Politics give you Gas

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A recent working paper from the IMF- Political Price Cycles in Regulated Industries: Theory and Evidence. Here’s the conclusion;

“This paper presented a model of industry regulation where information asymmetries and the government-regulator’s interest in being re-elected may generate a political cycle in the regulated price. Quarterly data covering 32 countries during 1978–2004 provided strong evidence of the occurrence of a political cycle in gasoline prices.

Our model characterizes the behavior of the government-regulator as an attempt to maximize an objective function comprised of the social welfare in the regulated market and the government’s chance of being reelected. The social welfare function follows a stochastic process in which the weights attributed to consumers’ utility and firms’ profits are determined by a shock at the beginning of an election period. This shock may reflect changing political alliances or economic conditions exogenous to the regulated market. Because this shock is not immediately observable to consumer-voters, the incumbent government-regulator may have incentives to set a price below the welfare-maximizing price to signal its pro-consumer nature and thus attract more votes in the upcoming election. In fact, our model derives equilibrium regulation strategies in which some types of government-regulator will lower the regulated price in an election period, thus generating a political price cycle in the regulated industry.

We tested the implications of our model for the gasoline market in the 32 industrial and developing countries for which data were available. The choice of the gasoline market is justified by the impact it has on consumers’ utility, the visibility that fluctuations in gasoline prices have, and the various ways—besides direct price determination—through which governments can influence domestic gasoline prices. Simple statistical analysis revealed that changes in gasoline prices were, on average, 1.4 percent above changes in domestic oil costs during “normal” quarters and 0.4 percent below during periods immediately preceding an election. Focusing on real gasoline prices alone, we observed that they declined 0.3 percent, on average, during “normal” quarters and about 0.7 percent during quarters of electoral campaign. Moreover, in 15 countries of the sample, this difference exceeded 2 percentage points, whereas it exceeded 6 percentage points in seven countries.

Econometric modeling also point toward the existence of a political cycle in gasoline prices. Simple equations linking gasoline prices to changes in the cost of oil to domestic gasoline producers (which is assumed to be driven by international oil prices and the exchange rate) and dummy variables indicating periods of electoral activity were estimated using panel data techniques. Our estimates consistently yielded negative and significant coefficients on the electoral dummy variable, suggesting that after controlling for cost changes, gasoline prices are reduced during periods of electoral activity. In fact, point estimates suggest that the real price of gasoline declines by at least 0.8 percent and up to 1 percent, on average, during each of the two quarters of election campaign in the 32 countries covered by our sample, a relatively sharp decline compared to the average reduction of 0.3 percent in the entire sample period. These results were robust across various model specifications. Since we do not expect the occurrence of political price cycles in all countries at all times, it is reasonable to assume that the decline in real gasoline prices would be significantly more pronounced in the countries where a cycle is in fact observed.

1 Comment

Interesting concept there at the end. I could think of a lot of problems with the paper, but I don't have time to read it. The first thing I would check to see if this correlated with political business cycles. They may have found something that is just coincident with that.


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This page contains a single entry by Paul published on November 27, 2006 3:08 PM.

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