DP7834 | The Role of Political Partisanship during Economic Crises

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24/05/2010

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Abstract

Large economic crises require quick policy reactions. They bring a sense of urgency by increasing the cost of the status quo, and may thus force policy-makers to reform. However, large crises increase also uncertainty for many individuals (entrepreneurs, workers, retirees), and thus induce more demand for protection particularly in the labor and product markets. The ideology and political partisanship of the ruling government may contribute to determine which of these two orientations will prevail during crisis. In good times, conservative parties are typically pro-reform. However, do these parties try to exploit periods of crisis to carry on their reform? Do social-democratic parties support even more social protection? To answer these questions, this paper uses indicators of structural reforms in the labour, product, and financial markets for twenty-five OECD countries over the 1975-2008 period. Besides examining the role of major economic crises and of political partisanship in enhancing, or perhaps hindering, reforms, particular emphasis is given to how governments of different political orientation or strength react to economic crisis. The empirical analysis shows that large economic crises promote liberalization in product markets, but lead to more regulation in financial markets. Partisan politics matters in product and labor markets, as right parties are associated with more product market liberalization and privatization, with less rigid labor markets, and less generous welfare states. However, partisan politics takes different patterns during crisis: right parties refrain from promoting product market privatizations, but also from introduce more financial market regulations. By contrast, left parties are willing to privatize during crisis. Furthermore, weak, fractionalized governments are associated with more regulated product markets, but are more likely to liberalize during crisis.