*Political Budget Cycles and the Civil Service*

One of my internal motivations for starting this blog was to have a commitment device for staying current and broad in the public finance literature. One of the surprises that has come of this venture is the amount of good research on political budget cycles, a subject that I thought was basically dead. A year ago, I would have thought political budget cycle research was basically non-existent and what remained likely to be uninteresting.

The July issue of JPubE posses another example of how wrong I was in “Political Budget Cycles and the Civil Service: Evidence from Highway Spending in US States” by David Bostashvili (Amazon) and Gergely Ujhelyi (University of Houston). Here is the abstract

We study political budget cycles in infrastructure spending that are conditional on bureaucratic organization. Bureaucrats can facilitate or hinder politicians’ ability to engage in voter-friendly spending around elections. To test this idea, we use civil service reforms undertaken by US states in the second half of the 20th century to study political budget cycles in highway spending under civil service and patronage. We find that under patronage, highway spending is 12% higher in election years and 9% higher in the year before an election. By contrast, under civil service highway spending is essentially smooth over the electoral cycle. These findings provide a novel way through which civil service rules can stabilize government activity.

Of course if you’re still with me, you’re wondering how the authors define and identify “patronage” and “merit” systems in the states. The answer is that the authors are actually studying  the adoption of merit system adopted throughout the 20th century that mimicked legislation at the state level. These acts included a competitive civil service exam, prohibited mandatory political services from employees, and established a bipartisan civil service commission. Therefore, “patronage” systems are states that did not adopt those laws. Here is a neat preliminary figure the presents per capita highway spending over the state electoral cycle from 1960-1995 in the 44 states with 4-year election cycles:

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And if you compare the 11 states that switch during their study period from patronage to merit, here is how they compare before and after:

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The rest of the paper goes on to show that this analysis holds up when you use a regression to control for other factors so that you get these graphs but with confidence intervals.

Score one for the Deep State.

Regulation and Government Debt

New in Public Choice by Niclas Berggren and Christian Bjørnskov is evidence that more regulation in the market economy results in higher levels of public debt.

Government debt is large in most developed countries, and while budget deficits may reflect short-term attempts to kick-start the economy in times of crisis by means of fiscal stimulus, the longer-term consequences may be detrimental to investment and growth. Those negative consequences make it important to identify factors that are associated with public debt. While previous studies have related government debt to economic and political variables, they have not incorporated the degree to which the economy is regulated. Using a measure of regulatory freedom (absence of detailed regulation of labor, business and credit) from the Economic Freedom of the World index, we conduct an empirical analysis covering up to 67 countries during the period 1975–2010. The main finding is that regulatory freedom, especially with respect to credit availability, reduces debt accumulation. The effect is more pronounced when the political system is fractionalized and characterized by strong veto players, indicating policy stability and credibility, and when governments have right-wing ideologies.

This wasn’t very intuitive to me, so I’ll unpack the authors arguments a little bit here. By “debt accumulation,” the authors mean public debt as a percent of GDP (as opposed to per capita debt or total debt). I’m not crazy about that, as regulation plausibly affects GDP, but I’m not sure what a better way to scale it would be. Here is a preview of the theoretical explanation:

We propose that the extent to which an economy is regulated matters, on the basis of four theoretical links. The first is that people who hold pro-market attitudes tend to be opposed to public regulation of the private sector and hold skeptical views about substantial government debt. The second and third are that regulation affects the functioning of the economy in ways that influence debt, and that regulation may serve as a signal to lenders regarding contemporaneous or future problems in the economy or the government, such that they set interest rates (that influence debt levels) accordingly. Finally, a regulated economy may be comparatively inflexible and unable to adjust very well to changing macroeconomic circumstances, which could leave the government with incurring debt to counteract downturns as its only politically viable option.

The first link is probably true, but isn’t all that interesting as it is arguing that regulation is correlated with an omitted preference for government rather than being a causal factor in its own right. The other links are indirect in the sense that the regulation causes something else to happen and that something else also affects debt. This is usually the stuff that leads to structural modeling but that is not where this paper is going.

The last theoretical link is the most interesting I think, where the supply of regulation creates demand for additional government spending during recessions. My first thought was that more volatile economies (induced by regulation or not) should plausibly have governments more engaged with countercyclical policies that enable consumption smoothing. That should plausibly cause more short-term debt during downturns, but also greater rainy day fund balances (albeit it is not empirically obvious in looking at the American states).  However, the authors proposed mechanism for this link is a kind of political commitment where heavy regulation means the government is now more responsible for a well-functioning economy. Kind of a “you break it you bought it” style of commitment.  I’m not sure I believe that specific mechanism, but it does make some intuitive sense to me that a more regulated private economy that restricts access to private credit or slows down private capital reallocation will increase the government’s comparative advantage in borrowing over private citizens. That is, the larger the Okun Gap, the greater the gap in borrowing costs between the private and public sectors that might plausibly favor government-over-private borrowing.

The regression results hold up the association (see the last variable, “Regulatory freedom”) that less regulation implies less public debt, though the point estimate will halve or double as you start adding control variables, so we are a long way from a convincing causal estimate.

DebtRatio

Still, it is an interesting hypothesized mechanism, and it would be interesting to see if it would bear out in a cleverly designed citizen or policy maker experiment of some type.

 

Informal Norms in the Federal Budget Process

Confronted with the threat of another impending federal government shut-down over the budget, much has been made of recent trends in the dissolution of norms in both politics and civility.

For a longer run perspective on the role of norms, I thought it useful to visit an interesting paper (ungated) in the Journal of Institutional Economics by Peter Calcagno (College of Charleston) and Edward Lopez (Western Carolina University) on the role of informal norms in the federal budget process. The argument is in the title with “Informal Norms Trump Formal Constraints: The Evolution of Fiscal Policy Institutions in the United States.” Here is the abstract:

Two shifts of informal rules occurred in the decades around the turn of the 20th century that continue to shape U.S. fiscal policy outcomes. Spending norms in the electorate shifted to expand the scope of the government budget to promote economic security and macroeconomic stability. Simultaneously, norms for elected office shifted to careerism. Both norms were later codified into formal rules as legislation creating entitlement programs, macroeconomic responsibility, and organizational changes to the fiscal policy process. This institutional evolution increased demand for federal expenditures while creating budgetary commons, thus imparting strong motivations to spend through deficit finance in normal times. Despite the last four decades of legislative attempts to constrain spending relative to taxes, the informal norms have trumped the formal constraints. While the empirical literature on deficits has examined the constraining effects of informal rules, this paper offers a novel treatment of shifting norms as having expansionary effects on deficits.

Here is some more:

Our historical investigation traces today’s U.S. fiscal policy challenges to two shifts of fiscal norms from about 1880 to 1930. First, there emerged new demands on federal spending to support economic security at the household level and economic stability at the macro level. Second, the industrial organization of supplying federal spending became professionalized and competitive, as elected office transformed from a temporary public service to a pursuit of a career ambition. We describe the combination of these two shifts–the demand side spending norm and the supply-side professionalization norm–as the American polity’s shift away from a balanced-budget norm in favor of a deficit-as-policy norm.

See also a recent blog post here on a paper in Public Choice on the influence of formal rules in state constitutions.  It is tempting to see those two as opposing views, but I would be inclined to read it as Calcagno and Lopez arguing that informal rules carry more explanatory power, not that formal rules are irrelevant at the margin.

The Effect of Inherited Fiscal Rules

Many budgeting scholars are currently interested in whether a rule-based system could be used for improving fiscal sustainability. In the US, congress’s own dismissive treatment of the rules governing the budget process are supportive anecdotes of the view that self-imposed rules do not bind. Furthermore, there is little doubt that adopting rules (e.g. like Balanced Budget Amendments) is at least partially just signalling what you intend to do regardless of the rules. Nevertheless you’d expect that it is possible to raise the political cost of certain actions.

In this spirit is an interesting article forthcoming in Public Choice by Csaba Toth (Central Bank of Hugary) on “Valuable Legacy? The Effect of Inherited Fiscal Rules.” Here is the abstract:

The working mechanism of national fiscal rules depends strongly on whether a government must comply with its own rules or inherited ones. In the former case, a government usually introduces fiscal rules to show its commitment to a disciplined fiscal policy (the signaling function). In the latter context, however, inherited rules constitute external obstacles to budgetary policymaking (the limiting function). This study mainly is concerned with the limiting function and therefore bases its empirical analysis on periods when the ruling government inherited fiscal rules introduced by a previous government. The results of a panel-data econometric study indicate that national fiscal rules do contribute to disciplined fiscal policy after a change in government in times of an economic upturn. That finding, however, does not mean that the signaling function is ineffective: quite the contrary. My results, in line with the literature, indicate that the double functions of rules may complement one another. A government that introduces such rules is often already committed to a disciplined policy and wishes to signal such commitment in the short term. With the appearance of new government, however, the function of rules changes, and they efficiently promote disciplined fiscal policy in the long term.

That abstract is a nice summary of the paper’s main points. The empirical work is based on 27 EU members states from 1995 to 2008. Section 3 (Databases and New Methods) is a section not to be skipped, and it is a credit to the author that such a detailed description of where the reader might want to be skeptical of the data’s coding and other limitations. For instance, this has the potential to be a big drawback.

Before delving into the details, however, I need to emphasize that my definition of budgetary rules is limited in several ways. On the one hand, this study concerns only the numerical values of the procedural rules in effect during the compilation and enforcement of the general public budget. In doing so, I concentrate exclusively on the rules contained in national legal systems and thus ignore supranational provisions. Third, budget rules are in place worldwide; this study focuses on European practice and more precisely on the EU member states.

It is an impressive paper, and if you teach a doctoral level course on budgeting it is worth consideration for syllabus space.