How Much Do Election Shakeups Affect the Nation’-s Economy? – [US politics &- financial markets] – by Justin Wolfers and Mark Thoma – 2006-11-03
[Justin Wolfers] And the major puzzle that I currently see? The past two years have clearly been terrible for Republicans, with Iraq deteriorating, Katrina undermining the public trust, and corruption scandals aplenty. And consequently their chances of keeping control of the House have fallen precipitously (Intrade.com charts here). But the real surprise? Prediction markets tell us that the odds of Republicans winning the White House in 2008 remain virtually unchanged. Neither the incumbency advantage coming from victory in the 2004 elections, nor the subsequent declines in Republican fortunes have shifted the odds (chart: here), and the 2008 Presidential election remains a coin flip. Stay tuned: It looks like Tuesday will be a long night. And when the counting ends, the two-year campaign for the White House begins.
My Take: Our good doctor Justin Wolfers takes his Democratic dreams for the reality (all that said in all due respect for this bright researcher). We’-re two years away from the November 2008 presidential election. The margin of error is still enormous, so today’-s market-generated probabilities (Dems: 48.6% – GOP: 48%) for the 2008 presidential race mean strictly nothing. Plus, at times, a US presidential candidate can get substantial votes from the other camp (e.g., Ronald Reagan seducing many Democratic voters, etc.).
Addendum: Mike Linksvayer has an interesting comment, attached below this blog post.
Addendum 2 (November 04): Professor Justin Wolfers has responded, in the comment area, below this blog post. (And his paper is excerpted here, on Midas Oracle.)
Chris, for once I completely agree with your commentary.
I only skimmed the Wolfers/Thoma conversation and haven’t read the papers referenced, but one thing missing from the exchange concerning GDP growth and presidential party is that causation may run in both directions, e.g., if people are more likely to vote for a party when growth is slowing, presumably it will appear that having that party in office is correlated with slower growth to a greater extent than having that party in office actually slows growth.
Of course this is #5 on Wolfers’ list of five open questions for prediction markets, but it has been bugging me. It seems that any interpretation like the above growth/party correlation or conditional PM prices need to carefully explain why causation runs primarily in the implied direction or come with a huge disclaimer.
A quick response to Chris:
Let me clarify what I think the key puzzle is: the odds of either Democrats or Republicans are – literally – unchanged since the week before the 2004 election. It seems amazing to me that there has been *no news* that is relevant to the 2008 election.
And I don’t really know which way it should have gone (I’m not yet calling ‘08 for the Dems). For instance, Bush winning in ‘04 provides the Republicans with an incumbency advantage. Countering that, the last two years have provided the Dems with an advantage in the midterms, which you might think could persist to ‘08. And the cast of possible candidates is also starting to take shape, and the absence of Warner, the rise of Barak, and the continuing dominance of both Hillary and McCain are all important factors that we didn’t know about two years ago. All of this is hard to reconcile with the odds remaining unchanged.
I response to Mike’s point: he is exactly correct to emphasize the difficulty in discerning the direction of causation between election outcomes and economic outcomes. But that is precisely the point of my forthcoming QJE paper with Snowberg and Zitzewitz (available at: http://bpp.wharton.upenn.edu/j…..ctions.pdf).
In that paper (which is what I describe in the WSJ), we look at stock market reactions to what are clearly random (or exogenous) shocks to the expectations of Bush’s re-election – the leaked exit polls, and the subsequent vote count. These experiments allow us to draw inferences about how changes in electoral prospects drive economic outcomes.
I see, thanks for the answer and reference. I missed Thoma’s mention of your paper and direction of causality when I first skimmed the WSJ conversation.
Would’ve been really nice if GDP markets were available.
That the 2008 presidential odds haven’t budged over 2 years is interesting, but perhaps not surprising if you keep in mind that…
* our two-party system is deeply entrenched and inherently symmetric
* the parties are more alike than different in the most important way: they are both organizational vehicles designed to help broad coalitions get power, and each can be very flexible with candidates and policies as necessary to win
* with a full 2 years to go, there’s plenty of time for the ‘median voter theorem’ process of crafting candidates to win the median ’swing’ voter to work
Until the election is a lot closer — and parties start to lock-in on issues of that future day — almost any exogenous info shock can be absorbed, by varying the future candidates/policies/spin/campaigning, restoring a highly-competitive expectation.
And of course the current market-implied odds mean more than “nothing”: if cocky partisans of either side offer significantly better odds, bet them and hedge for free money.