Leaping into the Dark: A Model of Policy Gambles with Self-Fulfilling Features

Abstract

We examine why rational voters support risky “policy gambles”, even when detrimental to welfare, over maintaining a safe status quo. We present a model of electoral competition with two groups of agents. Elites own the means of production and choose how much future output they require as compensation for investing in risky projects. Voters are residual claimants of output. The output depends on the future government’s policy. When investments are made, the incumbent cannot pre-commit to retain the status quo. Instead, future policy is determined by political parties vying to win the election. Voters can increase their expected output share by supporting policy gambles. Our analysis highlights how uncertainty about future policy shapes equilibrium policy choices and provides a mechanism where income inequality is a driver for abandoning the status quo. Institutions that support consensus between political parties can improve welfare by eliminating the gamble equilibrium.