Fiscal federalism and the composition of public investment in Europe

Does competition for capital discipline governments? The role of fiscal equalization

“…In the specification, I it is the dependent variable, which is defined as the share of public input expenditure in total budgetary expenditure of state i in year t. I it−1 is a one-period (timely) lagged dependent variable, which is included to account for the high degree of persistence in the government policies that is typically observed in the data (e.g., Foucault et al, 2008;Kappeler and Välilä, 2008;Ghinamo et al, 2010;Klemm and Van Parys, 2012 In the theoretical model, I clearly defined initially poorly-endowed regions as those regions that have lower output productivity, while initially well-endowed regions refer to those regions having higher output productivity. Since the large productivity gap between East Germany and West Germany has been well documented in the literature (e.g., Barrell and Te Velde, 2000;Burda and Hunt, 2001;Czarnitzki, 2005), my classification should be viewed to make a lot of economic sense.…”

“…Both are measured in relative to GDP and have been shown to be significant in the determination of public investment in the literature. Population density serves as the needs for and cost of public input networks that differ between densely and sparsely populated regions (Kappeler and Välilä, 2008). I also include a set of political variables capturing the effects of elections and political preferences.…”

“…Openness, which is calculated as the ratio of total trades (import plus export) to GDP, aims to capture the exposure of a state to trade and competition for capital. Following the studies by Mehrotra and Välilä (2006) and Kappeler and Välilä (2008), the short-and long-term fiscal environment is captured by the budget surplus of the state government and its public debt respectively. Both are measured in relative to GDP and have been shown to be significant in the determination of public investment in the literature.…”

Changes in the fiscal stance and the composition of public spending

“…Table 2 shows the estimation results with the ratio of aggregate public investment to consumption expenditure in value terms as a dependent variable. In the preferred specification the variable GDP is considered endogenous; the only control variables are trade openness (as in Lane, 2003); public debt to GDP (as in Kappeler and Välilä, 2008); and the number of lags of the dependent and GDP used as instruments is 5. Specification A excludes the dummies CU and DT, seeking to capture any asymmetries between fiscal tightening and loosening.…”

“…Following that definition, final consumption expenditure amounts on average to 25 percent of GDP in our sample. When considering different types of government investment in the numerator of the dependent variable, we employ the breakdown introduced in Kappeler and Välilä (2008) into investment in infrastructure, schools and hospitals, public goods, and redistribution. All data on government investment are obtained from Eurostat, while the data on government consumption originates from the OECD.…”