Politca Económica

The Political Economy of Local Governments’ Expenditures

by Linda Gonçalves Veiga Economic Policies Research Unit Universidade do Minho P-4710-057 Braga – Portugal Tel.: +351-253-604568 Fax: +351-253-676375 E-mail: linda@eeg.uminho.pt

Abstract: Although the literature on the political economy of public finance is already quite extensive, most articles analyse the behaviour of centralgovernments. Furthermore, studies about the Portuguese economy are scarce. The present article contributes for a better understanding of these phenomena by testing the influence of political factors on municipal expenditure decisions in Portugal. The dataset used in the empirical work has information for all mainland Portuguese municipalities from 1979 to 2000. The tests performed reveal that localpoliticians increase capital expenditures before elections, particularly on roads and streets construction. Results also indicate that when the mayor belongs to the party that dominates the municipal assembly capital expenditures are higher. Finally, no support was found for partisan effects on incumbents’ investment expenditures choices.

Keywords: political economy, local public finance, politics,Portugal.

Draft (April 2003)

The author acknowledges the financial support of the Portuguese Foundation for Science and Technology under the research grant (POCTI/2001/ECO/37457). I am also grateful to Francisco Veiga, Henry Chappell, and Martin Paldam for helpful comments. This article also benefited from the efficient research assistance of Claudia Ribeiro and César Coelho.

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1.INTRODUCTION Recently, a growing body of literature analysed the impact of political motives on economic policy decisions, particularly on fiscal policy. Although the international research on this topic is already quite extensive,1 most papers analyse the behaviour of central governments and very few focus on local authorities. Furthermore, the number of studies investigating the Portuguese case,both at the central or local governments, is extremely small. The present research contributes for a better understanding of these phenomena in Portugal. It studies the impact of political factors on capital expenditure decisions in a sample composed of all mainland Portuguese municipalities, over a twenty two year period (from 1979 to 2000) This article reveals that local politicians increasecapital expenditures before elections, particularly on items highly visible to the electorate such as streets and roads construction. This behaviour is in accordance with the rational opportunistic theory, which predicts that incumbents increase public expenditures before elections in order to appear more competent, and improve their chances of winning the election. Evidence also suggests that thesize of the opportunistic cycle does not depend on whether the mayor’s political party has a majority in the local assembly. Political cohesion is, however, positively associated with the amount of capital expenditures spent in the municipalities. Regarding partisan theory, the tests performed reveal that the mayor’s ideology does not determine the type of privileged investments. The next sectionbriefly reviews the literature on the political economy of public finance. Section 3 presents a short digression on municipalities in Portugal, while section 4 describes the dataset. The empirical strategy used to investigate the impact of elections on municipal expenditures is explained in section 5 and the results obtained are present in section 6. Finally, conclusions are reported.

2. THEPOLITICAL ECONOMY OF PUBLIC FINANCE In the seventies, two seminal contributions, Nordhaus (1975) and Hibbs (1977), initiated the literature on political business cycles2 (PBC). Nordhaus (1975) presented a model of opportunistic incumbents that manipulate the economy before elections in order to appear more competent and increase their probability of re-election. The model
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