Political institutions and government spending behavior: theory and evidence from Iran


This study examines how the quality of political institutions affects the distribution of the government budget in Iran. We first introduce a mechanism through which democracy can shift government expenditure from national defense (military) to productivity-enhancing public spending (e.g., education). Using impulse response functions and a variance decomposition analysis on the basis of a vector autoregressive (VAR) model, our results imply that the response of military spending to an improvement (a deterioration) of democratic institutions is negative (positive) and statistically significant, whereas that of education spending is positive (negative) and significant. Our results are robust to other indicators of political institutions, different orderings of variables in the VAR, and alternative specifications of government spending categories.

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  1. 1.

    See the English translation of the message at http://www.princeton.edu/irandataportal/laws/proclamations/icrg-letter/ and its original text in Farsi at http://www.princeton.edu/irandataportal/laws/proclamations/icrg-letter/ICRG_Letter_Persian.pdf.

  2. 2.

    For a review of “The Revolutionary Guards’ Role in Iranian Politics,” see Alfoneh (2008).

  3. 3.

    In addition, Aidt and Eterovic (2011) suggest that political competition appears to be negatively correlated with the government size, and the opposite is true for political participation.

  4. 4.

    Saint-Paul and Verdier (1993) also present a model where public education constitutes an instrument of intergenerational redistribution and creates human capital. In their setup, democratization increases education spending.

  5. 5.

    Iran is a follower in the oil market, and global oil prices are determined to a great extent based on international markets and affected largely by factors beyond the Iranian economy, e.g., global economic growth, the production of other oil countries, OPEC restrictions, and speculation activities, among others.

  6. 6.

    Note that \(\varphi _{X}(Z^{*})\) is not equal to one because the worker is skilled and has a higher productivity than it could have achieved in the state sector, which requires no skills.

  7. 7.

    Adding a rent component to the utility of workers would leave the key message unchanged: Education spending in a democracy would still be relatively higher than that in an autocracy because its positive effect in Eqs. (7) and (8) would, in this case, be added to the negative effect in Eq. (6) to measure total welfare under a democratic state.

  8. 8.

    The Central bank of Iran follows the Government Finance Statistics Manual 2001—GFSM 2001 to prepare the income and spending categories of the government (http://www.cbi.ir/page/4488.aspx). In this classification of the functions of the government, the category “public order and safety” (which is translated into disciplinary services in the Iranian National Accounts—English version by CBI) includes police, fire protection services, law courts, prisons, and R&D related to public order and safety. The category of defense (military) spending covers military and civil defense, foreign military aid, and R&D related to defense. Thus, spending on “disciplinary or public order and safety” is related to law enforcement and the securing of property rights.

  9. 9.

    In the VAR estimation process, there are two steps: (1) estimating the reduced form for all equations and (2) computing the Cholesky decomposition of the variance-covariance matrix of the residuals. Therefore, the equations in VAR models are in their reduced form so that we can estimate each equation using the ordinary least squares (OLS) method.

  10. 10.

    These tests include a constant but not a time trend, as recommended by Dickey and Fuller (1979). To determine the number of co-integrating vectors, we use the approach of Johansen and Juselius (1990). The test statistics indicate that the hypothesis of no co-integration among the variables can be rejected for Iran. The results reveal that at least three co-integrating vectors exist among the variables of interest.

  11. 11.

    Because the GIR results are identical to those obtained by the Cholesky ordering, we have not reported them here. They are available upon request.

  12. 12.

    These results are available upon request.

  13. 13.

    The estimated VAR model satisfied the stability and co-integration conditions. The results of these tests are available upon request.

  14. 14.

    The results with Hamilton’s definition of asymmetric shocks are available upon request.

  15. 15.

    The diagnostic statistic results are available upon request.

  16. 16.

    In addition, we have estimated a VAR model using the per capita form of each component of government spending. We have estimated an unrestricted VAR model with a Cholesky ordering [polity, lhealthcap, ldefecap, ldicipcap, leducap, lcultcap]. We can find significant responses only for the defense expenditure. The IRF show that defense expenditure responds both negatively and significantly (within the first 2 years after initial shock) to a one-standard- deviation shock in the Polity index. We cannot find significant responses regarding the other types of expenditure. These results are available upon request.

  17. 17.



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The authors thank the helpful comments and suggestions of the Editor-in-Chief (Ronald B. Davies), two anonymous reviewers, Vesa Kanniainen, Christian Pfeil, Marcel Thum, and participants in the 8th Workshop on Political Economy (Dresden, 2014), and the 70th Annual Congress of the International Institute of Public Finance (Lugano, 2014).

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Correspondence to Alireza Naghavi.


Appendix 1

See Table 3.

Table 3 Summary statistics—sample period: 1960–2006

Appendix 2

See Table 4.

Table 4 Summary of main impulse response analyses

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Dizaji, S.F., Farzanegan, M.R. & Naghavi, A. Political institutions and government spending behavior: theory and evidence from Iran. Int Tax Public Finance 23, 522–549 (2016). https://doi.org/10.1007/s10797-015-9378-8

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  • Political institutions
  • Military spending
  • Education spending
  • Iran
  • VAR modeling

JEL Classification

  • H11
  • H41
  • P16
  • O53
  • O43