On the Determinants of Local Government Debt: Does One Size Fit All?

ABSTRACT

This article analyzes the factors that directly influence levels of debt in Spanish local governments. Specifically, the main objective is to find out the extent to which indebtedness is originated by controllable factors that public managers can influence, or whether it hinges on other variables beyond managers’ control. The importance of this issue has intensified since the start of the crisis in 2008, due to the abrupt decline of revenues and, simultaneously, to the fact that the levels of costs these institutions face has remained the same or, in some cases, increased. Results can be explored from multiple perspectives, given that the set of explanatory factors is also multiple. However, the most interesting finding is the varying effect of each covariate depending on a municipality's specific debt level, which suggests that economic policy recommendations should not be homogeneous across local governments.

ACKNOWLEDGEMENTS

All three authors are grateful to two anonymous referees, and especially Professor Steve Kelman, for constructive comments which have contributed to improving the overall quality of the paper, as well as to Willem Sas and José Luis Zafra-Gómez and participants at the University of Granada seminar, XX Encuentro de Economía Pública, and 12th Journées Louis-Andre Gerard-Varet.

Notes

See also Zafra-Gómez et al. (2013) and González-Gómez et al. (2011) for related problems of Spanish municipalities.

The Spanish regions or comunidades autónomas (autonomous communities) correspond to level NUTS3 of the European Union (Nomenclature of Territorial Units for Statistics), whereas municipalities correspond to level LAU2 (Local Administrative Units). There are 8,112 municipalities and 17 regions. However, the level of heterogeneity across both municipalities and regions is notable in several dimensions, particularly size.

For an informative introduction, see Cade and Noon (2003), and for a compilation of relevant applications, see Fitzenberger et al. (2002).

These contributions are particularly interesting, since the title also stresses the relevance of considering approaches whose conclusions might differ depending on certain characteristics of the units of analysis.

Other contributions in the field of finance that consider quantile regression are Bassett Jr. and Chen (2001), who use regression quantiles to extract additional information from the time series of returns; Meligkotsidou et al. (2009), who introduce the idea of modeling the conditional quantiles of hedge fund returns using a set of risk factors; Luo and Li (2008), who investigate whether and how futures market sentiment and stock market returns heterogeneously affect the trading activities of institutional investors; Füss et al. (2009), who analyze the impact of experience and size of hedge funds on performance; and Chen and Huang (2011), who study the relation between mutual fund performance and Morningstar fiduciary grades, among others.

The use of quantile regression has also proved relevant in other fields, such as applied industrial organization (Coad and Rao 2008) or to study issues related to the structure of wages (Buchinsky 1998), among others. The compendium on empirical illustrations of quantile regression by Cade and Noon (2003) includes an interesting set of applications.

For instance, some authors such as Benito and Bastida (2004; 2005) define it as a ratio of real investments and capital transfers to total expenditures. However, others (Vallés et al. 2003; Cabasés et al. 2007) calculate it as the ratio of real investment to GDP, and refer to this variable as intergenerational equity—since future generations will also benefit from the capital investments that current generations may make. In contrast, Escudero (2002) defines it as the consolidated non-financial fixed assets per capita, although others (Fernández Llera et al. 2004) confine the contents of this variable to real investments only.

LRHL, Ley Reguladora de Haciendas Locales, Law 39/1988 December 28.

In Spain, the amount local governments can borrow is limited by a set of restrictions imposed by central government. The legal framework regulating credit operations is established under Law 39/1988, of 28 December, on Local Governments (“Ley 39/1988 Reguladora de las Haciendas Locales”). The original wording of this law has been modified substantially through the Consolidated Text of the Law on Local Governments 2/2004 (“Real Decreto Legislativo” 2/2004 of 5 March) and the approval of other subsequent laws. Some of the reasons for establishing debt restrictions are described in Monasterio Escudero (1996). The details of this law are carefully summarized in, for instance, Guillamón et al. (2011).

Previous contributions using this variable, although considering a slightly different definition, are Brusca and Labrador (1998) and Cabasés et al. (2007). The former authors consider a gross savings index in their use of the variables, whereas the latter define it as the ratio of net savings to GDP. In this respect, Cabasés et al. (2007) also note how local governments that have an austere current expenditure policy, that obtain higher current income, or that plan debt amortizations appropriately, have a greater financing capacity, and are less likely to resort to borrowing to fund their investment expenses. Therefore, as indicated, we may hypothesize a negative relationship between the levels of debt and net savings; in other words, when an institution has positive net savings, the need to resort to borrowing might be, cæteris paribus, lower.

This variable has been defined in different ways in the literature. For example, whereas Benito and Bastida (2004; 2005) calculate it in relative values, Brusca and Labrador (1998) consider total budgetary revenues and expenditure—in other words, the difference between total budgetary revenues and total budgetary expenditure, what they term budgetary deficit.

As indicated by Campos et al. (2006), when evaluating the importance of this variable, it should also be taken into account that there might be an “unexplained” part of debt corresponding to the so-called “stock-flow reconciliation” (see also Lane and Milesi-Ferretti 2009).

However, the opposite effect may occur, as municipalities with more of their own resources will face lower financial risks and will therefore be granted certain advantages when accessing loans.

The tourism variable has been used not only by Benito and Bastida (2005) and Benito and Bastida (2004), who introduced two dummy variables to differentiate between coastal and inland municipalities, but also by Escudero (2002), who used the tourism index from the “Anuario Económico de España” (Spanish Economic Yearbook) published by La Caixa Foundation. See http://www.anuarieco.lacaixa.comunicacions.

While some authors, such as Clingermayer and Wood (1995) or Kiewiet and Szakaty (1996), consider its effect to be positive, others, such as Adams (1977), claim a negative relationship.

“Instituto Nacional de Estadística” (Spanish Bureau of Statistics).

In the particular Spanish case, previous studies considering this information include Benito and Bastida (2005), Benito and Bastida (2004), Cabasés et al. (2007), Escudero (2002), or Vallés et al. (2003), among others, who have used per capita income level as a possible indicator of economic level.

For year 2008 onwards, only the variable measuring economic activity is available. This is the one we use and, in addition, we consider that it has a stronger link with a municipality's possible debt level than when per capita income is considered, as those local governments operating in environments where the general economic activity is more intense will have to provide their constituencies with more and, probably, more complex services, which generally imply higher costs.

However, some authors, such as Fernández Llera et al. (2004), consider that foral regions have created a relatively higher number of public firms (compared to the rest of Spain). Therefore, some municipalities might have decided to outsource some services which would lead to lower levels of municipal debt, pointing to a negative link with this variable.

See also Zafra-Gómez et al. (2013).

We will refer to debt per inhabitant and debt per capita interchangeably throughout the article.

In addition to this, the quantile regression estimator has other benefits, such as being characteristically robust to outliers on the dependent variable.

Additional information

Notes on contributors

Maria Teresa Balaguer-Coll

Maria Teresa Balaguer-Coll ([email protected]) is Associate Professor of Finance and Accounting at the University Jaume I, Spain. She is a member of the Spanish Association of Accounting University and a member of the Spanish Association of Accounting and Business Administration. Her research interests are focused on local government finance. She has published in journals such as European Economic Review, Annals of Regional Science, Journal of Productivity Analysis, Environment and Planning A, Spanish Accounting Review, Applied Economics, and European Journal of Political Economy.

Diego Prior

Diego Prior is Full Professor in the Business Department at the University Autònoma of Barcelona, Spain. His research interests are focused on efficiency and productivity analysis, research in financial accounting and management in the public sector. He has published in journals such as Public Administration, International Journal of Management Science, European Economic Review, Annals of Regional Science, Annals of Operations Research, Journal of Productivity Analysis, Journal of Business and Finance Research, Journal of Environmental Management, Financial Accountability and Management, Journal of Banking and Finance, Applied Economics, Environment and Planning A, Omega, and Journal of Accounting and Auditing and Finance.

Emili Tortosa-Ausina

Emili Tortosa-Ausina is Associate Professor of Applied Economics at the University Jaume I (Spain) and Associate Researcher at the IVIE. His main fields of research are efficiency and productivity analysis, banking and finance, and regional economics. He has also made contributions in the area of international economics and economic geography, creating a database on indicators of international economic and financial integration. He has published several books and articles in specialized journals, including European Economic Review, European Journal of Political Economy, Journal of Banking and Finance, World Development, Studies in Nonlinear Dynamics and Econometrics, Journal of Productivity Analysis, Omega, European Journal of Operational Research, Manchester School, and Journal of the Operational Research Society, among others.