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Overlapping political budget cycles

Abstract

We advance the literature on political budget cycles by testing for cycles in expenditures for elections to the legislative and the executive branches. Using municipal data, we identify cycles independently for the two branches, evaluate the effects of overlaps, and account for general year effects. We find sizable effects on expenditures before legislative elections and even larger effects before joint elections to the legislature and the office of mayor. In the case of coincident elections, we show that it is important whether the incumbent chief executive seeks reelection. To account for the potential endogeneity of that decision, we apply an IV approach using age and pension eligibility rules.

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Notes

  1. 1.

    Alternatively, Persson and Tabellini (2000) and Shi and Svensson (2006) provide a theoretical foundation for political budget cycles assuming rational expectations and moral hazard. A second strand of theoretical work relates to partisan cycles (e.g., Hibbs 1977; Alesina 1987, 1988a) that explain electoral cycles by shifts in political ideology.

  2. 2.

    Studies finding only weak or no evidence for cycles in real macroeconomic aggregates include, among others, Lächler (1978), Golden and Poterba (1980) and Alesina et al. (1997).

  3. 3.

    Further evidence at the national level is provided by Alesina (1988b), Alesina et al. (1992), Schuknecht (1999), Potrafke (2012) and Klomp and Haan (2013).

  4. 4.

    While some papers study the composition of spending and distinguish between different types of spending categories that are more or less observable (see, e.g., Khemani 2004; Drazen and Eslava 2010), we take the route of most of the literature and study total expenditures.

  5. 5.

    The unique setting of our design is acknowledged in Alesina and Passalacqua (2016) in the Handbook of Macroeconomics.

  6. 6.

    While a longer time series would always be desirable, we are bound by data availability in Baden-Württemberg before 1992 and the introduction of new accounting standards in Bavaria after 2006.

  7. 7.

    More broadly, our paper generally contributes to the understanding of political economy at the regional level (see, e.g., Kessing 2010; Solé-Ollé and Viladecans-Marsal 2013; Baskaran 2012; Freier and Odendahl 2015; Garmann 2015).

  8. 8.

    Note that the literature is divided into research studying the size of aggregate expenditures close to elections (similar to our question) and those testing for PBCs in the composition of expenditures. Evidence for the latter is first presented by Blais and Nadeau (1992) and Kneebone and Mckenzie (2001) for Canada and subsequently by Drazen and Eslava (2010), Veiga and Veiga (2007) and Akhmedov and Zhuravskaya (2004) in the case of municipal or regional legislative elections in Colombia, Portugal and Russia, respectively. Common to all their results is a shift in expenditures, especially to categories with high visibility for the electorate.

  9. 9.

    Earlier studies for Germany include Seitz (2000), Galli and Rossi (2002) and Schneider (2010) as well as Mechtel and Potrafke (2013), which test for PBCs in total expenditures, budget deficits and unemployment using state-level data.

  10. 10.

    In Sect. 5, we highlight that we can control for the timing of state-level elections. However, as we have just two states, we cannot make the same analytical progress (carefully studying the interaction of those cycles) as skillfully achieved by Furdas et al. (2015). On the other hand, our focus on executive and legislative budget cycles can be studied uniquely in the present design, as institutional circumstances and data availability prevent us from using other German states.

  11. 11.

    The municipal level in Germany is the lowest of four governmental tiers. In addition to the federal level, Germany comprises 16 federal states, about 450 counties and about 12,000 municipalities.

  12. 12.

    Note that the mayor also is a voting member of the council. Generally, the mayor is responsible for city administration, formulating all municipal decisions and overseeing their implementation. Also, she often is the town’s only full-time working politician.

  13. 13.

    The electoral rules in both states are quite similar. There are, however, also subtle differences. For legislative elections, both states have open-list proportional elections where voters have as many votes as there are seats in the council (which allows for vote-splitting and cross-voting). There are no explicit hurdles for small parties. While BW uses a Sainte-Lague seat allocation mechanism, BAY uses a two-step D’Hondt approach. For executive elections, both states use a two-round majoritarian procedure. If no candidate obtains the absolute majority in the first round, a second election must be held. In BAY, this second election is a classical run-off election between the two leading candidates. In BW, the second election is open (even new candidates are allowed) and first-past-the-post.

  14. 14.

    Exceptions to this rule arise when mayoral terms end prematurely. In that case, a Bavarian municipality might hold an independent executive branch election for one term, with the requirement to align with the state wide election dates again in the subsequent election.

  15. 15.

    The number of elections in BW goes up slightly over time as it becomes easier to obtain all necessary information in later years.

  16. 16.

    No option for premature elections exists for the legislative branch. As no formal coalition agreements are negotiated at the local level, a municipal government cannot break down. If a council member dies in office or resigns for personal reasons, she is replaced automatically with a successor. These successors are determined during the election and consist of candidates which exhibited sufficient votes but have not been allocated seats in the local council due to the D’Hondt allocation mechanism.

  17. 17.

    While recall is a constitutionally guaranteed right of the citizens and the council, we almost never observe such an event during the period covered in this study.

  18. 18.

    We discuss the importance of premature executive elections further in our section on identification (see Sect. 5).

  19. 19.

    Municipalities in BW are responsible for 52.9% of all state expenditures, which exceeds the German average (including municipal budgets as well as public companies under the control of local towns). Municipalities in BAY administer 49.7% of total state spending.

  20. 20.

    And even then, evidence from those other German states would be particular as their direct mayoral elections were introduced very recently.

  21. 21.

    BAY was governed by absolute majorities of the Conservative Party throughout the period covered by this study. In BW, the Conservative Party also headed the state’s government; however, it did so as the predominant member of a coalition.

  22. 22.

    Consequently, the municipal structures are quite similar. While BW has slightly larger municipalities on average, the differences are rather small compared to other German states. Together, the two states account for more than 25% of the German population.

  23. 23.

    Together they account for approximately 75% of total state income redistribution under the German fiscal equalization scheme (see Heinemann et al. 2015).

  24. 24.

    Municipalities in other German states might have very limited financial opportunities for extraordinary investment projects or other general pork barrel spending before elections.

  25. 25.

    The latter, for instance, involves issues regarding public administration.

  26. 26.

    One careful referee raised the issue that mayors could in fact have incentives to signal competence even when not running for office again: if they hope to be elected in a different municipality, they may still opt to increase spending. Reassuringly, the number of such cases is not large in our dataset. Ninety-eight percent of the candidates in our sample run for election only in a single municipality. We further want to note, however, that as those switching candidates are included in the baseline model (coded as not re-running), any positive spending effect for them would represent a lower-bound and conservative coefficient estimate.

  27. 27.

    We would argue that it is indeed very likely that both branches can claim (at least partial) credit. That is particularly the case because local mayors and local council members face much higher degrees of direct political exposure to one another than they do at higher levels of government. We therefore assume that mayors and councils can solve any emerging free-rider problems or credit-claiming issues. If voters attribute spending to a particular politician and reward her accordingly, the resulting incentives could well produce the opposite results in which, e.g., a mayor would spend more only when she receives all of the credit in her stand-alone election. While we cannot rule out that credit-claiming or free-rider issues exist, we thank a careful referee by noting that any remaining credit-claiming issue means that we estimate a lower bound of the effect stemming from Hypothesis 4.

  28. 28.

    The time coverage of this study is limited by the availability of data on municipal spending (Jahresrechnungsstatistik). Additionally, data for earlier mayoral elections in BW are hard to obtain, thus preventing the coverage from being expanded. Data beyond 2006 cannot be used to estimate electoral cycles because in 2007, BAY’s municipalities changed their accounting standards. This change was implemented at endogenous times in each municipality, which opens up opportunities to manipulate the observable budget strategically around election years.

  29. 29.

    We contacted all major authorities, including the state statistical office, the association of municipalities, the state ministry of interior affairs and the state election office. No summary of official data exists for mayoral elections in BW.

  30. 30.

    About 60% of the mayors in the sample work full-time. To test the sensitivity of our results, we also tested models in which we focus exclusively on full-time mayors. Those results return similar point estimates, both in sign and magnitude. Because of the significantly smaller sample size, however, the statistical significances of those estimates are not comparable to those reported in the main text (results are available upon request).

  31. 31.

    We assume that the mayor, at least, has some preferences about that decision, which leads to a final decision at the end of her term. Note that without adopting that assumption, we would condition the incumbent dummy on election years only, which would render separating general from specific incumbent effects infeasible.

  32. 32.

    We also experimented with state-specific year effects, which eliminates the identification of the council election effects. However, such a model can still identify mayoral and joint election effects and when we do this the results remain reassuringly similar (results not reported).

  33. 33.

    In particular, the term of the mayor may end prematurely if (1) the citizens or the council recall a mayor (which is an extremely rare event); (2) the mayor dies or resigns owing to sickness (arguably exogenous to our application); or (3) the mayor resigns for other reasons (personal or political reasons). It is clear that a mayor will not return to office if his or her term ends prematurely because of resignation. One potential reason for resignations in our data is given by mayors taking office in a larger city for greater remuneration. While the decision to run for office in another municipality potentially is endogenous, the timing is again exogenous because it is predetermined by the timing of elections in other towns.

  34. 34.

    Note that potential incumbent incompetency would not cause such a pattern. Incompetency would influence a municipality’s fiscal position negatively throughout the mayor’s full term, and is not necessarily confined to the years around an election.

  35. 35.

    One might falsely consider estimating the first stage regression exclusively for the single instrument and the incumbent dummy and then compute the interaction term for the second stage regression manually by using the predicted values of the incumbent indicator. That procedure, however, will produce inconsistent estimates. The results of the first stage regression for the incumbent dummy are presented in Table A.6 in the Online Appendix. The results of the remaining first stage regressions for the interaction terms are available upon request. In Eqs. (3.1) and (3.2), municipality and time fixed effects as well as the state-specific time trends are summarized by \({\mathbf{C^{\prime}_{i,t}}} \equiv {\mathbf{X^{\prime}_{i,t}}}+\lambda _{t}+\mu _{i}+h(t,s)\).

  36. 36.

    Again, as for the incumbent seeks reelection dummy, both indicators are equal to zero/one for the full term of office.

  37. 37.

    In BAY, the mayor is eligible to receive a pension if she has served as a mayor for two complete terms and was not reelected at the next election or refused to accept election. In BW, the rule is more complex: The mayor is eligible to receive a pension if she has completed one full term and fulfills one of three criteria: (a) she has served as a temporary civil servant (including positions in the public sector, but not necessarily as a mayor) for 18 years and is older than 47 years of age in the election year; (b) has served as a mayor for two complete terms (= 16 years); or (c) has served as a mayor for 8 years and is older than 60 years of age in the election year. For further details see article 21 KWBG (Law on local elections and public servants) (BAY) and §36ff LBG (Law on state public servants) (BW).

  38. 38.

    We refer to men only because the vast majority of mayors are men. The figure increases only slightly if women are taken into account.

  39. 39.

    Note that age is insignificant throughout all specifications (see Table A.5 in the Online Appendix).

  40. 40.

    In both tables we report the results for our main variables of interest only (council and mayoral election dummies, the incumbent runs again dummy as well as the various interaction effects). The results for the control variables are presented in the Online Appendix (see Table A.5). Interestingly, statistically significant effects are not found for the mayor’s age, the full-time mayor dummy, or either political ideology proxies. While rising total population has a concave effect on local expenditures, the population shares of young and old people do not affect spending.

  41. 41.

    The same is done for the OLS estimates in Table A.4.

  42. 42.

    The underlying marginal effects and levels of statistical significance all refer to column (4) in Table 3.

  43. 43.

    The federal states in Germany are further subdivided into administrative counties. These counties usually subsume several cities. In case of several large cities, however, these form a county on there own and are referred to as county-free cities. BW has 9 county-free cities and BAY has 25 county-free cities.

  44. 44.

    Information on the municipal unemployment rate from the Federal Employment Agency is available only from 1998 onwards.

  45. 45.

    The literature on PBCs has often employed dynamic specifications (solving the estimation issues in GMM methods) because of the persistent nature of expenditures. In the present application, the estimation is complicated further by the fact that we must instrument the incumbent mayor’s decision to stand for reelection. We would thus have to solve the dual problem of instrumenting both the lagged endogenous variables and the reelection variable. That is not possible using standard methods for dynamic estimations. For robustness, we opted for the simpler LSDV approach. However, we decided that those results are not very informative as—given our data structure—the resulting Nickel bias cannot be argued to be small. All such estimates are available upon request.

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Acknowledgements

We thank Florian Ade, Jeanne Diesteldorf, Lars P. Feld, Peter Haan, Niklas Potrafke, Friedrich Schneider, Robert Schwager, Johannes Voget and seminar participants at the IIPF, ECPS, ZEW Public Finance Conference and the University of Göttingen for helpful comments and suggestions. We are greatly indebted to Fabian Franke, Jenny Freier, Kathrin Friedrich, Heike Hauswald, Ilknur Köysüren, Larissa Lehn and Marc Schmidt who provided excellent research assistance as well as Adam Lederer for editorial support. Ronny Freier (project: 10.12.2.092) as well as Marc-Daniel Moessinger and Mustafa Yeter (project: 10.12.1.094) gratefully acknowledge financial support from the Fritz Thyssen foundation. Dirk Foremny gratefully acknowledges financial support from the projects ECO2012-37131 (Ministerio de Educacíon y Ciencia) and 2014SGR420 (Generalitat de Catalunya). The usual disclaimer applies. The authors declare that they do not have relevant or material financial interests that relate to the research in this paper.

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Foremny, D., Freier, R., Moessinger, MD. et al. Overlapping political budget cycles. Public Choice 177, 1–27 (2018). https://doi.org/10.1007/s11127-018-0582-9

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Keywords

  • Election cycles
  • Municipal expenditures
  • Legislative and executive elections
  • Instrumental variables approach

JEL Classification

  • H11
  • H71
  • H72
  • H74