HOHENHEIMER DISKUSSIONSBEITRÄGE Are Less Constrained Governments Really More Successful in Executing Market-oriented Policy Changes von Hans Pitlik Nr. 255/2005 Institut für Volkswirtschaftslehre (520) Universität Hohenheim, 70593 Stuttgart ISSN 0930-8334
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HOHENHEIMER
DISKUSSIONSBEITRÄGE
Are Less Constrained Governments Really More Successful in Executing
Market-oriented Policy Changes
von
Hans Pitlik
Nr. 255/2005
Institut für Volkswirtschaftslehre (520)
Universität Hohenheim, 70593 Stuttgart
ISSN 0930-8334
Are Less Constrained Governments Really More
Successful in Executing Market-oriented Policy
Changes?
Hans Pitlik* University of Hohenheim, Department of Economics 520D
It is commonly suspected that market-oriented reforms require a centralized and autonomous
government. According to this view, institutional constraints on a government weaken
decisiveness of state action and constitute a major obstacle to policy reform. However, this
line of reasoning neglects the importance of government credibility for implementation and
consolidation of policy reforms. Lack of credibility causes higher economic and political costs
of reform and reduces incentives of governments to undertake risky policy changes. Contrary
to conventional wisdom, more veto gates may at the same time increase both government
credibility and decisiveness, and may therefore be conducive to reform. This alternative view
of the role of institutional constraints is supported by empirical evidence.
JEL classification: D78, P11, P21
Keywords: democracy, market-oriented reform, political credibility, veto players
* The author is especially indebted to Friedrich Heinemann, Sebastian Moll, Jörg Naeve, and the participants and discussants at DISS.KURS at the University of Hohenheim and at the ZEW Seminar, Mannheim.
F 25.72 25.82 25.90 25.95 24.22 24.44 Note: Period dummies and constant included, but not reported. P-values in parentheses are based on robust standard errors.
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The behavior of the several indicators of executive restrictions is as expected, as they show
positive signs in all specifications. The democracy indicator polity (columns (1) and (2)) is
however only significant if it is controlled for the average number of government changes
govchg. This indicates that democracy is only good for reform if government is reasonable
stable. This is in line with theoretical assertions on the effects of policy credibility on
economic reforms. These results are fully confirmed using an alternative indicator of political
liberties from Freedom House (2002) (results not reported). The Henisz-indicator of executive
restrictions polconv, shown in columns (3) and (4), is always positively related to
liberalization at a 1 per cent level of significance.3 A third indicator of executive restrictions,
checks, is statistically significant only when it is controlled for govchg, too. Yet, this effect
depends on inclusion of secenrol. If secenrol is eliminated from the set of regressors, checks
also becomes significantly associated with lib in all specifications.4
The indicator of government stability govchg shows the expected highly significant
negative correlation with lib in all specifications. If on average a country's executive is
dismissed once a year, reform effort lib is reduced by 0.8 efw-points. This may yet also be a
result of reverse causation. Thus, all specifications have been re-estimated by employing the
political variables lagged one period. With respect to the several indicators for executive
constraints, the results are fully confirmed with this alternative specifications. However,
lagged govchg completely loses significance. Thus, obtained results may be caused by a
reverse causality. Yet, it may also be the case that only a current executive instability reduces
credibility of reform policies. In the next sub-section, endogeneity is addressed by an
instrumental variable estimator.
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4.3.2 Arellano and Bond-estimator
Table 2 shows results for the One Step-Arellano and Bond-estimator. As can be seen, first
differencing and instrumenting causes a significant loss of observations. Tests for over-
identification and for (absent) second-order autocorrelation show validity of specifications.
AR (2) (P-Value) (0.655) (0.357) (0.680) (0.535) (0.651) (0.429) Note: Period dummies and constant included, but not reported. P-values in parentheses are based on robust standard errors. Results of Sargan-Test are from a Two Step-Estimator. All explanatory variables are treated as endogenous.
Throughout all models, initial efw-values are again significantly related to lib. Coefficients
however drop from about –0.6 to about –0.35 in first difference estimations. The behavior of
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all controls and all explanatory political variables is almost similar to the within-estimates.
Neither growth, nor open and secenrol seem to be related to lib. All equations, except for (1),
show a highly significant positive relation between the respective indicators of executive
constraints and the dependent variable. Results for polconv are particularly impressing.
According to estimates (3) and (4), increasing political constraints from 0, which is a typical
value for many lower developed countries, to 0.9 (the common value for Belgium) leads to a
higher liberalization intensity of about 1 point. In two out of three specifications govchg is
negatively related to lib at a 1 per cent-level of significance. In model (4), the P-value is
slightly reduced to 0.13. Thus, even for govchg there is not too much evidence that previous
results from a within-estimator are mainly caused by endogeneity.
4.3.3 Pooled OLS-estimator
Results for a simple pooled OLS-estimator are shown in table 3. In contrast to previous
regressions country dummies are not included here in order to emphasize cross sectional
variation. P-Values reported are based on clustered standard errors, i.e., it is assumed that
observations are independent across countries but not necessarily independent within groups.5
It should be noted first that outcomes in principle confirm results obtained above, where
unit fixed effects were included. Except for lagged growth, coefficients of all variables show
expected signs and are significant at least at a 10 per cent confidence level. The entire set of
covariates indicating restrictions on the executive shows a behavior similar to fixed effects
regressions, though coefficients are generally smaller. Government instability govchg again is
negatively related to economic liberalization lib. Once more, bad inflation performance in the
preceding period leads to higher reform efforts in the current period.
With respect to international trade openness open and to the education-variable secenrol
the level-effects suppressing consequences of including country dummies are seen most
clearly. Both open and secenrol are now highly significant with the expected positive signs. In
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a cross-country dimension more open economies and economies with a better educated people
observe more intense economic policy reforms, ceteris paribus. In both cases level effects
seem to have been hidden by unit specific effects.
Table 3: Results of Pooled OLS-estimator, no unit fixed effects
F 17.32 15.73 15.81 14.71 15.07 13.92 Note: Period dummies and constant included, but not reported. No country dummies included. P-values in parentheses are based on clustered standard errors.
5 Conclusion
Economic policy reform is a conflict-ridden political process. Beneficial policies for society
as a whole are often not implemented due to a fierce opposition from politically powerful
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prospective losers of reforms. Thus, it is commonly suspected that the introduction of market-
oriented reforms requires a strong and autonomous government. Institutional restrictions on
the executive appear to weaken decisiveness of state action and constitute a major obstacle to
change. Empirical investigations however often find no evidence supporting the hypothesis of
a superiority of unconstrained governments in executing reforms, so far.
The present paper has reviewed shortly some important contributions to Political
Economy of Reform and attempted at a re-interpretation in the light of credibility problems.
Seen from this view, resistance to beneficial reforms often stems from a lack of government
credibility to keep compensation promises and to not withdraw from a policy change. As
credibility is increasing in the number of procedural restrictions (democracy) and political
veto players, there may be a trade off between decisiveness and resoluteness of a polity.
Moreover, standard theory also disregards that conflict over reform cannot be 'solved' by
unilateral action of an unconstrained executive. In political systems which require a consent
of societal groups for a policy change, distributional conflict is necessarily settled by
negotiations when it comes to an agreement. In an inter-temporal perspective, checks and
balances reduce the risk of an open-ended political dispute and may thereby increase
decisiveness of governmental action.
In the final part of the paper previous empirical results have been put to the test. Two
major problems that have not yet been addressed are (1) that an endogeneity bias due to a
dynamic model specification may determine results, and (2) that the use of a model
specification with country unit effects may eliminate too much cross sectional variation in the
data, especially in the case of almost time invariant political variables. As no method qualifies
as the single best way to estimate the effects of political structures on observed behavior, to
increase confidence in results one might be best advised to compare results from different
estimation techniques as a second best-solution. Doing this, ample evidence has been found in
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favor of the hypothesis that more constrained governments are also more successful in
executing market-oriented policy changes.
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Appendix: Summary statistics
Variable Obs Mean Std. Dev. Min Max
checks 594 0.820 0.635 0 2.625
efw 605 5.362 1.396 1.68 9.03
govchg 541 0.175 0.165 0 0.800
growth 534 0.032 0.035 -0.141 0.146
inflation 584 0.175 0.330 -0.120 3.437
lib 605 0.250 0.664 -2.32 2.65
open 598 0.666 0.479 0.037 3.803
polconv 578 0.384 0.333 0 0.893
polity 573 0.614 0.370 0 1
secenrol 583 0.414 0.205 0.022 0.860
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Appendix: Correlation matrix (P-Values in parentheses)
lib efw polity polconv checks govchg inflation growth open