MIDTERM EXAM: Political Economy Winter 2013

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1 Name: MIDTERM EXAM: Political Economy Winter 2013 Student Number: You must always show your thinking to get full credit. You have one hour and twenty minutes to complete all questions.

2 This page is for your grade. Leave it blank please.

3 Question 1 Electoral Rules You will compare a single member electoral system (one seat for one district) under two different electoral rules. Assume four candidates (A,B,C,D) are running in a district. The first voting rule is first-past-the-post election, i.e. the candidate with the largest number of preferences wins. The second rule is single transferable vote. In this system voters rank all four candidates on the ballot in order of preference. If one of the four candidates reaches 50% of first preferences, he wins. If not, the last candidate in terms of first preferences, call her A, is eliminated and the preferences on her ballot are allocated to the other three candidates (so the second preferences to B on ballot that list A first go to B, the second preferences to C go to C, etc.). If a candidate reaches 50% of the first and second preferences she is elected, otherwise the last candidate is eliminated and his preferences reallocated, and so on. Explain what are the likely differences in electoral outcomes and political alignment of parties under FPTP and STV. Are winners under FPTP going to be likely coincide with STV ones? What is the role for party coalitions (assuming candidates come from four different parties)? Are there ways under STV for parties to form alliances across districts? How? [30 points].

4 Question 2 Modernization Hypothesis This is the argument according to which economic development (i.e. higher income levels per capita) causally determines the creation and consolidation of democratic institutions. Do you believe the hypothesis is true? Present empirical or anecdotal evidence in favor and/or against this hypothesis and discuss. [30 points]

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6 Question 3 Bargaining in legislatures over policy (Baron and Ferejohn, 1989) Consider a legislature of n (odd) members that deliberates with a simple majority rule. The goal is to share a cake, of value normalized to 1, across the members. Time is discrete and discounting happens at rate d < 1. At each time t a formateur i is randomly chosen (recognized) for deciding on how to split the cake. The proposal presented by i is indicated as x i = (x i 1, x i 2,, x i n) such that S n x i j 1 and we let x i j indicate the share accruing to j under i s proposal. Preferences of member j are given by u j (t, x i ) = d t x i j Notice that delay is costly in this setup because for given share of the pie waiting another period reduces the payoff by a factor d < 1. The proposal is voted upon immediately and it cannot be amended (a closed amendment rule). If i s proposal is approved by other (n-1)/2 members, it passes and payoffs realize. If the proposal fails, the period ends and the next time period starts anew (so another formateur is picked at random, a new proposal is presented and voted upon, and so on ). If no proposal is approved the status quo payoff is 0. We will focus on characterizing the stationary subgame perfect equilibria of this game. [20 points each answer] a) Suppose time is finite and the bargaining is at the last period T. Do you agree that the optimal strategy of formateur i is to set for (n-1)/2 members j i x i j = arbitrarily close to 0 and keep essentially the whole cake (of value 1) for himself? Why?

7 b) The recognition probability of every player is 1/n and the discount factor is d. What is the discounted continuation value v j for any j=1,,n at T-1? Consider that j could be the formateur, could be in the coalition but not the formateur, or j could be out.

8 c) Characterize the equilibrium of this game for T=2 based on your answer to points a) and b). Importantly, do specify the strategy of the formateur and that of the members at t=1.

9 d) A stationary equilibrium for infinite T will require that for j to accept the proposal x i j dv j Note that the present value of rejecting a proposal for member j must be equal to the continuation value of rejecting at the next period or v j = 1/n*[1- v j *(n-1)/2] + (n-1)/2n*[ v j ] Can you characterize the (stationary SPE) equilibrium of this game now? [Hint: as a formateur you have to make the other members in your minimum winning coalitions indifferent between accepting your proposal or rejecting and continue playing.]

10 Question 4 China s Demise? Please comment on this HuffPost.com entry by Daron Acemoglu and Jim Robinson in light of our discussion on institutions and China. With reference to our discussion in class, how strong is the link between property rights protection and economic development? How strong is the link between political rights protection, democracy, and economic development? Do you believe there is sufficient empirical evidence for Acemoglu and Robinson to seal the deal on their main hypothesis? [ ] According to the Economist magazine and the International Monetary Fund, China will overtake the U.S. as the largest economy in the world within the next decade. This outlook overstates China's potential for continued economic growth, however. Our research on national economies throughout world history shows that long-term economic growth, while indeed based on technological innovation, only sustains itself in the presence of democratic political institutions that provide people with incentives to innovate. China may continue to grow in the near term, but the limited rights it affords its citizens places major restrictions on the country's longer-term possibilities for prosperity. [ ]Chinese growth has not come simply by government fiat, but also because, starting with Deng's government, China has made changes allowing people -- from farmers to industrial leaders -- more incentives and autonomy to start using their land, capital, and talents. China can also export goods globally, unlike the Soviet Union during the Cold War; these larger markets may allow for more growth. China's growth may also be higher because it had even more technological catching up to do than the Soviets. Still, while China has implemented policies that seem radical compared to the ones it maintained in the mid-1970s, Chinese growth, like Soviet growth, has occurred under authoritarian political institutions. The country still lacks an independent judiciary and an independent media. Entrepreneurs have been jailed for dubious reasons -- not coincidentally when they went against businesses with stronger political backing. Many key economic decisions are still made by party elites who can change the CEOs of its largest companies on a whim. There will be limits on how much innovation such a system can generate, even if China keeps growing this decade. For all its changes, China still has what we term "extractive" political institutions, those that direct resources away from the people and toward the state and a small number of its elites. History is littered with states that have had some democratic or "inclusive" features, but remained essentially extractive: from ancient Rome to early-modern Venice to many authoritarian nations within the last century, these states have ultimately failed to deliver sustained growth. By their nature, extractive states are against the kind of innovation that leads to widespread prosperity: this kind of change threatens the hold on political and economic power that elites in such states fight to maintain. And fight they will: contra Steffens and others who have argued that some economic modernization leads to political reform, history shows this is not an inevitable pattern. Watching Xi and China's other senior leaders is important. However, the biggest questions about China's future growth do not involve its next economic investments, but rather, its political essence. Unless China fundamentally reforms its political institutions, a change that seems unlikely in the short term, a trajectory of economic growth followed by relative decline is more likely than a trajectory of long-term increasing prosperity [30 points]

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