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Defusing Democracy: Central Bank Autonomy and the Transition from Authoritarian Rule

Defusing Democracy: Central Bank Autonomy and the Transition from Authoritarian Rule

by Delia Margaret Boylan


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Product Details

ISBN-13: 9780472112142
Publisher: University of Michigan Press
Publication date: 07/31/2001
Pages: 312
Product dimensions: 6.00(w) x 9.00(h) x 1.30(d)

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Defusing Democracy: Central Bank Autonomy and the Transition from Authoritarian Rule

By Delia M. Boylan

University of Michigan Press

Copyright © 2001 Delia M. Boylan
All right reserved.

ISBN: 0472112147

Chapter 1 - Introduction - The Challenge of Democratic Consolidation

The tide of countries making the transition from authoritarian rule in the late 1980s and early 1990s was initially greeted with euphoria. It was taken as a hopeful sign that the post-cold war era would be characterized by a community of nations-developed and developing alike-with a commitment to democratic institutions and democratic values (Fukuyama 1991). Nonetheless, as countries move from the installation of democracy to its consolidation, optimism has faded. While it is true that many countries have succeeded in moving away from their authoritarian pasts, few seem poised today to assume the mantle of a fully democratic future.

Any number of factors have worked to thwart the consolidation of democracy in third world polities. Many countries are riven by economic crisis, prompting political polarization, declining participation, and an escalation of crime and civil violence (Londregan and Poole 1990; Edwards and Tabellini 1991). In other countries, ethnic rivalries have come to the fore, calling preexisting boundaries of political community into question (Horowitz 1985; Young 1993). Finally, many states lack even the basic institutions of a modern democratic polity and are locked into a historical pattern of patron-client relationships and personalistic rule (Sandbrook 1985; Van de Walle 1994).

But the constraint that this study will focus on is of a different order. It stems from the fact that in many of these new democracies, newly empowered leaders are operating within institutional forms and structures that they did not create. Rather, they find themselves trapped within an institutional environment that is designed and controlled by their authoritarian predecessors.

This book offers an explanation for the existence of these authoritarian institutional legacies. It develops a systematic logic of "institutional insulation" that links the incentives and constraints facing power holders in the transition to the nature of the institutions that subsequently emerge. Specifically, I trace these vestigial institutions to strategic behavior by previous authoritarian elites seeking to guard against the inevitability of democracy. By entrenching their preferences in institutional footholds, the authoritarians ensure that the kinds of policies they favor will continue to be pursued long after they have left office. A defining feature of these enclaves of de facto authority is thus their potential to compromise the power and policies of successor governments.

Exiting authoritarian elites may employ any number of institutional strategies in order to protect their interests. For example, military regimes frequently set up mechanisms that allow for military representation in top policy-making bodies and/or shield military officials from dismissal or oversight (Stepan 1988; Agüero 1992). Electoral rules may also be designed to disproportionately advantage certain partisan interests over others (Geddes 1995; Londregan 2000). Or the authoritarians might try to cement in place certain social privileges before leaving power, such as institutionalizing the gains from land reform.

Another way that authoritarians can seek to protect their interests is to increase the autonomy of institutions that would otherwise be subject to the vicissitudes of the democratic political process. In the realm of the economy, one institution that lends itself to such insulation is the central bank. As the agency empowered to administer the country's currency, the central bank plays an important role in shaping the overall direction of the economy. By making the central bank autonomous, control over monetary policy is effectively removed from the hands of politicians.

At first glance, central bank autonomy might seem to offer a somewhat unconventional lens through which to explore this line of reasoning. After all, an autonomous central bank is generally seen as an unmitigated "good." On the theoretical front, it is thought to enable governments to credibly commit to macroeconomic stability. On the empirical end, there is a demonstrated relationship between central bank autonomy and low inflation. This study departs from the received wisdom and offers an alternative, less uniformly benign interpretation of central bank reform. Its starting point is the observation that all political actors should not value central bank autonomy equally. Rather, central bank autonomy is likely to be a source of conflict between those groups that favor low inflation and those who wish to use the economy for political ends. This assertion thus sets the stage for a redistributive perspective on central bank reform, in which central bank autonomy serves as a strategic tool through which conservative governments seek to limit the policy choices of their successors. I argue that where authoritarian elites fear the populism that may be endemic to new democracies and know that a change of regime is imminent, they can be expected to create an autonomous central bank to lock in a commitment to price stability over the long haul.

To lend support to this argument, the study draws upon evidence from the so-called third wave of democratization sweeping the globe over the past twenty-five years. It focuses primarily on two Latin American countries- Chile and Mexico-both of which undertook central bank reforms amid a transition from authoritarian rule. The study concludes by suggesting how this framework might be extended to institutional contexts beyond Latin America and to insulation strategies other than central banks.

At the broadest level, then, this is a book about efficiency versus redistribution in institutions. It is about how people in power protect their interests against subversion in the future. At a more pragmatic level, it is also an attempt to grapple with a recurring feature of the institutional landscape of the contemporary developing world. As I will be at great pains to show, the institutional constraints that new democracies face as they emerge from authoritarian rule are neither accidental nor surprising. Rather, they are the inevitable by-product of the very logic of the transition itself.

Theorizing Insulation in Transitional Democracies

For students of transitional polities, the observation that new democracies are frequently constrained by the institutional choices of former leaders is hardly novel. Contributors to the "transitions" literature have long recognized the continuing influence that previous authoritarian rulers can exert over certain areas of substantive policy-making. Valenzuela, for example, highlights a number of "reserved domains" that governmental officials "would like to control in order to assert governmental authority . . . but are prevented from controlling by veiled or explicit menaces of a return to authoritarian rule" (Valenzuela 1992, 65). Garretón similarly devotes an entire chapter to the myriad "political proscriptions and exclusions that limit the democratic game," coining the term authoritarian enclave to underscore their birthplace in the previous regime (Garretón 1989, 52).

Scholars of democratization have also speculated about the general processes producing these authoritarian institutional legacies. We know, for example, that during the negotiations that may precede the transition, the interests of the outgoing authoritarians are of paramount importance. More specifically, the "king and queen" of the transition game (propertied classes and armed forces) cannot be placed in direct jeopardy (O'Donnell and Schmitter 1986, 69). Absent certain guarantees that their interests will be protected, these elites may fail to support a democratic alternative (Przeworski 1991).

The pace and duration of the transition are also thought to bear on the authoritarians' ability to affect the substantive and procedural landscape of the new regime. Where political change is so sudden and sweeping that incumbent elites are caught off guard, they are less likely to play a role in shaping the parameters of what is to follow. But where the transition is more gradual and protracted, elites have more time to set the terms of their withdrawal. The implication is that exiting elites are more likely to leave a strong imprint on the transition in the latter set of "top down" elite-dominated transitions than those "bottom up" transitions led by the masses (Karl 1990; Karl and Schmitter 1994).

Despite these useful insights, however, the transitions literature has yet to offer an overarching explanation for the origins of these institutional holdovers and the conditions under which they are likely to arise. Absent any explicit analytical link between the nature of the authoritarians' interests, the pace of the transition process, and the subsequent appearance of these biased institutional forms, we are at best left with a series of correlations. When all is said and done, how and why these institutional enclaves come about remains a mystery.

In part, this theoretical lacuna is attributable to the fact that authors writing in this tradition have generally been more concerned with exposing the perverse implications of these institutional structures than with exploring their foundations (Karl 1986; Linz 1990; Sørenson 1993). Because of this overriding preoccupation with the "effects" question, the discussion of such insulation tactics has tended to be largely descriptive. This remains true, despite recent contributions where authors have speculated more precisely as to the conditions under which such insulation is likely to occur. In keeping with their broader arguments about regime change, for example, Haggard and Kaufman (1995, 109-39) maintain that the degree of economic crisis is likely to be an important factor in determining how much control exiting military elites are likely to retain under democratic rule. But given that such economic crises are in many cases caused by the very regimes whose behavior these authors seek to analyze, their argument is vulnerable to an endogeneity critique, similarly compromising any speculation about attendant insulation strategies. For their part, Linz and Stepan (1996, 66-71) suggest that we are most likely to see this sort of insulation behavior carried out by hierarchical militaries, followed by nonhierarchical militaries, civilian leadership, on down to sultanistic regimes. While this typology may be accurate, it fails to offer much in the way of a generalized rationale for the presence or absence of these authoritarian enclaves.

In addition to this descriptive bias, a more comprehensive explanation for these authoritarian enclaves has also been limited by a fundamental assumption underlying much of the transitions literature. According to this body of work, the transition is a time of great uncertainty with a large quotient of unpredictability and accident (O'Donnell and Schmitter 1986, 4). Actors may not know their preferences, and even if they do, their actions may have unforeseen consequences that prevent them from realizing their goals. The bottom line is that because of the uncertainty that pervades transitions, we as analysts cannot ascribe purposeful intent to the actions of actors in any systematic fashion.

This study questions the uncertainty assumption. Or at least it questions that assumption where an important set of actors is concerned: authoritarian elites who know that they are losing power to democratic forces. For these elites, the world is not so uncertain. Indeed, precisely because exiting elites can foresee the impact that democracy is likely to have on their interests, they act strategically to make sure that these are not placed at risk. In the chapters that follow, I use this assertion about actors' behavior to generate predictions about how exiting authoritarian elites use institutions to fend off the threat of democracy. I suggest why authoritarian elites choose to deploy institutions defensively; under what conditions they are likely to succeed; and why, once created, "their" institutions are likely to endure.

Insulation Strategies: Central Bank Autonomy

The starting point for this argument is the literature on bureaucratic insulation in the advanced industrial world. Contemporary theories of bureaucracy offer powerful insights into why an anticipated turnover in power may prompt politicians to use institutions defensively. In brief, the claim is that turnover matters because it signals that politicians cannot enjoy the perquisites of office forever. It also means that their opponents will someday be in power and are likely to pursue policies that work to their disadvantage. Recognizing that their days in office are numbered, incumbent politicians thus have incentives to create institutions that protect their interests from their opponents, who may, as a result, be left worse off (McCubbins, Noll, and Weingast 1987; Horn and Shepsle 1989; Moe 1990a).

It is easy to see how the thrust of this literature might accurately capture the distorting effects of the more obvious perverse institutional forms that tend to accompany transitions, such as biased electoral laws or veto powers for the military. It is admittedly more difficult to see its ready application to central bank reform.

After all, the conventional wisdom now holds that insulated bureaucracies are an essential component of successful economic reform in developing countries (Bates and Kreuger 1993, 464-65; Nelson 1993, 436; Geddes 1994a). By providing policymakers with protection from their political constituencies, such insulation is thought to facilitate the government's ability to use bureaucratic capabilities effectively without "threatening the economic logic of the adjustment process" (Callaghy 1989, 120). This is considered particularly important in new democracies where the reemergence of social demands heightens distributive pressures (Haggard and Webb 1994, 13-15). Central bank autonomy in many ways epitomizes the virtues attributed to such bureaucratic insulation.

And yet, it is precisely because this technocratic interpretation of central bank reform is so widely accepted that autonomy is rendered such an interesting candidate through which to explore the insulation dynamic at hand. For as I argue subsequently, there may be another story to tell in which the Pareto-improving nature of central bank reform is not a given. Rather, politicians have incentives to feel differently about the relative merits of central bank autonomy. The autonomy question is thus transformed from a simple efficiency story into a redistributive struggle over macroeconomic policy.

The Argument

Rethinking the Credibility Literature: The Logic of Tying Successors' Hands

Most research on central bank autonomy falls into the category of the "credibility" literature. In a nutshell, this literature argues that governments create autonomous central banks in order to "tie their own hands." Models build from the premise that all politicians have the ability to use surprise inflation to generate short-term gains in output (Kydland and Prescott 1977; Barro and Gordon 1983a, 1983b). As a result, even when governments may pledge a commitment to macroeconomic stability, domestic economic agents know that politicians will always be tempted to inflate to improve their electoral fortunes.

In order to solve this commitment problem, politicians take monetary policy out of their own hands and place it under the charge of an autonomous central bank. Precisely because the central bank does not have to respond to voters' interests, it is thought to be more likely to pursue policies conducive to macroeconomic stability (Wooley 1984; Cukierman 1992). The bottom line, then, according to the credibility literature, is that central bank autonomy enables governments to credibly commit to low inflation. And while autonomy is generally thought to come at the cost of greater output variability, on net, society is left better off by delegating monetary policy to a more conservative central banker (Rogoff 1985).

In addition to generating more than a decade's worth of research in the field of economics, the credibility hypothesis has become the received wisdom in political science. Its influence has been particularly strong on a small but growing body of literature that attempts to explain the recent trend toward central bank reform in developing countries. Maxfield (1997), for example, argues that developing country governments make their central banks autonomous in order to signal a commitment to low inflation before international creditors and investors. She thus modifies the conventional wisdom to underscore the important role that international economic actors play as an audience for developing country reforms. The basic intuition, however, is exactly the same: central bank autonomy is executed as a means of demonstrating a credible commitment to low inflation.

Despite the widespread currency of credibility-based reasoning within the fields of economics and political science, this study suggests three reasons that it needs to be nuanced with a more distinctly political orientation. Consider first the empirical evidence from the less developed countries (LDCs). There is no doubt that international economic pressures inevitably play a role in pushing developing country governments toward central bank reform. But if these pressures were the sole determinant of central bank autonomy, then virtually all developing countries would have autonomous central banks. And yet, as we will see in chapter 2, this is simply not the case. Variation is readily apparent whether one chooses to employ formal/legal or more behavioral measures of central bank independence. Even in the face of overriding economic incentives to delegate authority over monetary policy, then, some governments must find it advantageous to maintain political control over the central bank.

The observed empirical variation on central bank autonomy ties to a second weakness in the credibility literature: its underlying premise that all politicians have the same incentives to inflate. Partisan theories of political economy have long argued precisely the opposite. They suggest that parties of the left and right, for example, differ systematically over the mix of inflation and unemployment they prefer (Hibbs 1977). Early variants of these theories were discredited for their assumption of a permanently exploitable Phillips curve (the trade-off between low inflation and low unemployment). More recent work has demonstrated, however, that in the wake of uncertainty surrounding elections, politicians can capitalize upon a short-run Phillips curve in order to manipulate the economy temporarily to their advantage, whether toward low inflation (in the case of the right) or toward low unemployment (in the case of the left) (Alesina and Rosenthal 1995).


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