Political markets

Posted: Nov 01, 2002 12:00 AM
As the election gets down to the wire, pundits of all kinds are speculating on the outcome. Usually, they look at polls, debates, press coverage, advertising and such. Economists prefer to look at markets. They are signaling that maintenance of the status quo is the most likely outcome, with continued Republican control of the House and Democratic control of the Senate. For some years, the University of Iowa has run a futures market on key elections. Investors can buy contracts for various electoral outcomes, with prices changing depending on events. Right now, contracts are available for 4 possible outcomes on Tuesday: Republican House/Republican Senate, Republican House/Democratic Senate, Democratic House/Republican Senate, and Democratic House/Democratic Senate. The website for those interested is www.biz.uiowa.edu/iem. As this is written on Oct. 31, the prices show that there is a 1 in 2 chance of Republicans keeping the House and Democrats keeping the Senate. In other words, even money. The chances of full Democratic control of Congress and of Republicans gaining full control are almost exactly the same at 1 in 4. However, in recent days the odds of full Democratic control have virtually doubled. They were 1 in 8 just a few days ago. Simultaneously, the odds of full Republican control have fallen from 1 in 3. The most unlikely result, according to the market, is Democratic control of the House combined with Republican control of the Senate. The chances of that happening are just 1 in 25. Anyone who feels that these odds are wrong is free to bet their own money by buying a contract. However, my reading of the polls suggests that the market's judgment is pretty close to the mark. It's hard to say which party will be more disappointed by continuation of the status quo. Both had hoped to make gains at the other's expense. But realistically, it was always the Republicans who had the most to lose. They had more seats in the Senate to defend (20 Republican versus 14 for Democrats) and had a powerful historical trend going against them. The party controlling the White House almost always loses in midterm elections. Political scientist Larry Sabato has assembled a history of midterm elections at www.centerforpolitics.org/crystalball. The record is virtually unbroken since 1934. The sole exception was in 1998, when Democrats picked up 9 House seats despite holding the White House. However, they lost 2 Senate seats in the process, leaving Republicans in control of both houses of Congress. Given the strong proclivity of voters to punish the party holding the White House in midterm congressional elections, Republicans have to view continued control of the House with great relief. This is especially so in light of their thin margin and the poor state of the economy, which normally spells doom for the party in the White House. In 1982, for example, in the midst of a similar economic downturn, Republicans lost 26 House seats. Why Republicans seem to be getting a pass from voters on the economy is a mystery. It may be that they are becoming more economically sophisticated as a result of increased stock ownership and the proliferation of cable business programs. Thus the latest NBC/Wall Street Journal poll shows 34 percent of voters primarily blaming the Sept. 11 terrorist attacks for the economic slowdown, with 16 percent saying it is just the normal business cycle. Only 12 percent said it was due to the Bush administration's policies -- the same percentage that blames the Clinton administration. In any case, it is clear that Democrats did little to exploit their apparent advantage on the economy. While they talk a great deal about it, they have never come forward with a meaningful economic stimulus program. The reason may be that voters are more inclined toward Republican-style tax cuts for stimulus, rather than Democrat spending programs. According to the same poll, 48 percent of voters favor more tax cuts to stimulate the economy, with only 31 percent preferring more spending. Of course, elections affect the economy as well as the other way around. Economist Augustine Faucher of economy.com thinks continued gridlock is not all bad. Although it may stymie Republican efforts to make last year's tax cut permanent and reform Social Security, it may also doom Democrat plans for a big government prescription drug plan and a patient's bill of rights that would increase lawsuits against HMOs. Thus budget deficits are likely to be smaller under gridlock than if either party controls Congress entirely. One thing that is certain is that the outcome of Tuesday's elections will tell us almost nothing about what will happen in 2004. Republicans lost big in 1982, yet Ronald Reagan came back to win easily in 1984. Similarly, Democrats lost big in 1994, but Bill Clinton won handily in 1996.