preferences and deficits: do emu regions need an external control? francesc pujol departament...
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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
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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
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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)
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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)
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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.
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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)
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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)
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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An Index of Cantonal Fiscal Conservatism
75 pertinent referenda between 1979 and 1998 (out of 156)
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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An Index of Cantonal Fiscal Conservatism
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
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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Index of Cantonal Fiscal Convervatism (1979-1998)
30
35
40
45
50
55
Jur
a
Gen
ève
Neu
chât
el
Val
ais
Vau
d
Fri
bour
g
Tes
sin
Sol
eure
Sch
affh
ouse
Sch
wyt
z
Bâl
e-V
ille
Bâl
e-C
ampa
gne
Arg
ovie
Luc
erne
Ber
ne
Obw
ald
Gri
sons
Thu
rgov
ie
Uri
Zou
g
Nid
wal
d
Zur
ich
St-
Gal
l
App
enze
ll R
hExt
.
Gla
ris
App
enze
ll R
hInt
.
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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+)
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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Explaining Swiss Cantonal Deficits
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
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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Explaining Swiss Cantonal Deficits
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)
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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Explaining Swiss Cantonal Deficits
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)
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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The adjusted R2 of the OLS model are, respectively : 0.554; 0.619; 0.554; 0.607
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1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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
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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
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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)
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity
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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.
1. Need for control? / 2. Voters Preferences / 3. Preferences and Deficits / 4. Endogeneity