## sdnea19008

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### EXECUTIVE SUMMARY
- Context: Persistent, weak medium-term growth and limited fiscal space have shifted policy agendas toward structural reforms.
- Objective: Examine whether political costs from structural reforms are borne out by evidence and derive lessons on reform design to mitigate political costs.
- Data innovation: New structural reform database covering 90 countries during 1973–2014 combined with a new electoral data set.
- Core empirical findings:
  - Reforms do not lead to electoral costs when implemented in ways that internalize political-economy considerations.
  - Electoral costs are significant only when reforms are implemented in the year prior to an election.
  - Reforms in weak economic activity periods tend to have political costs; reforms in good times have benign or positive electoral consequences.
  - Some reform types—particularly certain financial deregulation measures and external capital account liberalization under some conditions—can have sizable short-term adverse distributional effects and be electorally costly.
- High-level policy implications:
  - Implement reforms early in the political term (political “honeymoon”).
  - Implement reforms when economic conditions are favorable; during recessions provide macro policy support.
  - Address distributional effects upfront (fiscal incentives, job search assistance, retraining, stronger social safety nets).
  - Ensure credible political commitment, strong ownership, and enhanced dialogue with business and civil society.

### DATA AND EMPIRICAL APPROACH
- Structural reform data set:
  - Coverage: 90 countries during 1973–2014.
  - Country composition: 29 advanced economies, 50 emerging market economies, and 21 low-income countries.
  - Sample represents 96 percent of the world’s 2017 nominal GDP.
  - Sectors: domestic finance, financial current account, capital account, trade (tariffs), product markets (telecommunication and electricity), labor market regulation (EPL).
  - Indicators scaled between 0 and 1; higher values denote greater liberalization.
  - Data set documents implementation dates of major reforms.
- Sectoral indicator details:
  - Domestic finance: interest rate controls, entry barriers, privatization, supervision and regulation, securities markets, credit controls.
  - Current and capital accounts: restrictions on external payments and receipts; components include FDI, portfolio, bonds and other debt securities, money market instruments, financial credits.
  - Trade: product-level tariffs aggregated with simple and weighted averages (weights = export share).
  - Product markets: privatization, entry barriers, supervision and regulation in telecommunication and electricity.
  - Labor market indicator: EPL for termination of full-time indefinite contracts in a typical firm of 250 workers; dimensions: procedural requirement, firing costs, valid grounds for dismissal, redress measures.
- Electoral data set:
  - Contains election date, incumbent leader and party affiliation, new leader and party affiliation, date incumbent took office, vote share of each party in coalition at current, last, and second-last elections.
  - Additional variables: political system type (presidential vs. parliamentarian), electoral system (majoritarian vs. proportional), number of parties in coalition, ideology of government (right, center, left).

### STYLIZED FACTS ON REFORM PROGRESS
- Temporal and sectoral patterns:
  - Broad tendency toward liberalization since the late 1980s; pace declined since the global financial crisis with modest reversals in some countries.
  - Reform frequency uneven: domestic finance, trade, capital and current accounts saw more frequent reforms than product and labor markets.
  - Timing of major liberalization pushes:
    - Trade: concentrated in the 1970s and 1980s.
    - Domestic and external finance: early 1990s.
    - Product markets: late 1990s.
  - Labor market regulation (EPL): no deregulation trend; tightening in recent years.
- Cross-country and regional patterns:
  - Advanced economies more liberalized than emerging markets, which are more liberalized than low-income countries.
  - Emerging markets and low-income countries had similar liberalization levels until the 1990s; since then emerging markets progressed more strongly (except for EPL).
  - Reform progress strongest in Europe; modest in the Middle East, Central Asia, and sub-Saharan Africa.

### KEY EMPIRICAL RESULTS
- Average effects:
  - On average, reforms are associated with electoral costs, but effects vary by reform type, timing, and macro conditions.
- By reform type:
  - Financial sector reforms tend to have adverse electoral consequences.
  - Real sector reforms (trade, product, labor) on average are electorally benign; in good economic times, real sector reforms can be rewarded.
- By timing in electoral cycle:
  - Electoral costs concentrate when reforms are implemented relatively late in the political calendar—particularly in the year prior to an election.
  - A major reform (defined as a change of two standard deviations in the reform indicator) in the election year is associated with about a 3 percentage points decrease in the vote share of the coalition.
  - That effect is equivalent to a reduction in the chance of the incumbent leader of the coalition being re-elected by about 17 percentage points.
  - Reforms undertaken earlier in the incumbent’s term do not appear to affect election prospects.
- By macroeconomic conditions:
  - Reforms enacted in weak economic conditions are penalized; reforms enacted in strong economic activity periods have benign or positive electoral consequences.
  - In bad times, both financial and real sector reforms are associated with lower vote share.
  - In good times, real sector reforms have a positive and statistically significant effect on vote share; financial sector reforms do not have a statistically significant effect.
- Heterogeneity and contextual findings:
  - Clarity of responsibility matters: the effect on incumbent majority party’s vote share is three times larger when the party is governing alone than when governing in a coalition.
  - Liberalization tends to decrease electoral support; tightening does not significantly influence voters.
  - Reforms under IMF-supported programs do not appear to have an additional impact on electoral outcomes; estimated effects are not statistically different from those implemented in other circumstances.
- Endogeneity and robustness:
  - Selection bias may imply actual electoral costs are larger than baseline estimates: stronger governments may implement reforms early; weak governments avoid reforms yet may still lose elections.
  - Addressing endogeneity (instrumental variables; focusing on exogenous elections) yields larger negative effects of reform on election outcomes (see Online Annex 3 referenced).
  - Augmented specifications controlling for budget changes and inflation yield effects smaller in magnitude but not statistically different from baseline.

### THEORIES AND WHO IMPLEMENTS REFORMS
- War of attrition:
  - Politicians seeking reelection exchange distortions for support; organized minorities can delay reforms.
  - Multiparty/fragmented governments increase veto power; presidential regimes tend to face weaker opposition to reforms.
- Partisan theory:
  - Different parties have different policy preferences; majoritarian rules produce fewer, more polarized parties.
  - Right-wing governments are predicted to implement market-oriented reforms though empirical findings show right-leaning governments do not adopt more free-market policies than left-leaning ones; left-leaning governments sometimes implement larger liberalizing reforms.
- Crisis-induced hypothesis:
  - Crises can catalyze reform by increasing pressure on blocking minorities; effects vary by crisis type.
- Stylized facts on when reforms occur:
  - Presidential systems: larger and more frequent swings in economic policy; liberalizing and tightening reforms more frequent than in parliamentary systems.
  - Majoritarian electoral rules: larger reforms and reform reversals.
  - Crises and growth regime: crises do not foster reforms on average; during low growth, reform tightening is relatively common.

### MECHANISMS, INTERPRETATIONS, AND CASE-STUDIES
- Mechanisms:
  - Distributional effects: reforms often produce diffuse gains and concentrated losses; organized losers can impose political costs.
  - Timing and information: voter myopia and gradual realization of gains reduce electoral costs if reforms are implemented early.
  - Clarity of responsibility: single-party governments face larger voter attribution for reforms.
- Case studies:
  - Spain (1977–1979):
    - UCD garnered 34 percent of the vote share and formed a minority government.
    - Reforms included fiscal stabilization, external and domestic finance liberalization, reduction in nominal wage growth; political democratization and consensus-building aided electoral success.
  - Peru (1990–1995):
    - GDP growth turnaround from –5.3 percent in 1990 to 7.1 percent in 1995.
    - Inflation decline from 432.8 percent in 1990 to 10.6 percent in 1995.
    - Fujimori won the 1995 presidential election with 64 percent of votes.
    - Immediate adjustment included removal of many subsidies and price increases of basic goods up to 3,000 percent; reforms covered trade and capital liberalization, public administration downsizing, social security and SOE reforms, financial reforms, and labor market flexibilization.
    - Political developments included the 1992 "autogolpe" and adoption of a new constitution in 1993.

### POLICY-RELEVANT LESSONS AND RECOMMENDATIONS
- Timing and political capital:
  - Implement reforms early in the government’s term to exploit honeymoon periods.
  - Avoid enacting major reforms in the year prior to elections.
- Macroeconomic conditions:
  - Implement reforms when economic conditions are favorable (“fix the roof when the sun is shining”).
  - During recessions, combine reforms with macro policy support to reduce political costs.
- Sectoral prioritization:
  - Prioritize real sector reforms when political feasibility is a concern, given generally benign electoral effects.
  - Be cautious with financial sector liberalization because of electoral and distributional risks.
- Distributional mitigation:
  - Address income-distribution effects upfront via fiscal incentives, job search assistance, retraining, and stronger social safety nets.
- Ownership, communication, and stakeholder engagement:
  - Ensure credible political commitment and strong ownership.
  - Enhance dialogue and communication with business and civil society to build broad support and mitigate political costs.
- IMF programs:
  - Reforms under IMF-supported programs do not show additional electoral penalties on average; nevertheless, emphasize program ownership, communication, and stakeholder engagement.

### BOX 1 — FISCAL CONSOLIDATIONS AND ELECTORAL OUTCOMES (SUMMARY)
- Estimation: Probit model of probability of re-election following fiscal consolidation; consolidations classified as spending-based or tax-based; sample covers OECD countries during 1980–2016 where exogenous consolidation measures are available.
- Main quantitative findings:
  - A 1 percentage point of GDP consolidation (for each year of the term) lowers the probability of the re-election of the incumbent government party by nearly 20 percentage points.
  - Electoral costs arise mostly from tax-based consolidation: a 1 percentage point of GDP tax-based consolidation (for each year of the term) lowers the probability of re-election by nearly 45 percentage points.
  - Spending-based consolidation does not appear to affect re-election prospects; when controlling for changes in growth and unemployment, tax-based effects diminish and spending-based effects can turn positive.
- Heterogeneity across tax types:
  - Effects larger for measures aimed at increasing corporate income and indirect taxes: "A 1-percentage point of GDP corporate income tax (indirect tax) consolidation lowers the probability of the re-election of the incumbent government party by almost nearly (11) percentage points."
  - Personal income tax effects are small and not statistically significant.
- Policy takeaways:
  - Fiscal consolidation outcomes depend on package design and the identity/number of affected interest groups.
  - Spending-based consolidations and some corporate tax reforms are typically benign electorally.
  - Protect vulnerable groups and design growth-friendly measures to mitigate political costs.

*Source: sdnea19008 — IMF Staff Discussion Note (excerpted).*

### INTRODUCTION _________________________________________________________________________________ 5

### sdnea19008 - INTRODUCTION _________________________________________________________________________________ 5

### EXECUTIVE SUMMARY
- Context: Persistent, weak medium-term growth and limited fiscal space have shifted policy agendas in advanced and developing economies toward structural reforms.
- Objective: Examine whether the fear of political costs from structural reforms is justified by available evidence and derive lessons on reform design to mitigate potential political costs.
- Data innovation: A newly constructed database on structural reforms covering 90 advanced and developing economies during 1973–2014 is combined with a new electoral data set.
- Core empirical findings:
  - Reforms do not lead to electoral costs when implemented in ways that internalize political-economy considerations.
  - Electoral costs appear significant only when reforms are implemented in the runup to elections (notably in the year prior to an election).
  - Reforms enacted in periods of weak economic activity tend to have political costs; reforms in good times have benign or even positive electoral consequences.
  - Some reform types—particularly certain financial deregulation measures and external capital account liberalization under some conditions—can have sizable short-term adverse distributional effects and be electorally costly.
- Policy implications (high level):
  - Implement reforms early in the political term (political “honeymoon”).
  - Implement reforms when economic conditions are favorable (“fix the roof when the sun is shining”); during recessions, provide macro policy support to reduce political costs.
  - Address distributional effects upfront via fiscal incentives, job search assistance, retraining, and stronger social safety nets.
  - Ensure credible political commitment, strong ownership, and enhanced dialogue with business and civil society.

### INTRODUCTION: CONTEXT AND RESEARCH QUESTIONS
- Structural reforms under consideration include: reducing regulatory barriers to competition in product and financial markets, opening to trade and financial flows, and increasing labor market flexibility.
- Motivations for reforms: raise productivity and employment, improve debt sustainability, and enhance resilience to shocks.
- Political-economy concern: Reforms may produce diffuse gains but concentrated losses, allowing organized minority opponents to impose political costs on reforming governments.
- Research questions posed:
  - Do structural reforms lead, on average, to electoral costs?
  - Does the timing of reform in the electoral cycle and the state of the economy matter?
  - Does the effect depend on the type of reform?

### DATA AND EMPIRICAL APPROACH
- Structural reform data set:
  - Coverage: 90 countries during 1973–2014.
  - Country composition: 29 advanced economies, 50 emerging market economies, and 21 low-income countries.
  - Sample represents 96 percent of the world’s 2017 nominal GDP.
  - Sectors covered: domestic finance, financial current account, capital account, trade (tariffs), product markets (telecommunication and electricity), and labor market regulation (employment protection legislation, EPL).
  - Indicators scaled between 0 and 1; higher values denote greater liberalization.
  - The data set identifies and documents implementation dates of major reforms.
- Sectoral indicator details:
  - Domestic finance index covers: interest rate controls, entry barriers, privatization, supervision and regulation, securities markets, and credit controls.
  - Current and capital account indicators cover restrictions on external payments and receipts and components of the capital account (FDI, portfolio, bonds and other debt securities, money market instruments, financial credits).
  - Trade indicator measures product-level tariffs aggregated with simple and weighted averages (weights = export share).
  - Product market indicators cover privatization, entry barriers, supervision and regulation in telecommunication and electricity.
  - Labor market indicator: EPL for termination of full-time indefinite contracts in a typical firm of 250 workers; dimensions are procedural requirement, firing costs, valid grounds for dismissal, and redress measures.
- Electoral data set:
  - Contains election date, name of incumbent leader and party affiliation, name of new leader and party affiliation, date incumbent took office, vote share of each party in coalition supporting the incumbent at current, last, and second-last elections.
  - Additional variables: political system type (presidential vs. parliamentarian), electoral system (majoritarian vs. proportional), number of parties in coalition, and ideology of government (right, center, left).

### STYLIZED FACTS ON REFORM PROGRESS
- Temporal and sectoral patterns:
  - Broad tendency toward liberalization since the late 1980s; pace of liberalization declined since the global financial crisis, especially in domestic finance and external current and capital accounts with modest reversals in some countries.
  - Reform frequency uneven across sectors: domestic finance, trade, capital and current accounts saw more frequent reforms than product and labor markets.
  - Timing of major liberalization pushes by sector:
    - Trade: concentrated in the 1970s and 1980s.
    - Domestic and external finance: early 1990s.
    - Product markets: late 1990s.
  - Labor market regulation (EPL): no deregulation trend; tightening in recent years.
- Cross-country and regional patterns:
  - Advanced economies more liberalized than emerging markets, which are more liberalized than low-income countries.
  - Emerging market economies and low-income countries had similar liberalization levels until the 1990s; since then emerging markets progressed more strongly (except for EPL).
  - Regional variation: reform progress strongest in Europe; modest in the Middle East, Central Asia, and sub-Saharan Africa.

### KEY EMPIRICAL RESULTS
- Average effects:
  - On average, reforms are associated with electoral costs, but effects vary by reform type and timing.
- By reform type:
  - Financial sector reforms tend to have adverse electoral consequences.
  - Real sector reforms (trade, product, labor) on average are electorally benign; in good economic times, real sector reforms can be rewarded.
- By timing in electoral cycle:
  - Electoral costs are concentrated when reforms are implemented relatively late in the political calendar—particularly in the year prior to an election.
  - Reforms undertaken earlier in an incumbent’s term do not affect election prospects.
- By macroeconomic conditions:
  - Reforms enacted in weak economic conditions are penalized.
  - Reforms enacted in strong economic activity periods have benign or positive electoral consequences.
- Case-study insights:
  - Governments may avoid electoral punishment even under difficult economic conditions when:
    1. Reforms coincide with a transition to democracy.
    2. There is strong ownership and consensus that a broad reform package (including macro-stabilization) is unavoidable.
    3. The government effectively signals political commitment and conducts enhanced dialogue to garner support from business and civil society.
- Endogeneity and selection concerns:
  - Selection bias could cause underestimation of electoral costs because stronger governments may choose to implement reforms early, while weak governments avoid reforms yet may still lose elections.
  - Results in Online Annex 3 suggest addressing endogeneity may yield larger negative effects of reform on election outcomes.

### POLICY RECOMMENDATIONS (DESIGN AND IMPLEMENTATION)
- Timing and political capital:
  - Governments should act swiftly following an electoral victory to implement reforms during the political “honeymoon.”
- Macroeconomic conditions:
  - Implement reforms when economic conditions are favorable (“fix the roof when the sun is shining”).
  - During recessions, combine reforms with macro policy support to reduce political costs.
- Distributional mitigation:
  - Factor in and address upfront the income-distribution effects of reforms.
  - Use fiscal incentives and policies—job search assistance, retraining, stronger social safety nets—to support those most affected.
- Political commitment and stakeholder engagement:
  - Ensure credible political commitment, strong ownership, and enhanced dialogue with business and civil society to build broad-based support.

### QUALIFICATIONS AND SCOPE
- Selection bias caveat: Estimated electoral costs may be underestimated due to strategic timing by governments with different political strengths.
- Focus of reforms analyzed: The note considers reforms aimed at improving functioning of financial, labor, and product markets, which may generate uneven gains. Other reforms (e.g., education, health, infrastructure, governance, laws to foster women’s labor force participation) may generate fewer political costs because of smaller distributional impacts.

### ROADMAP OF THE NOTE
- Documentation of stylized facts on reform progress and political circumstances surrounding enactment.
- Analytical considerations on electoral consequences focusing on gains, distribution, and political interaction.
- Empirical evidence on electoral consequences and selected case studies.
- Conclusions discussing key findings and implications.

*Source: INTRODUCTION (sdnea19008) — IMF Staff Discussion Note, excerpted content provided.*

### Annex 1.

### Annex 1. C. Who Implements Reforms and When

### Theories on the Determinants of Reforms
- War of attrition (Alesina and Drazen 1991)
  - Politicians seek reelection and exchange policy distortions for political support.
  - Structural reforms have redistributive consequences; interest groups (represented by parties with veto power) prefer to delay reforms.
  - Probability of delay is higher the weaker or more fractionalized the executive power is.
  - Multiparty/fragmented governments increase veto power of single players; coalition governments with divergent interests make compromise difficult (Haggard and Webb 1994, Roubini and Sachs 1989).
  - Presidential regimes, with generally stronger executive power, tend to face weaker opposition to reforms.

- Partisan theory (Hibbs 1987, Alesina and Roubini 1992)
  - Different parties have different distributional and policy preferences; presidential systems and majoritarian rules tend to produce fewer, more polarized parties and larger swings in economic policy.
  - Parliamentary regimes with proportional rules and coalitions allow centrist parties to veto radical proposals.
  - Partisan models predict right-wing governments are more likely to implement market-oriented reforms.
  - Cukierman and Tommasi (1998) note episodes where left-leaning governments implemented “right-wing policies” and propose a representative-democracy model explaining this evidence.
  - Jain and Mukand (2003) and related theoretical models with endogenous redistribution provide mechanisms where governments ideologically distant from pro-market reforms can implement them by redistributing gains to losers.

- Crisis-induced hypothesis (Krueger 1993; Tommasi and Velasco 1996)
  - Crises can catalyze reform by increasing pressure on blocking minorities.
  - Drazen and Grilli (1993): a crisis could be welfare improving if it leads to reforms whose payoff exceeds the direct welfare loss from the crisis.
  - Crises may also increase parliamentary fragmentation and weaken reform efforts (Mian, Suffi, and Trebbi 2014).

### Stylized Facts on When Reforms Occur (Frequency and Intensity)
- Four main stylized facts emerge from the analysis on frequency and intensity of reforms:
  - Countries with presidential systems:
    - Characterized by larger and more frequent swings in economic policy.
    - Liberalizing and tightening reforms are more frequent than in parliamentary systems.
    - Supports both the war of attrition and partisan models.
    - No significant difference in reform progress depending on the initial vote share of governing parties, nor on whether the government is single- or multiparty.
  - Countries with majoritarian electoral rules:
    - Characterized by larger reforms and reform reversals.
    - Consistent with partisan theory: majoritarian rules produce fewer, more polarized parties.
  - Government ideology:
    - Right-leaning governments do not adopt more free-market policies than left-leaning ones.
    - Left-leaning governments typically implement larger liberalizing reforms, consistent with Cukierman and Tommasi (1998).
  - Crises and growth regime:
    - Crises do not foster reforms on average; during periods of low growth, reform tightening is relatively common.
    - The effect of crises varies by crisis type and regulation: economic recessions foster trade, labor market, and domestic financial liberalization in the medium term, whereas banking crises tend to lead to higher regulation in domestic finance and capital account (see Chapter 3 of the October 2019 IMF World Economic Outlook).

- Notes on empirical presentation:
  - Figures show frequency and intensity of liberalizing and tightening reforms by (1) political system, (2) electoral system, (3) type of government, (4) ideological orientation, (5) initial vote share, and (6) growth regime.
  - *, **, *** denote statistical significance at 10, 5, and 1 percent, respectively.
  - Major reform event defined as a change of two standard deviations in the average reform indicator.

### Reforms and Elections: Analytical Considerations
- Reform inertia explanations:
  - Uncertainty about what to do may make doing nothing optimal.
  - Lack of technical expertise to implement reforms.
  - If perceived economic weakness is temporary, governments may wait.
  - Behavioral tendency to postpone difficult decisions even if postponement increases future costs.

- Political opposition and distributional effects:
  - Reforms can cause uneven gains; losses concentrated, gains diffused (Rodrik 1994).
  - Opponents face lower costs to organize, becoming politically strong (Olson 1971).
  - Median voter may prefer status quo and penalize reformers.
  - Uncertainty about individual gains/losses dampens aggregate support (Fernandez and Rodrik 1991, Alesina and Drazen 1991).

- Scenarios where reform may be electorally beneficial:
  - Implementing reform may signal competence and be rewarded by well-informed voters (Rogoff 1990).
  - Economic gains from reforms materialize over time—successful reforms can enhance re-election prospects (IMF 2016; October 2019 IMF WEO Chapter 3).
  - Improvements in democratic institutions often accompany economic reforms (Haggard and Webb 1994; Giuliano, Mishra, and Spilimbergo 2013), potentially reducing electoral penalties for unpopular reforms.
  - New democracies may exploit a “honeymoon” period to enact reforms swiftly at term outset.

- Timing and macro conditions:
  - Reforms implemented early in an electoral term are likely less politically costly:
    - Voter myopia: voters overweight policies implemented close to elections.
    - Gains from reforms materialize gradually, increasing likelihood early reforms show benefits by election time.
  - Economic conditions at implementation matter:
    - Voters may attribute economic performance (good or poor) to reforms.
    - Reforms enacted during expansions are associated with significant macroeconomic benefit and limited distributional cost.
    - Reforms enacted during weak economic conditions tend to be contractionary and distributionally adverse; may produce limited overall gains and significant costs for large population shares, leading to electoral costs (Duval and Furceri 2018; Ostry, Berg, and Kothari 2018; October 2019 WEO Chapter 3).

### Reforms and Electoral Outcomes: Evidence
- Empirical setup:
  - Outcome variable: change in incumbent coalition (party) vote share; also model whether reforming incumbent/party remains in office (1 = re-election, 0 otherwise).
  - Key explanatory variable: unweighted average of all six reform indices; also distinguish financial sector reforms (domestic finance, capital and financial current account) and real sector reforms (trade, product, and labor markets).
  - Sample: unbalanced sample of democratic elections from 1973 (or first year country is democratic) to 2014 for 66 countries.
  - Baseline controls include:
    1. Average GDP growth during the electoral term.
    2. Advanced economy dummy (1 = continuous membership in the OECD since 1963, or 0 otherwise).
    3. New democracies dummy (1 = countries for the first four elections after a year with a negative Polity score on the –10 to 10 scale, or 0 otherwise).
    4. Majoritarian political system dummy (1 = electoral system that awards seats in “winner-take-all” geographically based districts per Database of Political Institutions, or 0 otherwise).
    5. Initial level of regulation.
    6. Initial level of vote share.
  - Democratic regime identification: POLITY2 score range –10 (strongly autocratic) to 10 (strongly democratic); democratic regime defined as POLITY2 >= 1.

- Main empirical findings:
  - Timing matters: reforms are associated with electoral costs only when implemented in the year prior to an election.
    - A major reform (increase larger than two standard deviations in the reform indicator) is associated with about a 3 percentage points decrease in the vote share of the coalition.
    - This effect is equivalent to a reduction in the chance of the incumbent leader of the coalition being re-elected by about 17 percentage points (Figure 5).
    - In contrast, reforms undertaken earlier in the incumbent’s term do not appear to affect election prospects.
  - Results are consistent with voter myopia and with economic gains from reforms materializing gradually.
  - Better economic conditions during the year before the election are associated with more favorable political outcomes.
  - Changes in vote shares are typically larger in advanced economies and in majoritarian systems (consistent with Brender and Drazen 2008).
  - No significant variation in the effect of reform across countries or with the ideology of the government.
  - No evidence that the speed of implementation has a salient impact on electoral outcomes (see Online Annex 3 for details).

- Endogeneity and robustness concerns:
  - Selection bias may imply actual electoral costs of reforms are larger than baseline estimates:
    - Governments with stronger political support may implement reforms early.
    - Politicians may avoid reforms if they anticipate electoral costs.
    - Weak governments may refrain from reforms and also lose at the polls.
  - Addressing endogeneity (instrumental variables; focusing on exogenous elections) yields larger negative effects of reform on election outcomes (Online Annex 3).
  - Reforms often part of packages targeting macro stability (inflation, deficit); to address potential bias the analysis controls for:
    1. Changes in the budget during the election year and the rest of the term.
    2. A measure of inflation.
  - These augmented specifications yield effects smaller in magnitude but not statistically different from baseline.

*Source: sdnea19008 - Annex 1.*

### Annex 3). In addition, the analysis on “exogenous” fiscal consolidations suggest that their effect on

### THE POLITICAL COSTS OF REFORMS: FEAR OR REALITY?

### Key empirical findings
- Electoral costs of reforms depend on the design of stabilization packages: "tax-based consolidation episodes with significant contractionary effects tend to be associated with sizeable political costs, growth-friendly spending-based consolidation are largely benign from an electoral standpoint and may increase the chance of re-election (Box 1)."
- Clarity of responsibility matters: "the effect of reforms on the incumbent majority party’s vote share is three times larger when the party is governing alone than when governing in a coalition."
- Asymmetry between liberalization and tightening: "liberalization tends to decrease electoral support, tightening does not significantly influence voters."
- Sectoral heterogeneity:
  - Electoral costs arise mainly from pro-finance reforms (domestic and external financial sector; financial current and capital accounts).
  - Real sector reforms are "largely benign from an electoral standpoint" and have "minor distributional consequences."
- Economic conditions condition political costs:
  - "Reforms are politically costly only when enacted in periods of weak economic activity."
  - In bad times, both financial and real sector reforms are associated with lower vote share.
  - In good times, real sector reforms have a positive and statistically significant effect on vote share; financial sector reforms do not have a statistically significant effect.
- IMF programs: "Reforms implemented under an IMF-supported program do not appear to have an additional impact on electoral outcomes." The estimated effects of reforms under IMF-supported programs are "not statistically different from those implemented in other circumstances." There is "no evidence that being in an IMF-supported program per se comes with an electoral cost."
- Statistical significance notation used in figures: "*** denotes statistical significance at 1 percent." "**, *** denote statistical significance at 5 and 1 percent, respectively."

### Quantitative and historical benchmarks cited
- Spain 1977 election: UCD garnered "34 percent of the vote share" and formed a minority government.
- Spain 1976–79 indicators shown include evolution of "Domestic finance", "External finance", and "GDP growth".
- Peru macro indicators (1990–95):
  - GDP growth turnaround from "–5.3 percent in 1990 to 7.1 percent in 1995."
  - Inflation decline from "432.8 percent in 1990 to 10.6 percent in 1995."
  - Fujimori won the 1995 presidential election with "64 percent of votes."
- Reform magnitude used in empirical specification: "a major reform event—defined as a change of two standard deviation in the reform indicator—in the election year on the change of the incumbent coalition vote share."

### Mechanisms and interpretations
- Clarity of responsibility: high when a single party majority controls the government; low when government is controlled by multiple parties or lacks majority support.
- Distributional effects: financial sector reforms are associated with increased inequality; real sector reforms have minor distributional consequences. Empirical references cited in the text support this association.
- Timing and macro conditions: reforms enacted during weak economic activity produce larger electoral penalties; when growth conditions are favorable, real sector reforms can enhance re-election odds.

### Case studies illustrating exceptions
- Spain (1979)
  - Two main contributing factors to electoral success despite unfavorable conditions: simultaneous political democratization and consensus-building with society and parties.
  - Reforms included fiscal stabilization, external and domestic finance liberalization, and reduction in nominal wage growth.
  - Political reforms included drafting and approving a new constitution (parliament approval October 1978; referendum December 1978).
- Peru (1995)
  - Three contributing factors to re-election: reforms part of broad macro-stabilization aimed at ending the crisis; perceived ideological distance of leader from pro-market reforms aided credibility; anti-poverty and social cohesion measures implemented.
  - Key policy actions: removal of many subsidies and price increases of basic goods (up to "3,000 percent" in the immediate adjustment), liberalization of trade and capital markets, public administration downsizing, reforms of social security, state-owned enterprises, and financial institutions, labor market flexibilization.
  - Political developments included the 1992 "autogolpe", followed by congressional elections and adoption of a new constitution approved in 1993 referendum.

### Policy-relevant lessons and recommendations
- Timing matters: implement reforms early in a government’s term to exploit honeymoon periods and generate longer-term gains.
- Differentiate reforms by sector: prioritize real sector reforms when political feasibility is a concern, given their generally benign electoral effects; be cautious with financial sector liberalization because of associated electoral and distributional risks.
- Avoid enacting major reforms in periods of weak economic activity where political costs are higher.
- Build and signal ownership and credibility:
  - Ensure strong ownership by political leaders and convey that reform-cum-stabilization is unavoidable when applicable.
  - Enhance dialogue and communication with business and civil society to build broad support and mitigate political costs.
- IMF-supported programs: while reforms under IMF programs do not show additional electoral penalties on average, attention to program ownership, communication, and engagement with stakeholders remains important.

*INTERNATIONAL MONETARY FUND*

### Box 1. Fiscal Consolidations and Electoral Outcomes

### Box 1. Fiscal Consolidations and Electoral Outcomes

### Methods and Data
- Estimation approach: Probit model of the probability of re-election of the incumbent government party following fiscal consolidation.
- Identification: Fiscal consolidation episodes identified at their announcement date in the electoral term and classified as spending-based or tax-based (following Alesina, Favero, and Giavazzi 2019). Within tax-based measures, distinguished between direct (corporate and personal income) and indirect measures (Dabla-Norris and Lima 2018).
- Controls included: initial general government debt, financial and debt crises, growth and change in unemployment during the electoral term, initial tax system characteristics.
- Sample coverage: 16 and 10 Organisation for Economic Co-operation and Development countries, respectively, during 1980–2016. The country-coverage and time-dimension of the sample is dictated by the availability of the exogenous fiscal consolidation measures.
- Significance notation used in figures: ***, **, * indicates significance at 1, 5, and 10 percent, respectively.

### Main Findings on Electoral Effects
- Fiscal consolidations are, on average, associated with electoral costs:
  - "A 1 percentage point of GDP consolidation (for each year of the term) lowers the probability of the re-election of the incumbent government party by nearly 20 percentage points."
- Effects depend on design of consolidation package:
  - "Electoral costs arise mostly from tax-based consolidation, with a 1 percentage point of GDP consolidation (for each year of the term) lowering the probability of the re-election of the incumbent government party by nearly 45 percentage points."
  - "Spending-based consolidation does not appear to affect re-election prospect."
- When controlling for changes in growth and unemployment during the party’s term:
  - The electoral effect of tax-based consolidation significantly diminishes (turning to be not statistically significant in some specifications).
  - The effect of spending-based consolidation turns to be positive (Alesina, Favero, and Giavazzi 2019).

### Heterogeneity Across Tax Types
- Across types of tax-based consolidation, effects are larger for measures aimed at increasing corporate income and indirect taxes:
  - "A 1-percentage point of GDP corporate income tax (indirect tax) consolidation lowers the probability of the re-election of the incumbent government party by almost nearly (11) percentage points."
  - The effect of personal income tax (PIT) reforms is small and not statistically significant.

### Interpretation and Policy-Relevant Conclusions
- Fiscal consolidation does not necessarily lead to negative electoral outcomes; outcomes depend on:
  - The design of consolidation packages.
  - The number and identity of interest groups affected by the measures.
- Specific policy-relevant takeaways:
  - Spending-based consolidations, as well as reforms on corporate income taxes, are typically benign electorally.
  - Growth-friendly tax and spending measures, such as a cut in inefficient spending, do not reduce the chance of re-election and in some cases increase it.
  - Fiscal consolidation packages can be designed to mitigate political costs by protecting vulnerable groups who bear the brunt of the reform (Banerji and others 2017).

*This box was prepared by Aleksandra Zdzienicka based on Alesina and others (forthcoming b) and Chen and others (forthcoming).*

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_Source: https://www.imf.org/-/media/files/publications/sdn/2019/sdnea19008.pdf_