Economic Shocks and Populism: The Political Implications of Reference-Dependent Preferences


This paper studies electoral competition over redistributive taxes between a safe incumbent and
a risky opponent. As in prospect theory, economically disappointed voters become risk lovers,
and hence are intrinsically attracted by the more risky candidate. We show that, after a large
adverse economic shock, the equilibrium can display policy divergence: the more risky
candidate proposes lower taxes and is supported by a coalition of very rich and very
disappointed voters, while the safe candidate proposes higher taxes. This can explain why new
populist parties are often supported by economically dissatisfied voters and yet they run on
economic policy platforms of low redistribution. We show that survey data on the German
SOEP are consistent with our theoretical predictions on voters’ behavior.
JEL-Codes: H000, D700, D900.