Summary of JOIE article (18 August 2022) by Vincent Tawiah. The full article authored by Vincent Tawiah, DCU Business School, Dublin City University, Dublin, Ireland, Sivathaasan Nadarajah, Department of Accounting, Finance and Economics, Griffith Business School, Griffith University, Brisbane, Australia, Md Samsul Alam and Tom Allen, Leicester Castle Business School, De Montfort University, Leicester, UK is available on the JOIE website.
Leftist and rightist governments hold contending views on how the economy should be managed and have acted upon them, causing variations in socio-economic outcomes.
The impact of political ideology on domestic credit seems straight forward, but is a contentious issue. In a highly globalised and industrialised world, some scholars have argued that the impact of partisan politics, at best, has a marginal effect on economic outcomes. Consider the fact that, financial institutions are globally integrated and money can easily be moved from one country to another with ease. Moreover, there is growing number of multinational and transnational financial institutions and banks; hence, lenders are more likely to move funds to countries with favourable returns not necessarily based on the political party in government.
Whereas factors such as globalisation, technology, economics, demography, and culture are not insignificant determinants of domestic credit, the place of political ideology is central because all these factors are directly or indirectly shaped by government policies, and these policies emanate from the political ideology of the party in government.
For instance, political ideology shapes government policies relating to interest rate and inflation. Left-leaning governments are more likely to stimulate consumption creating high inflation. Right-leaning governments, on the other hand, are likely to formulate policies aimed to promote pro-market reforms by reducing the inflation rate.
From the supply side, in a left-leaning government, financial institutions will consider the expansionary and consumption-led policies of the government in designing their lending activities. For example, the financial institution needs to incorporate an increase in inflation rate on its lending rate for long-term loans. In addition, financial institutions would allocate a lesser amount of funds for loans to the private sector under the left-leaning government, because of the expectation of high-interest rate and slow private sector growth. However, financial institutions will plan for an increase in government borrowings at a high-interest rate, which will give higher profits to the financial institutions. In contrast, financial institutions may allocate a large sum of funds for loans in right-leaning government due to the expectation of investment-driven policies, such as interest rate cuts and higher commitment to the private sector growth.
From the demand side left-leaning governments will need more loans to finance the consumption-driven and expansionary budget creating a crowd-out effect on the credit market, resulting in high-interest rate and fewer funds to the private sector. In contrast, right-leaning governments will induce an increase in domestic credit to the private sector through favourable investment policies such as interest rate cuts, fewer government borrowings, and a reduction in the inflation rate.
Our analysis suggests that left-leaning governments reduce domestic credit allocations, left-leaning governments increase domestic credit to the public sector, and right-leaning governments boost credit to the private sector.
Our study contributes to the understanding of how banks and financial institutions respond to the political agendas of various governments. Specifically, we show that in a country where a right-leaning government is in power, lenders are inclined to lend more loans to the private sector. However, lenders may be incentivised to make additional loans to the public sector, particularly in left-leaning countries.
The findings imply that, even in the wake of globalisation and integrated financial markets, political ideology has a significant impact on the credit market due to the differences in policies and actions. Our results also imply that financial institutions model lending activities according to the ideological difference of the political parties; banks selectively allocate more credit to the private sector if the right-leaning political party is in government. Thus, players in the domestic credit market (e.g., credit lending institutions and borrowers) should focus on the differences in policies between left-leaning and right-leaning governments since differences in ideology affect the demand and supply of funds in the domestic debt market.
