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

Abstract

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.

This is a preview of subscription content, access via your institution.

Fig. 1
Fig. 2
Fig. 3
Fig. 4
Fig. 5
Fig. 6
Fig. 7

Notes

  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.

    http://www.al-monitor.com/pulse/originals/2014/04/irgc-iran-rouhani.html#

References

  1. Acemoglu, D. (2005). Politics and economics in weak and strong states. Journal of Monetary Economics, 52(7), 1199–1226.

    Article  Google Scholar 

  2. Acemoglu, D., Ticchi, D., & Vindigni, A. (2010). A theory of military dictatorships. American Economic Journal: Macroeconomics, 2(1), 1–42.

    Google Scholar 

  3. Acemoglu, D., Ticchi, D., & Vindigni, A. (2011). Emergence and persistence of inefficient states. Journal of the European Economic Association, 9(2), 177–208.

    Article  Google Scholar 

  4. Aidt, T. S., Dutta, J., & Dauntan, M. (2010). The retrenchment hypothesis and the extension of the franchise in England and Wales. The Economic Journal, 120(547), 990–1020.

    Article  Google Scholar 

  5. Aidt, T. S., & Eterovic, D. S. (2011). Political competition, electoral participation and public finance in 20th century Latin America. European Journal of Political Economy, 27(1), 181–200.

    Article  Google Scholar 

  6. Alfoneh, A. (2008). The revolutionary guards’ role in Iranian politics. Middle East Quarterly, 15(4), 3–14.

    Google Scholar 

  7. Berument, M. H., Ceylan, N. B., & Dogan, N. (2010). The impact of oil price shocks on the economic growth of selected MENA countries. The Energy Journal, 31(1), 149–176.

    Google Scholar 

  8. Besley, T., & Kudamatsu, M. (2006). Health and democracy. American Economic Review, 96(2), 313–318.

    Article  Google Scholar 

  9. Besley, T., & Persson, T. (2009). Repression or civil war? American Economic Review, 99(2), 292–297.

    Article  Google Scholar 

  10. Besley, T., & Robinson, J. A. (2010). Quis custodiet ipsos custodes? Civilian control over the military. Journal of the European Economic Association, 8(2–3), 655–663.

    Article  Google Scholar 

  11. Brown, D., & Hunter, W. (2004). Democracy and human capital formation: Education spending in Latin America, 1980–1997. Comparative Political Studies, 37(7), 842–864.

    Article  Google Scholar 

  12. CBI. (2014). Annual National Accounts of Iran. Central bank of Iran.

  13. Clements, M. P., & Hendry, D. F. (1995). Forecasting in cointegrated systems. Journal of Applied Econometrics, 10(2), 127–146.

    Article  Google Scholar 

  14. Deger, S. (1985). Human resources, government education expenditure and the military burden in less developed countries. Journal of Developing Areas, 20(1), 37–48.

    Google Scholar 

  15. Dickey, D. A., & Fuller, W. A. (1979). Distribution of the estimators for autoregressive time series with a unit root. Journal of the American Statistical Association, 74(366), 427–431.

    Article  Google Scholar 

  16. Dizaji, S. F., & van Bergeijk, P. A. G. (2013). Potential early phase success and ultimate failure of economic sanctions: A VAR approach with an application to Iran. Journal of Peace Research, 50(6), 721–736.

    Article  Google Scholar 

  17. Doan, T. (2000). RATS version 5 user’s guide. Evanston: Estima.

    Google Scholar 

  18. Engle, R. F., & Yoo, B. S. (1987). Forecasting and testing in co-integrated systems. Journal of Econometrics, 35(1), 143–159.

    Article  Google Scholar 

  19. Falkinger, J., & Grossmann, V. (2005). Institutions and development: The interaction between trade regime and political system. Journal of Economic Growth, 10(3), 231–272.

    Article  Google Scholar 

  20. Farzanegan, M. R. (2011). Oil revenue shocks and government spending behavior in Iran. Energy Economics, 33(6), 1055–1069.

    Article  Google Scholar 

  21. Farzanegan, M. R., & Markwardt, G. (2009). The effects of oil price shocks on the Iranian economy. Energy Economics, 31(1), 134–151.

    Article  Google Scholar 

  22. Farzanegan, M. R., & Parvari, M. R. (2014). Iranian-oil-free zone and international oil prices. Energy Economics, 45(C), 364–372.

    Article  Google Scholar 

  23. Fordham, B. O., & Walker, T. C. (2005). Kantian liberalism, regime type, and military resource allocation: Do democracies spend less? International Studies Quarterly, 49(1), 141–157.

    Article  Google Scholar 

  24. Fuller, W. A. (1976). Introduction to statistical time series. New York: Wiley.

    Google Scholar 

  25. Goldsmith, B. E. (2003). Bearing the defense burden, 1886–1989: Why spend more? Journal of Conflict Resolution, 47(5), 551–573.

    Article  Google Scholar 

  26. Hamilton, J. D. (1996). This is what happened to the oil price–macroeconomy relationship. Journal of Monetary Economics, 38(2), 215–220.

    Article  Google Scholar 

  27. Hausken, K., Martin, C. W., & Plümper, T. (2004). Government spending and taxation in democracies and autocracies. Constitutional Political Economy, 15(3), 239–259.

    Article  Google Scholar 

  28. Hewitt, D. (1992). Military expenditures worldwide: Determinants and trends, 1972–1988. Journal of Public Policy, 12(2), 105–152.

    Article  Google Scholar 

  29. Hoffman, D. L., & Rasche, R. H. (1996). Assessing forecast performance in a cointegrated system. Journal of Applied Econometrics, 11(5), 495–517.

    Article  Google Scholar 

  30. James, P., Solberg, E., & Wolfson, M. (1999). An identified systemic model of the democracy-peace nexus. Defense and Peace Economics, 10(1), 1–38.

    Article  Google Scholar 

  31. Johansen, S., & Juselius, K. (1990). Maximum likelihood estimation and inference on cointegration-with applications to the demand for money. Oxford Bulletin of Economics and Statistics, 52(2), 169–210.

    Article  Google Scholar 

  32. Kimenyi, M. S., & Mbaku, J. M. (1995). Rents, military states, and political democracy. European Journal of Political Economy, 11(4), 699–708.

    Article  Google Scholar 

  33. Lebovic, J. H. (2001). Spending priorities and democratic rule in Latin America. The Journal of Conflict Resolution, 45(4), 427–452.

    Article  Google Scholar 

  34. Marshall, M. G., Gurr, T. R., & Jaggers, K. T. (2012). POLITY \({}^{{\rm TM}}\) IV PROJECT: Dataset users’ manual. Center for Systemic Peace.

  35. Mork, K. A. (1989). Oil and the macroeconomy when prices go up and down: An extension of Hamilton’s results. The Journal of Political Economy, 97(3), 740–744.

    Article  Google Scholar 

  36. Mork, K. A. (1994). Business cycles and the oil market. The Energy Journal, 15, 15–38.

    Google Scholar 

  37. Naka, A., & Tufte, D. (1997). Examining impulse response functions in cointegrated systems. Applied Economics, 29(12), 1593–1603.

    Article  Google Scholar 

  38. Olson, M. (1993). Dictatorship, democracy, and development. The American Political Science Review, 87(3), 567–576.

    Article  Google Scholar 

  39. Oneal, J. R., & Russett, B. M. (1997). The classical liberals were right: Democracy, interdependence and conflict, 1950–1985. International Studies Quarterly, 41(2), 267–294.

    Article  Google Scholar 

  40. Palmer, G. (1990). Alliance politics and issue areas: Determinants of defense spending. American Journal of Political Science, 34(1), 190–211.

    Article  Google Scholar 

  41. Pesaran, M. H., & Shin, Y. (1998). Generalised impulse response analysis in linear multivariate models. Economics Letters, 58(1), 17–29.

    Article  Google Scholar 

  42. Plümper, T., & Martin, C. W. (2003). Democracy, government spending, and economic growth: A political-economic explanation of the Barro-effect. Public Choice, 117(1–2), 27–50.

    Article  Google Scholar 

  43. Rodrik, D. (2007). One economics, many recipes: Globalization, institutions, and economic growth. Princeton, NJ: Princeton University Press.

    Google Scholar 

  44. Russett, M. (1969). Who pays for defense? The American Political Science Review, 63(2), 412–426.

    Article  Google Scholar 

  45. Saint-Paul, G., & Verdier, T. (1993). Education, democracy and growth. Journal of Development Economics, 42(2), 399–407.

    Article  Google Scholar 

  46. Sims, C. A. (1980). Macroeconomics and reality. Econometrica, 48(1), 1–48.

    Article  Google Scholar 

  47. Sims, C. A., Stock, J., & Watson, M. (1990). Inference in linear time series models with some unit roots. Econometrica, 58(1), 113–144.

    Article  Google Scholar 

  48. Sims, C. A., & Zha, T. (1999). Error bands for impulse responses. Econometrica, 67(5), 1113–1156.

    Article  Google Scholar 

  49. Stock, J. H., & Watson, M. (2001). Vector autoregressions. Journal of Economic Perspectives, 15(4), 101–115.

    Article  Google Scholar 

  50. Tijerina-Guajardo, J. A., & Pagán, J. A. (2003). Government spending, taxation, and oil revenues in Mexico. Review of Development Economics, 7(1), 152–164.

    Article  Google Scholar 

  51. Vanhanen, T. (2011). Measures of democracy 1810–2010. FSD1289, version 5.0. Tampere: Finnish Social Science Data Archive.

  52. Wintrobe, R. (2001). How to understand, and deal with dictatorship: An economist’s view. Economics of Governance, 2(1), 35–58.

    Article  Google Scholar 

  53. Wintrobe, R. (2012). Autocracy and coups d’état’. Public Choice, 152(1–2), 115–130.

    Article  Google Scholar 

  54. Yildirim, J., & Sezgin, S. (2005). Democracy and military expenditure: A cross-country evidence. Transition Studies Review, 12(1), 93–100.

    Article  Google Scholar 

Download references

Acknowledgments

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).

Author information

Affiliations

Authors

Corresponding author

Correspondence to Alireza Naghavi.

Appendices

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

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

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

Download citation

Keywords

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

JEL Classification

  • H11
  • H41
  • P16
  • O53
  • O43