How do elections affect the economy?

Mumbai: The Indian economy typically slows down ahead of Lok Sabha elections even as government intervention turns opportunistic, a Mint analysis has found.

A study of key economic variables over the past 30 years shows that economic activity lost pace significantly every time there was a general election. Government spending went up in an average election year, which tended to fuel inflation rather than spur growth, suggesting that the extra public expenditure ahead of polls was largely wasteful.

The slowdown in investment and economic activity, however, is more pronounced this election season because the government failed to take policy decisions in the past couple of years while battling a raft of corruption charges.

The consumption of steel, for instance, slowed every time India had an election in the past two decades (see chart 1). The average growth in steel consumption in an election year is 6.45 percentage points lower compared with a non-election year in this period.

This year, the fall has been worsened because of the overall economic slowdown, with steel consumption falling 5.6% over the year-ago period in the nine months ended 31 December.

New project additions dry up in an election year (see chart 2). Investors and businessmen postpone key decisions till a new government is formed, and wait to gauge what the future policy environment will be before launching major projects.

At the same time, the pace of industrial credit growth decelerates (see chart 3). Industrial credit growth slows down as there are fewer industrialists lining up for bank loans ahead of elections. The average rate of industrial credit growth in election years was 1.8 percentage points lower in the past three decades compared with non-election years.

Policy uncertainty may not be the only reason for the decline in consumption of raw materials such as steel and cement. Cement consumption declines ahead of elections as builders divert funds to illicitly fund political campaigns, research by economist Devesh Kapur and political scientist Milan Vaishnav shows.

Government spending rises in election years although that affects inflation more than real economic activity. There’s a clear spike in both total and revenue spending in election years, or if the elections are held in April and May, the just-preceding fiscal year (see chart 4).

The average increase in nominal government spending during election years is 15.84% compared with 11.38% for non-election years. Looking at it another way, the increase in median spending is 14.73% compared with 11.28% for non-election years. The effect of government spending also clearly shows in the fiscal deficit numbers. Average fiscal deficit for the election year is 5.87% compared with 5.08% for the non-election years.

To be sure, the fiscal deficit and government spending numbers don’t seem to follow the pattern in 2013-14. However, this year the government’s hands were tied by threats of a downgrade by rating agencies.

In many cases, government intervention in an election year is designed to cater to special interest groups rather than to provide a boost to the overall economy. “We find that politicians manipulate fiscal policies before elections to provide targeted favours to specific interest groups, possibly in exchange for campaign support,” said a 2002 World Bank study by Stuti Khemani.

The amount of farm loans given by state-owned banks was 5-10 percentage points higher in election years than in years following an election, a 2007 research paper by Harvard University economist Shawn Cole found.

“In election years, more loans are made to districts in which the ruling state party had a narrow margin of victory (or a narrow loss) in the previous election. This targeting does not occur in non-election years,” Cole wrote. “Politically motivated loans are costly: they are less likely to be repaid, and election year credit booms do not measurably affect agricultural output.”

Given that government spending is usually opportunistic ahead of elections, the spike in spending fails to lift the economy and instead stokes the fires of inflation.

Inflation measured by the gross domestic product deflator spikes up around national elections (see chart 5). The average inflation during election years is 8.56% since 1980, compared with 7.55% for non-election years.

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