[Joshua Tucker: Continuing our series of collaborations with political science journals to bring you recently published research, we are pleased to welcome the following guest post from Princeton University political scientist Brandice Canes-Wrone on her recent article (co-authored with Jee-Kwang Park) "Elections, Uncertainty and Irreversible Investment" at the British Journal of Political Science. The article is available ungated here for the next six months.]
Some scholars and policy analysts contend that policy uncertainty has negatively affected recent economic activity, while others such as Paul Krugman label this argument a “phony fear factor.” A longstanding challenge in evaluating these and other arguments about policy uncertainty is disentangling cause and effect: A poor economy may cause policy uncertainty as well as potentially result from it. To get around this issue, our recent article focuses on a type of policy uncertainty that reoccurs regularly at predetermined times: namely, that associated with US elections. We propose that this electoral uncertainty produces a pre-election decline in costly-to-unload investments, particularly housing.
Scholars have labeled these sorts of costly-to-unload investments “irreversible.” Examples other than housing include automobiles or for businesses, private fixed capital. The incentives for delay exist because the electoral outcomes have significant implications for fiscal, regulatory, trade and other policies that influence the value of certain types of investments over others. For instance, if one political party favors opening up an area to the exploration and production of shale gas, and the other political party opposes this doing so, the election should affect the value of various investments in the area, including housing. Assuming that the costs of delaying such a costly-to-undo investment for a few months is not high, then one would expect a decline in the associated sector in the pre-election period. Moreover, because the incentive for delay derives from the policy uncertainty associated with the election, the pre-election decline should be related to the competitiveness of the race and the policy differences between the candidates.
Our paper tests these arguments with survey and housing market data from the United States, and we make use of the staggering of US gubernatorial elections across time and states to examine whether this variation is associated with change in state and local housing markets. The results suggest that a pre-election decline routinely occurs in the housing market. Moreover, as expected, this decline depends on the competitiveness of the race and the policy differences between the major parties. In fact, the housing market analysis suggests that a decline occurs only when the election is competitive, which is what we would expect if the decline is caused by the policy uncertainty associated with the election. Likewise, the survey analysis suggests that the likelihood of delaying costly-to-undo investments corresponds to respondents’ perceptions of the magnitude of the policy differences between the competitors. The results are thus consistent with arguments that policy uncertainty can have a substantial impact on economic outcomes. At the same time, it is important to highlight that the observed pre-election declines regard a particular type of costly-to-undo investment, and the finding is not necessarily applicable to the macroeconomy more broadly.
(The full article can be downloaded here.)