Leaping into the Dark: A Model of Policy Gambles
57 Pages Posted: 20 Sep 2021 Last revised: 2 Dec 2022
Date Written: September 10, 2021
We examine why rational voters support risky ``policy gambles'' over a safe status quo, even when such policies are detrimental to welfare. In a model of electoral competition, investors finance domestic projects in exchange for a stake in future output, while voters receive the remaining output. Government policy influences the riskiness of projects' output. However, when investors invest, the incumbent cannot pre-commit to retain the status quo policy into the future. Instead, the policy is determined subsequently in an election where voters can increase their expected output by voting for policy gambles. Our analysis highlights how investors' self-fulfilling beliefs interact with the distribution of output in abandoning the status quo. We argue that institutions that foster political consensus can eliminate the gamble equilibrium and raise welfare.
Keywords: Policy uncertainty, electoral competition, multiple equilibria, political consensus
JEL Classification: D72, D78, P16
Suggested Citation: Suggested Citation