This paper examines the Faustian dynamics of policy and power. We posit a general class of dynamic games in which current policies affect the future distribution of political power, resulting in the following Â“Faustian trade offÂ”: if the current ruler chooses his preferred policy, he then sacrifices future political power; yet if he wants to preserve his future power, he must sacrifice his present policy objectives. The trade-off comes from the fact that the current political ruler/pivotal voter cannot un-couple the direct effect of his policy from its indirect effect on future power. A Policy-endogenous (PE) equilibrium describes this endogenous transfer of power, and the resulting evolution of policy and political power over time. We show that the Faustian trade-off in a PE equilibrium is decomposed into two basic rationales. The political preservation effect induces more tempered policy choices than if oneÂ’s policy choice did not affect oneÂ’s political fortunes. However, the reformation effect induces Â“more aggressiveÂ” policies in order to exploit the productivity gains from policies chosen by even more aggressive successors. We distinguish between political systems that give rise to monotone Faustian dynamics Â— political power that progressively evolves toward more fiscally liberal types of leaders, and cyclical Faustian dynamics Â— political power that oscillates between liberal and conservative types of leaders. In each case, we show that the Faustian trade off moderates the choices of each type of leader.Monotone and cyclical Faustian dynamics, policy-endogenous equilibrium, permanent authority, preservation and reformation effects, biased political system, distortion-adjusted Euler equation
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