Essays in Political Economy: Incentive and Efficiency Implications of Institutional Rules in Three Political Settings

Abstract

This collection of essays employs techniques in dynamic game theory to study applied questions in political economy and associated fields. In each essay, I investigate the consequences and efficiency implications of the various rules, structures and biases associated with a given political institution. The first essay studies rule making by common law courts that are bound by the doctrine of stare decisis. The court is imperfectly informed about the ideal legal rule but can learn about it through the cases it hears. Since agents are rationally responsive to the court's decisions, the court's learning is limited by its ability to make experimentation incentive compatible. The model provides a systematic explanation for why courts write narrow rules in some cases, but broad rules in others. The constrained court will never perfectly discover the ideal rule, and so the common law will entrench inefficient rules with positive probability. The second essay studies the properties of fiscal policies that are the consequence of political competition when voters exhibit a projection bias, whereby agents are unduly optimistic during booms (about the boom's persistence) and unduly pessimistic during recessions. In this environment, I show that the equilibrium fiscal policy will feature taxes that are inefficiently volatile and debt that ceases to efficiently smooth the deadweight cost of taxes through time. This mechanism explains both the public's complacency towards rising debt during booms, when debt should ideally fall, and the public's significant debt aversion during recessions, when debt should ideally increase. An implication for public policy is that the government should implement mechanisms - such as strongly progressive tax codes - that amplify deficits during recessions and amplify surpluses during booms. The third essay studies the nature of optimal coalitions in bicameral legislatures when the preferences of certain agents in the two chambers are correlated. Contrary to the received wisdom, I show that it is possible for bicameralism to privilege large states, by skewing the composition of the coalitions that will optimally form in equilibrium.