Incentives matter: the Mr Market LOOOOOVES death squads

In 1970, Chile elected Salvador Allende, a socialist, to office; he instituted sweeping reforms aimed at ending the corrupt rule of a small, monied, brutal elite; in 1973, the dictator Augusto Pinochet led a US-backed military coup that involved horrific torture and mass executions of political enemies.

In a Journal of Development Economics paper, Daniele Girardi and Samuel Bowles investigate the stock market's response to these two events. They find that share prices fell by 50% in response to Allende's democratic election, but the prices rallied, rising by 80% on the news that the country had been taken over by an autocratic dictator who had pledged to execute everyone who disagreed with him.

Pinochet was given direct, on-the-ground assistance by economists from the University of Chicago including Milton Friedman; Pinochet's cheerleaders included such notable advocates of personal liberty as Friedrich von Hayek.

To study the effect of political and institutional changes on the economy, we look at share prices in the Santiago exchange during the tumultuous political events that characterized Chile in the early 1970s. We use a transparent empirical strategy, deploying previously unused daily data and exploiting two largely unexpected shocks which involved substantial variation in policies and institutions, providing a rare natural experiment. Allende's election and subsequent socialist experiment decreased share values, while the military coup and dictatorship that replaced him boosted them, in both cases by magnitudes unprecedented in the literature. The most parsimonious interpretation of these share price changes is that they reflected, respectively, the perceived threat to private ownership of the means of production under a socialist government, and its subsequent reversal.

Institution shocks and economic outcomes: Allende's election, Pinochet's coup and the Santiago stock market [Daniele Girardi and Samuel Bowles/Journal of Development Economics] (non-paywalled version)

(via Marginal Revolution)