Associated Press
In the days following Donald Trump’s reelection, we, like millions of others, spent a fair amount of time reading articles recapping the political earthquake we’re living through. Trump won every swing state and the popular vote, and why? It was the economy, wrote journalist after journalist, in an echo of political strategist James Carville’s famous line from the 1992 presidential election: “It’s the economy, stupid.” Despite all the hot-button issues swirling throughout the presidential campaigns, when the time came, people primarily voted their pocketbooks. As economists ourselves, we can’t disagree with this general assessment.
That said, many journalists and pundits seem puzzled by a conundrum. The economy under President Joe Biden was remarkably strong, so why did Biden lose? The White House released a brief on October 30, just days before the election, touting the latest quarterly data. Under the Biden administration, real GDP rose 12.6 percent, rightly cheered in the report as “a historically robust expansion” that repeatedly defied forecasts. Since the pandemic, economic growth in the US has far outpaced that of our peer nations. Business investment is up; unemployment is low.
The consensus in the media seems to be that even though the economy is strong, people see it differently. Voters, burned by the rising price of groceries, felt pinched and demanded change. This story surely describes some voters, but we find it hard to believe that Americans elected Trump because they are confused about the economy.
Our research tells a different story, in which nobody is confused. Before the 2016 election, we wrote a simple economic model to explain the interplay between stock market returns and presidential elections. We then conducted an empirical analysis using 89 years of data. What we find challenges the notion that voters simply reward incumbents for strong economies and punish them for weak ones. While this narrative carries a fair amount of truth, it does not paint the full picture. The economy affects election outcomes in more than one way. It is not enough to say that a strong economy favors the incumbent.
Our main thesis is that a strong economy favors Republicans, and a weak economy favors Democrats, regardless of the incumbent.
Take the two biggest economic crises of the past century. In November 1932, when Americans were living through the Great Depression, they put Franklin D. Roosevelt, a Democrat, in the Oval Office. In November 2008, during the Great Recession, they elected Barack Obama, another Democrat.
Our mechanism doesn’t rely on voters acting irrationally by ignoring the strength of the economy and focusing only on the price of milk and eggs.
These are not the only examples of recessions that were good for Democratic candidates. John F. Kennedy was chosen in 1960, during the 1960–61 recession. Jimmy Carter became president after the 1973–75 recession. Bill Clinton won shortly after the 1990–91 recession. And they are not coincidences, according to our model.
In fact, the same pattern has held for all three presidential elections since 2015, when our data ended. In November 2016, when the economy was doing well, the Republican candidate, Donald Trump, was elected. In November 2020, during the COVID-19 crisis, voters preferred a Democrat, Joe Biden. This year, with the economy doing well again, the electorate went Republican. Summing up, all three elections that took place since we first wrote our model went exactly the way it predicted they would.
It indicated that the 2024 election would be won by the Republican candidate not despite the strong economy but precisely because of it. Our mechanism doesn’t rely on voters acting irrationally by ignoring the strength of the economy and focusing only on the price of milk and eggs. In our model, everyone behaves rationally, and what matters to voters is simply the parties’ opposing take on taxes.
In general, Democrats prefer high tax rates, and Republicans prefer low ones. When electing one party or the other, voters expect taxes to rise or fall. According to our calculations, the ratio of taxes to GDP rises by 0.44 percent per year, on average, under Democratic administrations and falls by 0.3 percent per year under Republican administrations. That’s a spread of 0.74 percent per year, which is highly significant.
Key to our findings is how voters feel about risk. We argue that when the economy is weak, Americans become more risk averse, and that’s why they favor the party that promises redistribution and social insurance—Democrats. During booms, by contrast, voters are more willing to take risks and therefore more likely to elect Republicans, who favor lower taxes.
We were, like many other people, still somewhat surprised by Trump’s win, because we don’t expect our simple model to explain voter behavior perfectly. The model assumes a single policymaker and ignores the interaction between various branches of government. Also, real-world Americans care about much more than just taxes—issues including abortion, immigration, social justice, wars, pronouns, and the candidates’ personal traits were also in the mix during this voting cycle. All of those could have, in principle, determined the outcome of the election.
According to our model, periods of rapid economic growth make Americans more comfortable with risk, increasing the likelihood of electing Republicans who support lower taxes. During slower growth, however, voters become more cautious, favoring Democrats for their focus on social insurance and redistribution.
If our argument holds, there’s also a lesson here for investors: Brace for lower-than-usual stock market returns under the new Trump administration. In finance, there’s a phenomenon known as the “presidential puzzle”—stock returns have been higher under Democratic administrations than Republican ones. Between 1927 and 2015, the period analyzed in our study, the average excess market return was nearly 11 percent per year higher under Democrats than Republicans.
Our model offers an explanation for this pattern. It’s not that Democratic presidents cause high stock returns; rather, they tend to get elected when risk aversion and expected future returns are high. The opposite is true for Republicans. According to our model, Trump just got elected because risk aversion is low due to the strong economy. And when risk aversion is low, so are expected future returns. Though the stock market spiked when the election results became clear, as the political uncertainty fades and the prospect of lower taxes sinks in, the stage is now set for lower stock returns during Trump’s term. This is not Trump’s fault—blame it on the strong economy under Biden.
Lubos Pastor is the Charles P. McQuaid Distinguished Service Professor of Finance and a Robert King Steel Faculty Fellow at Chicago Booth. Pietro Veronesi is deputy dean for faculty and the Chicago Board of Trade Professor of Finance at Booth.
Lubos Pastor and Pietro Veronesi, “Political Cycles and Stock Returns,” Journal of Political Economy, November 2020.
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