Financial Markets and the Political Center of Gravity

Abstract

Academics across multiple disciplines and policymakers in multiple institutions have in recent decades searched for the economic, political, and institutional foundations for financial market strength. Promising theories and empirics have developed, including ma-jor explanations from differences in nations’ political economy.A common view is that, because many pro-market corporate reforms occurred during the 1990s in Europe, when social democratic parties governed and financial markets deepened, basic left-right explanations do not work and more complex political explana-tions are needed, presenting an unexpected paradox, in some political scientists’ view. This finding might be interpreted to indicate that left-right orientation is unimportant in affecting financial development and that either nonpolitical institutional issues or different political considerations are more central.We show here, first, that conceptually it’s not relative local placement of the govern-ing coalition on the nation’s left-right spectrum that counts, but whether the polity as a whole — i.e., its political center of gravity or its dominant governing coalition — is left or right on economic issues. If interests and opinion shift in a nation such that its political center of gravity is no longer statist and anti-market, then even locally left parties could and would implement pro-market reforms. (And conversely, in an earlier era when inter-ests and opinions were statist and anti-market, one should not expect to see even locally right parties pushing pro-market financial reforms forward.)Second, we bring forward data showing substantial movement over recent decades of political parties and governing coalitions; these shifts must be accounted for in assessing the impact of left-right divisions on financial and securities markets. In large measure, these political shifts correlate with financial markets shifts. Left-right matters not only in the fixed-in-time cross-section, but also the left-right economic shifts over time make an empirical difference. The results thereby further buttress the importance of a nation’s basic left-right political orientation in explaining financial market outcomes.