two traditional parties (Liberal and Conservador) to share power, with parties alternating in the presidency, and strict parity in key policymaking arenas, such as Congress, the cabinet, courts, governors and majors. • 1991 Constitution and beyond • Exploits variation across policy areas • Fiscal policies • Monetary and exchange rate policies

36. Colombia: 1991 Constitution • In general, the Constitution reduced the power of the executive through different channels • Constitutionalization of some policy issues, such as pensions, transfers to local governments, etc. • Gave a more active role to Congress • Restricted decree powers of the president • Augmented capacity of Congress to override presidential veto • Lowered party discipline through ballot and campaign finance reform • Gave a more active role to the judiciary • Created Constitutional Court, much more active and independent • At the same time, introduced Central Bank independence • Changes in the key actors differ according to the policy domain, and this is exploited by the authors in their research

37. Colombia: The PMP before 1991 • Rules of political game constrained role of Congress in economic policy and enhanced the decision-making capacity of the government. • Frente Nacional coalition (sustained through cabinet and governorship appointments) ensured ample majorities. • Finance minister (typically a technocrat) had very large power. Liberals and conservatives would rather have a technocrat occupy this ministry than a potential rival. • Legislators got their pork (in the form of auxilios parlamentarios) and got out of the way of economic policymaking • All in all, small number of players with long time horizons that interacted repeatedly generated cooperative policymaking environment that produced stable and adaptable policies

38. Colombia: The PMP after 1991 • Significant aspect of economic policy get written into the constitution, and thus become more difficult to change. • Congress increasingly involved in policy discussion, introducing significant changes to legislation proposed by executive. Passing legislation becomes more costly as a result of increased fragmentation and reduction in party discipline. • By-passing Congressional discussion through the use of decree powers is severely curtailed by the Constitution, under the review of the Constitutional Court. • Even after enactment by Congress, the CC becomes a key player (on occasions a veto player) in the economic policymaking game. • Through CBI, Central bank board becomes a prominent actor, restricting the role of the executive in monetary and exchange rate policy

39. Colombia: Fiscal Outlook

40. Colombia: Fiscal Outlook

41. Colombia: Annual inflation Source: Banco de la República

42. Stage 2 of the agenda (IPES 2006)The cast of characters • Political parties and party systems • The legislature (and the legislators) • The president • The cabinet • The bureaucracy • The judiciary • Regional authorities (their role in the national PMP) • Business interests • The media • In each case, we look at their role in the PMP across countries, taking into account relevant interactions with other actors

43. Stage 2 of the agenda (IPES 2006)The PMP in action • Tax reform / tax policy • Budget Institutions • Privatization / Regulation • Social Protection • Health • Education • Decentralization

44. Need for GE approach: an example (Brazil) • Strong presidential powers, include capacity to impound budgetary amendments. But… • Congress highly fragmented. President needs to rely on coalitions to pass his agenda. • Legislators elected with open lists system, need to deliver pork to seek reelection. They add amendments to the budget bill, involving programs that benefit their jurisdiction. • Since the president can discretionally impound budget allocations, he holds key for the legislators to deliver the pork. • Thus, key exchange in Brazil is (little) pork for support • Reform is under discussion that would eliminate the discretion of the president in cutting the budget. • Our approach suggests that this may seriously compromise the ability of the president to pass legislation. • Ski boots and knees

45. Political Institutions, Policymaking Processes and Policy Outcomes:A Political Transactions Framework Pablo Spiller Ernesto Stein Mariano Tommasi