Political Markets, Bond Markets, and the Effects of Uncertainty: A Cross-National Analysis

Abstract

One of the critical challenges of contemporary democracy is securing a balance between the markets of representation and the markets of exchange and capital within democracies. This article explores the effect that political markets have upon capital markets' performance as measured by the market risks within the long-term government bond markets in nineteen democracies of the Organization for Economic Cooperation and Development (OECD) between 1955 and 1992. Our theory linking political markets and capital markets will be developed around the logic of transaction cost economics. We will argue that critical aspects of transaction costs within political markets generate corresponding transaction costs and risks within capital markets thereby reducing market efficiency. Specifically, we demonstrate that, based on cross-national evidence drawn from three panels over the time period 1955–1992, stochastic political markets generate transaction costs within long-term government bond markets, the consequences of which are reflected in rising market risk within these capital markets. Our pooled cross-sectional sample confirms that stochasticity in institutional structure presents trade-offs for democracy. Stochasticity may reflect more responsive and generally sensitive representative institutions, but often at the price of risk-laden capital markets. We consider the implications of these findings at the conclusion of the article.