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Public Choice

Erschienen in:

22.07.2020

Veto players, market discipline, and structural fiscal consolidations

verfasst von: Markus Leibrecht, Johann Scharler

Erschienen in: Public Choice | Ausgabe 3-4/2021

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Abstract

Based on a sample of 16 Western OECD countries we show that although veto players with heterogeneous political preferences reduce the probability of a structural fiscal consolidation, the effect of veto players declines with greater financial market pressure, which we measure as the spread between the long-term government bond yield and the corresponding yield in a base country (either the United States or Germany). We proxy veto players with heterogeneous political preferences primarily by the political constraints index of Henisz (Econ Polit 12(1):1–31, 2000). Our findings support the view that, as long as government bond yield spreads are sufficiently narrow, financial market pressure exerts a disciplining effect on fiscal policy by counteracting the political deadlock resulting from veto players who obstruct structural fiscal consolidations. The mirror image of our finding is that financial market pressure exerts a more positive impact on the likelihood of a structural fiscal consolidation in political environments characterized by many heterogeneous veto players.

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We follow Devries (2011) and OECD (2011) in interpreting structural fiscal consolidations as specific policies that are aimed at reducing government deficits. Structural consolidations do not include fiscal policies that are taken in response to current or prospective macroeconomic conditions.

Nevertheless, the presence of veto players may be conducive to economic development and growth because of their stabilizing influences on economic policy, that is, by making property rights protections more credible (Justesen and Kurrild-Klitgaard 2013).

Groups with access to the budgetary commons face a “soft” budget constraint in the sense that the strict relationship between public revenue and spending is relaxed as debt servicing is carried out by different constituencies (Kornai 1986).

Theoretically, however, veto players may act as "consensus-building" institutions (Keefer and Knack 2003). Gehlbach and Malesky (2010) argue that many veto players aid consensus finding if they make it more costly for special interest groups to lobby for partial reforms or no reforms at all. Alexiadou (2013) stresses that consensus governments may encourage reform if they are able to sideline special interests that favor the status quo. And, the policy stability induced by strong checks and balances increases the credibility of promises of compensation made to reform’s losers (Pitlik 2008; Leibrecht and Pitlik 2015).

For instance, groups that represent voters who favor less public spending or groups that represent younger and future generations.

The bond yield spread is defined as the nominal yield on a long-term government bond minus the nominal yield on the long-term government bond of a base country.

Exceptions include Dell’Erba et al. (2015) and Huebscher (2016), who likewise rely on Devries et al.‘s (2011) dataset.

A large literature dealing with the determinants of successful fiscal consolidations has emerged in recent years. Likewise, a vast literature exists that investigates the relationship between government fractionalization and the sizes of fiscal deficits. We do not explore that strand of research in our brief overview; the interested reader is referred to Schaltegger and Feld (2009), Foremny et al. (2017), Wiese et al. (2018) and Artes and Jurado (2018).

The countries in our sample are Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, the Netherlands, Portugal, Spain, Sweden, the United Kingdom and the United States.

Table A1 in the Appendix displays the country-years with structural fiscal consolidations. The table shows that episodes of structural fiscal consolidations are rather frequent. In total, about 39% of our sample observations comprise years with fiscal retrenchments. In addition, consolidations often occur over several consecutive years (see also Dell’Erba et al. 2015).

For the United States, ExchangeRateit is the annual rate of depreciation in the dollar’s purchasing power against the euro.

For the majority of countries in our sample, the budget year coincides with the calendar year. Thus, for those countries the budgeting process ends in t-1. In the United States, the fiscal year starts on 1 October. Appropriations bills, however, rarely are signed by that date and continuing resolutions to fund ongoing spending frequently are passed by Congress. In the United Kingdom and in Canada, the fiscal year starts in April; Australia’s budget year starts in July. In a sensitivity analysis, we exclude those four countries from our analysis to gauge the impact of variations in budget years across countries.

Based on Romer and Romer (2019), we convert Standard and Poor’s letter grades into numerical scores, for which a score of 50 corresponds to an “AAA stable” letter grade, 49 to an “AAA negative”, 48 to an “AA + positive”, and so on.

Duration models offer an alternative approach for modeling temporal dependence and delays in structural fiscal consolidations (see, e.g., Grier et al. 2015, for an application). Such models supply interesting avenues for future research.

The APE of Veto_it−1 is -0.011. The average value of Veto_it−1 over the sample period for the United States is about 40 and for Sweden it is about 50.

An effect of -0.01 means that the probability of consolidation declines by one percentage point when Veto_it−1 increases by one point.

In this analysis, we lose four observations owing to the limited availability of Standard and Poor’s rating data.

For the robustness check at hand, we also use inflation rates instead of inflation-rate differentials.

We also perform a country-jackknife analyses from which we exclude single countries, one at a time, from the estimation. Our main findings are robust to the exclusion of single countries. We also investigate whether high unemployment rates moderate the negative effects of heterogeneous veto players on fiscal consolidations. We do not uncover supporting evidence for that assertion. And, finally, we estimate Eq. (1) including in the set of control variables a dummy variable that takes on the value one if a country has a fiscal rule (either expenditure, revenue, balanced budget or debt based) in force in year t-1. Data are taken from Kinda et al. (2016) and are available from 1985 onwards. Including the fiscal rule dummy variable does not change our conclusions. Detailed results for robustness checks are available upon request.

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Titel: Veto players, market discipline, and structural fiscal consolidations
verfasst von: Markus Leibrecht
Johann Scharler
Publikationsdatum: 22.07.2020
Verlag: Springer US
Erschienen in: Public Choice / Ausgabe 3-4/2021
Print ISSN: 0048-5829
Elektronische ISSN: 1573-7101
DOI: https://doi.org/10.1007/s11127-020-00831-4

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