Elections, Special Interests and the Fiscal Costs of Financial Crisis

Abstract

Keefer proposes a new approach to explain why the costs of crisis are greater in some countries than in others. He begins with the premise that many crises result from the willingness of politicians to cater to special interests at the expense of broad social interests. A parsimonious model predicts that the less costly it is for average citizens to expel politicians, the more veto players there are; the less important are exogenous shocks, and the more difficult it is for politicians and special interests to forge credible agreements, the lower the costs of crisis are. Though these predictions differ from those in the literature, empirical evidence presented shows that they explain the fiscal costs of financial crisis, even after controlling for the financial sector policies believed to contribute most to the efficient prevention and resolution of financial crisis.

This paper - a product of the Growth and Investment Team, Development Research Group - is part of a larger effort in the group to understand the political economy of good policy.

Keywords: Special interests, crisis, financial crisis, elections, veto players, political instability

JEL Classification: D72, G21, G28, O10