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CURVE IN THE RIGHT PLACE
- Sweetening the budget before the polls may have less sweet results

The media and the opposition may have good reasons to reproach the Bharatiya Janata Party for its pre-poll populist measures, but the truth of the matter is that all incumbent governments tend to sweeten their budgets before elections. Perhaps the BJP overdid things a bit. The real question, however, is not about the extent of populism, which in any case is expected to vary from party to party, but as to why populism should work at all or why political parties should think it would.

Havenít the voters been repeatedly observing that tax breaks announced before the elections are often withdrawn after the polls' Havenít they experienced time and again that pre-poll sweeteners added to economic policies are only temporary' Donít they know that pre-poll concessions and spending sprees are usually followed by post poll rises in inflation rates' Why are they systematically fooled by pre-election populism then' Is it because they are a bunch of myopic morons incapable of learning from experience'

On the other hand, if we assume that voters on an average are reasonably intelligent and far-sighted, the pre-poll extravaganza is not likely to influence them. But if that is so, why do incumbent governments and political parties spend tons of money on populist measures, advertisements, gimmicks and tax breaks' This is indeed a puzzle and we shall try to resolve it in due time.

By no means is the phenomenon of pre-poll populism exclusively Indian, neither is it confined to less-developed countries alone. In election years, governments of mature democracies like the United States of America, Canada and western Europe as well as those of emerging democracies like the erstwhile Soviet bloc countries have been observed to be engaged in a consumption binge. As an essential part of election campaigns, taxes are cut, transfers are raised and government spending is distorted towards projects with high immediate visibility. The practice gives rise to budget cycles: recklessly expansionary fiscal policies before elections followed by careful contractionary measures after the polls. The budget cycles, in turn, lead to cycles in economic activities, cycles that are basically driven by politics.

Business cycles are certainly one of the greyer areas of economic science: in general, no one really knows why they occur or can predict when and how they will be generated. But here is one kind of cycle, the political cycle, which exhibits a fair amount of empirical regularity. The earliest attempt to point to this empirical regularity and to provide a theoretical explanation of this phenomenon was made by William Nordhaus of Yale University in 1975. He exploited the well-known Phillips Curve to establish a link between budget cycles and business cycles.

The Phillips Curve postulates that there is a trade-off, an inverse relationship, between the rate of inflation and the rate of unemployment. It is essentially a short-run relationship. The government can temporarily boost demand in the economy by pumping in more money. As the government finances its increased expenditure in the pre-election spending season by printing additional money, demand for goods and services tend to go up. Firms increase output and employment and as a result, the rate of unemployment in the economy goes down. The increase in money supply tends to increase the rate of inflation as well. Gradually, however, the price increase eats into the profit of the firms by increasing the cost of production, especially money wages. This leads to a contraction of output, which is reinforced by a contractionary policy adopted by the government in the post-election scenario. The cycle is thus complete.

The above account of business cycles, arising out of politically motivated budget cycles, crucially hinges on voter myopia. If voters are naïve and ignorant, they would associate pre-election booms directly with the efficiency level of the incumbent government and cast their votes accordingly. Knowing this, the incumbent government would have a strong incentive to adopt expansionary policies before the polls. The story runs into a logical problem if elections and budget cycles are perfectly anticipated events and if voters are non-myopic. One could still generate cycles: if the voters know with certainty that taxes are going to be raised in the future, they would, as rational consumers, complete their purchases, to the extent possible, in the current period. This would stimulate the economy at present through an increase in current demand.

At the same time, consumption in the post-election period would fall due to a perfectly anticipated rise in taxes leading to a downturn. The problem is that the voters have no reason to prefer this fluctuating economic scenario to a smooth one. Indeed, in most cases they would clearly prefer a smoothly functioning economy without ups and downs. If, in addition, they know from experience that the fluctuations are deliberately caused by government policy, they would certainly like to punish the government in office. Of course, anticipating all this, the incumbent government will not even try its pre-election gimmicks to impress the voters. As a result, no budget cycle or political business cycle will ever be observed.

The sizeable literature that followed the work of Nordhaus has mentioned this logical problem. Attempts were also made to explain budget cycles in a world where both voters and politicians are rational and non-myopic. It was argued that budget cycles occur because incumbent governments can credibly signal their strength and efficiency levels through pre-poll concessions in an environment of incomplete information. This signalling is more sophisticated than the naïve signalling mentioned above.

Now, if there are pre-poll concessions, the government, in order to balance its inter-temporal budget, has to take tough measures in future. These measures are painful not only for the voters but for the government as well, because no government wants to take unpopular measures if it can be helped.

But a more efficient government needs to take fewer tough measures, for it can generate its future funds more efficiently with relatively less pain. Hence it can afford to give more pre-poll concessions and, indeed, will choose to do so in order to signal its efficiency and strength. If we accept this argument then we must also concede that through its pre-poll machination, the BJP is actually revealing its efficiency and the whole manoeuvre is doing a lot of good to the country by signalling the citizens to make the right choice. The question is, are we to buy the argument'

The argument is based on state-of-the-art game theory and stretches the notion of votersí rationality to its logical extreme. Such over-stretched rationality is always a suspect. But more important, why do voters need to learn about the incumbent through pre-poll manoeuvres alone' A much better way is to learn uniformly through the five-year rule of the government in office.

In our country, the real key to explaining pre-poll populism seems to be the fact that the electorate consists of a handful of informed voters and a large number of voters who are not irrational but hopelessly uninformed. Preelection concessions are always targeted towards the small groups, which are politically informed, vocal, powerful, and united. On the other hand, the post-poll austerity measures are distributed evenly over the entire population ó for example, through a rise in the rate of inflation. This means that the small groups emerge as net gainers, so much so that they do not mind supporting the incumbent government. Since they are powerful, they can also help to influence the uninformed majority. It therefore pays to please these influential groups before the polls.

Two simple conclusions emerge from our hypothesis. First, the present feel-good factors indicating an economic upswing may very well be the result of a political budget cycle. In particular, it is likely to be the result of last yearís liberal budget drafted with an eye towards the coming elections. Second, the pre-poll concessions doled out by the BJP may benefit a few at present, but is likely to hurt the majority in future. The already rising rate of inflation clearly points to such a possibility.

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