Implementing reforms during the economic crisis

Table of contents

Introduction

I. Theories of state reforms
1. The Prospect Theory
2. The Theory of Blame Avoidance

II. Empirical examples
1. Italy in 1990s
2. Ireland in 2008 – 2010

Conclusion

Literature

Introduction

Despite of the fact that the market economy has demonstrated its superiority before the others types of economies it is still not protected from crises. Economic crises are usually connected with the end of business cycles but they can also take place by the negative state of economy or mistakes of governments. In any case crises have negative influence on the electoral support of governments because voters have to accept such negative economic phenomena as unemployment, inflation, bankruptcy of banks and companies. Voters are inclined to blame governments and political actors with such problems.

The most popular form of response of governments to economic crises is the implication of appropriate economic reforms. Some reforms can have negative consequences for voters and therefore for the electoral support and restrict some essential options of the welfare state. Nevertheless the examples from the current crisis of the Euro zone as well as the examples from previous crises show that certain states implement reforms and therefore overcome crisis more successful than others. In this way, the problem of this term paper is the following one: why are some countries in the Euro zone are more successful in implementing reforms than others?

In order to answer this question first of all the theoretical frames are represented. They include two theories which explain the decision of governments to undertake economic reforms as well as the behavior during the reforms’ implementation. The empirical examples of Italy which went through the severe economic crisis before the joining the Euro zone in the 1990s and Ireland which suffered from the financial crisis of 2008 – 2009 as a member state of the Euro zone and then overcame it will show how and why some countries can be successful in implementation of risky reforms in practice.

I. Theories of state reforms

1. The Prospect Theory

Prospect Theory was developed by American – Israeli economists Daniel Kahneman and Amos Tversky in 1979 and is mostly applied in the sphere of international relations. The theory is destined to explain the behaviour of people and political actors under conditions of risk and uncertainty (Kahneman/ Tversky 1979: 263 - 292).

The theory is based on experiments which have disclosed that people usually decide to behave themselves in the risky way if they appear in the situation of losses. However, they do not undertake risky actions if they find themselves in the domain of gains. Furthermore the way of the peoples’ behaviour has often deviated from the theoretical outlook of certain utilities. Such state of affairs has driven to the creation of two main statements of the Prospect Theory: ‘losses loom larger than gains ’ and ‘losses hurt more than equal gains please’ (Kahneman/ Tversky 1979: 279; McDermott 2004: 298). In this way, one needs to explain, why do peoples’ and political actors’ choices deviate from the theoretical predictions of the expected utility?

There are a few reasons which can explain this phenomenon. The first one is connected with the so – called ‘negativity effect’, which bases itself on the fact, that the subjective comprehension of the meaning of negative information always prevails the subjective comprehension of the meaning of equally extreme and equally likely positive information (s. Lau 1985: 119). The second reason is the so – called ‘certainty effect’, which means that the majority of people prefer to obtain the outcomes that are considered certain rather than outcomes which are merely probable (s. Kahneman and Tversky 1979: 265). The third reason is the ‘reflection effect’, which supposes that the preference order in the negative domain mirrors the preference order in the positive domain. In other words, the ‘frames’ of comprehension are built by individuals, which order the information from different sources according to individual preferences. The appropriate ‘frames’ are also constructed by a source of communication or by a decision – maker, which uses the ‘framed’ information for own goals and outcomes. For example, when people are faced with the fact that there is 10 per cent unemployment in a country, they probably are ready to accept tough policy measures against unemployment. However, when this fact is reformulated in positive terms, namely that employment is at 90 per cent, voters probably do not accept harsh measures to decrease the same level of unemployment. In other words, framing the information about the same fact has the different influence on voters’ preferences (Nelson/Oxley/Clawson 1997: 221; Tversky and Kahneman 1981: 453; Vis, B/van Kersbergen, K. 2007: 157 – 158). The fourth and the final reason of the deviation of peoples’ choices from predictions is the so – called ‘reference point bias’. According to this approach the reference point of the certain situation is defined as the status quo, and ‘individuals have a strong tendency to remain at the status quo, because the disadvantages of leaving it loom larger than advantages’. It is probable to define the status-quo as a reference point in order to establish the current situation as a loss or a gain for political actors (s. Kahneman/Knetsch/Thaler 2000: 163; Levy, 2003: 223; Vis, B/van Kersbergen, K. 2007: 158).

According to the introduced above the exposition of prospect theory can be formulated in the following way. Political actors will prefer to establish the current situation (status quo) if they see it as a gain and are faced with a choice between two options: the status quo (no reform) or some risks (reform). In both cases the value which is expected remains positive and the probability of losses is relatively small. For example, the assumed electoral punishment for reforms is smaller than the expected gain from them. From the other side, governments will prefer to take risky measures if they view their current situation as a loss and are confronted with a similar choice between the status quo (no reform) and some risks (reform). By both alternatives a further loss including further electoral loss or some smaller prospect for improvement are expected. The same theoretical model can be applied to voters and interest groups from different spheres of society (s. Berejekian 1997; Weyland 1996).

In the frames of prospect theory risky political, economic or social reforms in welfare states have the following consequences. Governments will realize such reforms only in the situation, when they consider their current domain as a ‘loss’. If the appropriate transformations are pursued by governments, there are two possible outcomes for them, which depend on the voters’ consideration of their current situation. The first outcome is that the implementation of a reform will be relatively unproblematic if voters consider themselves like governments in a losses domain. The second outcome is, that the implementation of a reform will be relatively difficult if voters consider themselves in a gains domain. In such situation the probability of electoral punishment or even socio – political conflict is rather high. From the other side, governments will not implement risky reforms, when they consider their current domain as a ‘gain’. If the reforms are not pursued, the outcomes are depended on the voters’ consideration of their current situation as a ‘loss’ or a ‘gain’. If voters consider their current domain as a ‘loss’, what does not correspond with the position of governments, the probability of electoral punishment or even socio – political conflict will be rather high. So risky welfare state reforms are likely to be successful only when either voters also regard themselves to be in a domain of losses so that they are able to accept the risk of reform, or when the government is ready to overcome the resistance of the voters to the risky reforms if they regard themselves to be in the domain of gains (s. Vis, B/van Kersbergen, K. 2007: 160, 162). According to prospect theory the outcomes of risky political, social or economic reforms are strongly depended on the contradiction between governments’ and voters’ consideration and interpretation of their current situation. In this way, governments can derive either electoral support or electoral punishment from risky reforms.

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