preferences and deficits: do emu regions need an external control? francesc pujol departament...

Preferences and Deficits: Do EMU Regions Need an External Control?

Francesc PujolDepartament d’Economia

Universitat de Navarra

IEB, Universitat de Barcelona24 de novembre de 2003

Structure of the Presentation

1. Explaining Deficits. A Need for an External Control?

2. Tracking Voters’ Preferences

3. Impact of Voters’ Preferences on Fiscal Discipline. Swiss Cantonal Case.

4. Are Fiscal Preferences Endogenous?

1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity

EMU Fiscal Framework and Effects on Subnational Layer

• Compliance with European rules depends on the behavior of all levels of government

• ... But only the central level is held accountable for respecting these rules

• This asymmetry can increase incentives for lack of fiscal discipline at sub-national level (common pool problem)


Do Regions Need an External Control on Deficits?

It depends on where Regional deficits come from.

Causes of sub-national deficits:

A review of the literature (López Laborda and Vallés 2001; Vallés 2003; Fernández Llera 2003)


Rules and Institutions1. hyerarchy of processus2. legislative/executive power3. formal rules

Budgetoutcome

Politics1. party ideology2. political stability and cohesion3. decentralization4. direct democracy

Socio-Economic Determinants1. income growth, unemployment 2. inflation, interest rates3. demography4. past debt5. public sector size

Preferences1. Voters2. Policymakers


Ways and Means to Control Sub-National Deficits

Fernández Llera (2003), Balassone, Franco and Zotteri (2002)

1. Capital market discipline (external pressure)2. Coordination between sub-national entities3. A market for deficit permits4. Formal Rules

– Deficit limits– Debt Limits– Indirect Measures (Expenditure limits, budgetary process

5. Direct control from Central Administration– Formal prohibition of sub-national deficits– An explicit authorization before creating new debt– Transfer of loan revenues from Central to Regional layer


Weaknesses of Each Mechanism

1. Market: incompatibility with EMU restrictions

2. Coordination: Costs of reaching agreements; sanctions non effective; incentives of non respect of agreements.

3. Formal Rules: clash of competencies; creative accounting; lack of flexibility (asymmetric shocks).

4. Centralization: moral hazard, time inconsistency, adverse selection


Which Causes and Which Remedies?

Demographics (young people, old people, migration): coordination / centralization

Economic (income, unemployment, inflation, growth): coordination /centralization

Institutional: if differences accepted, coordination /centralization

Political: formal rules

Strategic behavior, level of fiscal discipline: formal rules


How much important are political, strategic and preferences pressures on deficits?

Those are the main variables justifying the adoption of common formal rules concerning deficits and debt at a sub-national level.

Let us choose a very special institutional setting which enables us to reasonably argue that we can take into account all strategic and preference effects on deficits by just analyzing voters’ preferences direct democracy


Under direct democracy, politicians are expected to follow as near as they can voters preferences in order to see their policy proposals not refused in popular referenda, and to ensure the chances of reelection.

If politicians try to follow the path of voters preferences, then the reversal may also be true:

Under direct democracy, voters’ preferences reveal us which are the expected policymakers attitudes and preferences in place in a given collectivity.


Are Voters’ Preferences Relevant for Fiscal Discipline?

MaybePoterba (1996)Stein, Talvi and Grisanti (1998)

Probably noVon Hagen and Harden (1994)Bayoumi and Eichengreen (1995)Alesina and Perotti (1997)

Apparently yesRueben (1995)Dafflon and Pujol (2001)


Looking for Proxies of “Fiscal Conservatism”

• Political Parties Ideology(Holtz-Eakin, 1988)→ too crude measure

2. Establishing the list of “commonly agreed” Fiscal Conservative collectivities(Bohn and Inman 1997, Alesina and Bayoumi 1996) → an ex ante choice, without empirical support.

3. % of voters themselves identified as conservatives(Bohn and Inman 1997) → no clear relationship with deficits (Alesina and Roubini 1997)


A Measure of Voters’ Preferences on Fiscal Discipline

Taking advantage of exceptional Swiss institutional setting (fiscal federalism + semi direct democracy)

26 cantons with high level of autonomy to fix the level of cantonal taxes and expenditures. No external (confederation, UE) limits or restrictions on cantonal debt and deficits.

This leads to a wide differences on debt accumulation between 1979 and 1996


Referenda Nature: compulsory, facultative, constitutional initiative.Scope: Confederation, canton, local governmentPeriodicity: several times a year (4 to 8 voting days per year)

Swiss Semi Direct Democracy


An Index of Cantonal Fiscal Conservatism

StrategyLook at cantonal response to federal referenda concerning voting on budgetary issues: fiscal adjustment programs, tax modification, federal grants program modification.

Advantages1. All cantons vote on the same issue, without knowing other cantons’ behavior2. The voting is not linked a priori with cantonal fiscal situation



75 pertinent referenda between 1979 and 1998 (out of 156)



Each vote result normalized to value 50 referring to Swiss average acceptance of the proposed issue.

Each cantonal index calculated as the average of these 75 observations

A value higher than 50 reflects a more fiscal conservative profile than the Swiss average

A value lower than 50 corresponds to a canton less fiscal conservative than the Swiss average


Index of Cantonal Fiscal Convervatism (1979-1998)

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35

40

45

50

55

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Val

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Luc

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Ber

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Obw

ald

Gri

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Uri

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Explaining Swiss Cantonal Deficits

Economic determinants• Income• Income growth• Initial level of public debt

Structural determinants• Share of cantonal revenues coming from the Confederation• % cantonal expenditures over canton + local gov exp• % people living in cities• % of agriculture sector in cantonal economy• Demographics (% of 65+)



Political determinants• Share of right wing parties in Cantonal Government• Number of parties forming the Government

Fiscal Institutions• Cantonal compulsory referendum

Fiscal Preferences• Cantonal Referenda Behavior



Cross section analysis, using difference between final and initial level for dynamic variables. OLS and WLS.

Also panel data analysis (annual deficits).

Reduced forms (to increase degrees of freedom)



An additional point of the index of fiscal conservatism supposes a decrease of 380-650 Swiss francs of debt per inhabitant.

Influence of cantonal economic growth, urban distribution, (income), (share of agriculture sector), (share of cantonal income coming from the Confederation)


The adjusted R2 of the OLS model are, respectively : 0.554; 0.619; 0.554; 0.607


Conclusion

Our results suggest that

there is room for justifying the adoption of formal rules

(imposed by the Central Administration or by agreement with Regional cooperation)

to induce fiscal discipline at sub-national level,

when the ensemble of sub-national entities should reach a given deficit target

Are Voters’ Fiscal Preferences Exogenous?

If Voters’ manifested preferences are actually largely dependent on economic factors, then the measure proposed is superfluous as it is already captured by the standard variables included in explanatory models of deficits.

We test then if voters’ preferences can be explained by strictly non economic variables


Explaining Voters’ Fiscal Preferences

Ideological Preferences• % of leftists parties voters

Cultural determinants• Cultural area of influence (% German speaking people)• Religion influence (% Protestant)• University canton• (Urban cantons)


Explaining Voters’ Fiscal Preferences

Empirical results• Significant influence of strict cultural variables, specially the

variable Language.

• Cantons supporting Leftist parties are less proned to accept fiscal discipline choices


Checks of robustness1. Excluding referenda on grants and agriculture issues in

the calculation of the dependent variable

2. Regressing the Index of Fiscal Conservatism against the variable “Federal Funds”. Then regress the residuals against the standard explanatory model

1. Regressing only against the variable Language

Empirical results remain stable


ConclusionsLanguage (cultural appurtenance) behaves as a good proxy for voters’ fiscal preferences.

This is an ex post conclusion, non an ex ante supposition.

Fiscal Preferences cannot thus be reduced to a sub product of economic and political determinants.

If it is feared that preferences can play a role in better explaining an economic issue, an specific measure of such preferences ought to be elaborated.


preferences and deficits: do emu regions need an external control? francesc pujol departament...

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