Decentralization of public expenditure and growth in Italy: Does the ...

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Working Paper 04/17

Decentralization of public expenditure and growth in Italy: Does the composition matter? Floriana Cerniglia, Riccarda Longaretti, Alessandra Michelangeli

PP 4_17 Cerniglia-Longaretti-Michelangeli.qxd:_ 10/10/17 10:37 Page 1

Working Paper 04/17

Decentralization of public expenditure and growth in Italy: Does the composition matter? Floriana Cerniglia, Riccarda Longaretti, Alessandra Michelangeli

PP 4_17 Cerniglia-Longaretti-Michelangeli.qxd:_ 10/10/17 10:37 Page 2

Floriana Cerniglia, Professore ordinario di Economia Politica, Facoltà di Scienze Politiche e Sociali, Università Cattolica, Membro del Consiglio Scientifico del Centro di Ricerca Cranec dell’Università Cattolica. Riccarda Longaretti, Ricercatore di Economia Politica presso l’Università degli Studi Milano Bicocca. Alessandra Michelangeli, Professore Associato di Economia Politica presso l’Università degli Studi Milano Bicocca. COMITATO DIRETTIVO: Prof. Carlo Beretta (Direttore), Prof.ssa Floriana Cerniglia; Prof. Marco Fortis; Prof.ssa Fausta Pellizzari (Segretario); Prof. Alberto Quadrio Curzio (Presidente); Prof.ssa Claudia Rotondi; Prof. Roberto Zoboli. CONSIGLIO SCIENTIFICO: Prof. Gilberto Antonelli (Università degli Studi di Bologna), Dott. Antonio Andreoni (University of Cambridge, University of Chile – Santiago), Prof. Mauro Baranzini (Università della Svizzera italiana), Prof. Luca Barbarito (Università IULM), Prof.ssa Maria Agostina Cabiddu (Università Cattolica del Sacro Cuore), Prof. Giulio Cainelli (Università degli Studi di Bari), Dott. Ivano Cardinale (Emmanuel College, Cambridge), Dott.ssa Maria Chiara Cattaneo (Università Cattolica del Sacro Cuore), Prof.ssa Floriana Cerniglia (Università degli Studi di Milano – Bicocca), Prof.ssa D'Maris Coffman (UCL - University College London), Prof. Giuseppe Colangelo (Università degli Studi Insubria-Varese), Prof. Nicola De Liso (Università degli Studi di Lecce), Dott. Andrea Goldstein (ONU), Prof. Mario Maggioni (Università Cattolica del Sacro Cuore), Prof. Giovanni Marseguerra (Università Cattolica del Sacro Cuore), Prof. Guido Merzoni (Università Cattolica del Sacro Cuore), Prof.ssa Valeria Miceli (Università Cattolica del Sacro Cuore), Prof. Sandro Montresor (Università Kore di Enna), Prof. PierCarlo Nicola (Università degli Studi di Milano), Dott. Mario Nosvelli (Consiglio Nazionale delle Ricerche – Milano), Prof. Giovanni Pegoretti (Università degli Studi di Trento), Prof. Paolo Pini (Università degli Studi di Ferrara), Prof. Thomas Rosenthal (Università Cattolica del Sacro Cuore), Prof.ssa Claudia Rotondi (Università Cattolica del Sacro Cuore), Prof. Roberto Scazzieri (Università degli Studi di Bologna), Prof. Danielie Schilirò (Università degli Studi di Messina), Prof. Moshe Syrquin (University of Miami, USA), Prof.ssa Teodora Erika Uberti (Università Cattolica del Sacro Cuore).

Tutti i saggi sono soggetti al referaggio di due Membri del Comitato Scientifico prima di essere pubblicati nella Collana dei Working Paper Cranec edita da Vita e Pensiero.

[email protected] www.vitaepensiero.it Le fotocopie per uso personale del lettore possono essere effettuate nei limiti del 15% di ciascun volume dietro pagamento alla SIAE del compenso previsto dall’art. 68, commi 4 e 5, della legge 22 aprile 1941 n. 633. Le fotocopie effettuate per finalità di carattere professionale, economico o commerciale o comunque per uso diverso da quello personale possono essere effettuate a seguito di specifica autorizzazione rilasciata da CLEARedi, Centro Licenze e Autorizzazioni per le Riproduzioni Editoriali, Corso di Porta Romana 108, 20122 Milano, e-mail: [email protected] e sito web www.clearedi.org. All rights reserved. Photocopies for personal use of the reader, not exceeding 15% of each volume, may be made under the payment of a copying fee to the SIAE, in accordance with the provisions of the law n. 633 of 22 april 1941 (art. 68, par. 4 and 5). Reproductions which are not intended for personal use may be only made with the written permission of CLEARedi, Centro Licenze e Autorizzazioni per le Riproduzioni Editoriali, Corso di Porta Romana 108, 20122 Milano, e-mail: [email protected], web site www.clearedi.org.

Questo lavoro rientra nell’ambito della ricerca 2016 - 2018 “Territori e autonomie: un’analisi economico-giuridica” svolta dal Centro di Ricerche in Analisi Economica – Cranec con il contributo di Fondazione Cariplo.

© 2017 Cranec ISBN 978-88-343-3507-9

Abstract1 In this paper we exploit data at regional level on decentralized public expenditure provided by Conti pubblici territoriali from 1996 to 2014 and we decompose decentralized public expenditure into current and capital spending. The aim is to disentangle their specific effect on economic growth. Since literature does not provide unanimous indication about the effect of different component of expenditure on growth, we consider a generalized additive model, which is a semi-parametric estimation method that allows more flexibility than conventional estimation techniques. Our findings show a non-linear effect, that is different according to categories of expenditure. More specifically, the effect of capital expenditure is positive, while, decentralized current expenditure tends to have a negative effect on the rate of economic growth.

1

This paper is part of the research project “Territorii e Autonomie” financed by Cariplo Fundation.

3

4

INDEX 1. Introduction

7

2. Related literature

10

3. Decentralized public expenditure and regional growth in Italy

17

-

Data and variables Empirical methodology Empirical results

21 23 25

4. Conclusions: how to interpret the empirical results

28

Appendix References

34 35

5

6

1. Introduction The economic downturn, caused by the financial-economic crisis of 2008-2009, have had a huge impact on public finances in Europe, and represented a huge challenge for the institutional structure of the EU countries. At the national level, the fiscal adjustment following the crisis has led a massive halt on local governments’ autonomy. The need to respect the financial measures imposed by Europe, in other words, has led many countries to rethink to the financial relationships between levels of government concerning both tax and expenditure competencies. Specifically, all around Europe, there has been a substantial re-centralization of decision-making on public resources (see Ahmad, Bordignon and Brosio, 2016).

Italy experienced the same pattern. From the beginnings of the 1990’s an unprecedented process of institutional and fiscal decentralization has taken place in Italy, but, this process has had a halt with the 2008-09 crisis. During the economic crisis, and still now, Italy has experienced very low (even negative in some years) rates of growth and a worsening of all the relevant fiscal indicators. This profoundly affected the fiscal relationships between levels of government, and the system moved in the direction of re-centralization of policies. Local governments experienced increased financial adjustments. On one hand, they had higher tax autonomy, in order to collect resources to finance the deficit of the central government; on the 7

other hand, the new budget rules have left little room for capital expenditure (namely for public investments) by local governments.

Theoretically, the economic debate on whether to grant a greater or lower autonomy to sub-central entities is far from being solved. On one hand, the need to protect some primary objectives (such as macro-economic stability and the rebalancing of unequal levels of development among regions) may be better pursued at a more centralized level of government. On the other hand, it is necessary to find new ways to promote growth and make regions more competitive. In this respect, recently, in the literature on fiscal federalism, a new field of research, both theoretical and empirical, shows that decentralization could promote growth. Very little attention has been devoted, instead, to disentangle the effects of decentralization of different categories of expenditure on growth. Whereas there is a quite unanimous consensus about the positive effect of the public productive capital expenditure, namely public investments, on growth, in the literature it remains to be understood whether public investments should be left at the central or at the local level. The investigation on the link between decentralized current and capital expenditure and growth has not received a lot of analysis despite the fact that - as acknowledged by the economic literature - these two categories have different effects on growth.

8

This issue is particularly worth of analysis in Italy since the gap between North and South is huge both in terms of growth and in terms of capital expenditure, namely infrastructures2.

The goal of this paper is actually to fill this gap, in order to assess the effects of decentralized current and capital expenditure on regional economic growth in Italy. We aim to contribute to the debate whether the composition of decentralized public expenditure matters for growth, considering that total capital expenditure is managed mainly by sub levels of governments. By exploiting data at regional-level on decentralized public expenditure provided by Conti pubblici territoriali from 1994 to 2014, we decompose decentralized public expenditure into current and capital spending in order to disentangle their specific effect on economic growth. Our findings show a non-linear effect for both spending components. More specifically, the effect of capital expenditure is positive, while, decentralized current spending tends to have a negative effect on the rate of economic growth.

This paper is an additional improvement over previous literature focusing on the relationship between the direct impact of fiscal decentralization and economic growth in Italy. To the best of our knowledge previous papers are by Mauro and Pagliaru (2011, 2013), 2

The decree “perequazione infrastrutturale”.

9

Di Liddo et al. (2013), and Zanardi and Pluchino (2016). Mauro and Pagliaru (2011, 2013) find that decentralization enhances growth wherever social capital is high. Di Liddo et al. (2013) find that decentralization stimulates growth. Recently, Pluchino and Zanardi (2016), measuring the degree of decentralization both considering expenses and revenue (excluding transfers), find a positive effect on growth for both the decentralization indicators (i.e. decentralization of expenses and of revenue). Our paper goes one step further from these studies for two reasons: first we estimate a non-linear relationship, secondly we disentangle the effect on growth considering in turn current and capital decentralized expenditure.

The paper is structured as follows: section 2 is a survey of previous studies on which we build on; section 3 presents our empirical investigation a section 4 concludes trying to underpin a theoretical interpretation of our results.

2. Related literature In the following lines, we summarize the theoretical back-stones of the studies between decentralization and growth and the empirical achievements as well as the unsolved theoretical and empirical issues. Notice that these studies build on the results of static efficiency, shown in the literature on fiscal federalism, and try to consider its ef10

fects dynamically in terms of economic growth. In particular, this new strand of literature note that the effects of increased efficiency related to the local provision of certain types of expenditure (i.e. local public goods) could lead in the long run also to greater economic growth. To be more specific - as surveyed in Cerniglia and Longaretti (2013b) - the potential link between fiscal federalism and growth has been theoretically analyzed in the literature considering three potential mechanisms: 1) federalism can affect the savings rate; 2) federalism can increase the efficiency both of the public and of the private sector; 3) federalism can generate increasing returns to scale. 1) The path-breaking study that considers the first mechanism is Brueckner (2006). In this paper, the public good is financed by a uniform lump-sum tax and individuals have heterogeneous preferences about the public good. In a federal system individuals "vote with their feet" and, as a consequence, are sorted in two jurisdictions according to their preferences. In equilibrium it turns out that citizens of one jurisdiction pay a lower per-capita fee for funding the public good. This increases their incentive to save, promoting economic growth. Another proposed mechanism that explains the link between federalism and the savings rate is tax competition. Under the assumption of perfect capital mobility between regions, tax competition on the tax base lowers the tax burden. And then it increases savings, capital accumulation, 11

and growth (see Lejour and Verbon, 1997; Hatfield, 2015; Koethenbuerger and Lockwood, 2010; Chu and Yang, 2012). 2) The second mechanism considers the fact that fiscal federalism may imply greater public sector efficiency but also, as a result, in a decentralized system, the entrepreneurial "animal spirits" may be encouraged to look for new and more efficient technologies (Justman et al., 2002), that enhances the efficiency of the private sector. In this perspective, the decentralization of certain powers to local governments can have a greater impact on the agglomeration of economic activities and on the speed and the quality of accumulated capital. Hence, fiscal competition among local governments can encourage these effects of agglomeration and each different region can attract different types of private capital.3 In conclusion, this second theoretical explanation of the link between decentralization and growth has a sort of correspondence with the concept of "laboratory federalism", coined by Oates (1972). The idea is that politically decentralized countries may benefit from better policies than centralized countries, thanks to a greater efficiency in identifying the best policies. Multiple small scale experimentation may foster the identification and the implementation of the best 3

Some local policies could produce catching-up phenomena in growth rates between the poorer regions and the richer ones (Brakman et al., 2002).

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policies in a region, generating an informational externality which allows the other regions to learn about the quality and/or adequacy of this policy. 3) The third mechanism deals with the possibility that increasing returns may be generated by decentralizing the provision of local public goods. This possibility is modelled in Cerniglia and Longaretti (2013a) where the public good is "education-related". Education is indeed a competence of local governments in many federal and unitary countries, as documented in Sacchi and Salotti (2016). In Cerniglia and Longaretti (2013a), the local government provides a uniform level of the public good among all citizens of the territory. Education-related local public goods should be differentiated across regions on the basis of socioeconomic characteristics of territories and natural vocation of development. The authors show how this may generate increasing returns to scale, promoting growth and also territorial convergence. Recapping, the theoretical literature offers three operating mechanisms that explain the positive link between decentralization and growth. However none of these mechanisms has been singularly empirically tested. Beyond the theoretical underpinnings, the wide empirical literature is also inconclusive because decentralization is a very complex political phenomenon to be simply captured by a set of empirical measures. As pointed out by Iimi (2005) and recently by Martinez-Vazquez, 13

Lago-Penas and Sacchi (2015), results are influenced by: the variables used to measure the degree of decentralization, the dataset, and the level of spatial aggregation. The results of cross-country studies, on the one hand, (for example Davoodi and Zou, 1998) find no significant evidence of the relationship between decentralization and growth in developed economies, while the link is negative, although not significant, for developing economies. On the other hand, other papers showed a significant positive relationship, both in rich economies (Thiessen, 2003) and in low and middle income countries (Iimi, 2005). Studies applied to single countries get more tangible results in favour of a positive relationship between decentralization and growth in emerging economies, such as China (Lin and Liu, 2000; Qiao, Martinez-Vazquez and Yu, 2002; Qian and Weingast, 2005; Feldenstein and Iwata, 2005) and Russia (Desai, Freinkman and Goldberg, 2003). The evidence for developed economies (USA, Germany and Switzerland) is more ambiguous. For example, Xie, Zou and Davoodi (1999) find no statistically significant relationship between spending decentralization and growth for the USA in the period 1951-1992, while Stansel (2005) finds a positive relationship for the USA in the period 1959-1989. Summarizing, there is not an unanimous consensus about the sign of the effect of decentralization on growth. It is worth of notice that all these results show a monotonic and linear relationship between decentralization and growth. There are two pioneering studies (Thissen 2003; Rodriguez-Pose and Ezcurra 2011) 14

that had recognized and tested the possibility of a non-linear and non-monotonic relationship between decentralization and growth, but their results were not robust.4 In one of our previous studies (Carniti et al. 2017), we also have shown theoretically and empirically tested, with a panel of 25 European countries observed from 1995 to 2015, how this relationship may be non-monotonic. Our econometric results are statistically significant and show that the relationship between expenditure decentralization and growth, in Europe, may be bell-shaped. As far as Italy is concerned, some studies analyze the relationship between decentralization and territorial inequalities. Calamai (2009) finds a link between the large increase of devolution and the reduction of territorial inequalities. Using a time-series approach over the period 1980-2004, Calamai verifies if decentralization has increased convergence between the Italian regions. In his study a positive link emerged, although the mechanism at work remains unclear. Mauro et al. (2014) instead support the idea that decentralization in the Italian case has been the key determinant of the halt of regional convergence. Some other studies analyse the relationship between decen4

Thiessen (2003) found a non-linear inverted U-shaped relationship between decentralization and growth. However, this relationship becomes fragile adding advanced developing countries with relatively low income. Rodriguez-Pose and Ezcurra (2011) incorporated the square of the measure of fiscal decentralization employed as an additional regressor, but the corresponding coefficient was not statistically significant.

15

tralization and regional growth. Mauro and Pagliaru (2011; 2013) find that the economic success of decentralization policies depends on the local endowment of social capital: decentralization enhances growth wherever social capital is high. Di Liddo et al. (2013) find that decentralization exerts a positive impact on public sector efficiency, contributing to stimulate growth. Recently, Pluchino and Zanardi (2016), measure the degree of decentralization both considering expenses and revenue (excluding transfers) and analyze the effects of fiscal decentralization on economic growth and on territorial convergence. In their work the interval is considered is the period 19952012. It emerges a positive effect on growth for both the decentralization indicators (i.e. decentralization of expenses and of revenue), but the effect is greater when expenses are decentralized. Decentralization also seems to reduce territorial inequality even if the results are not completely statistically significant. None of these studies for the Italian case considers the composition of public expenditure. As for the link between decentralization and expenditure composition, Grisorio and Prota (2015) find that the decentralization process in Italy over the last decades changed the composition of expenditure at local level. The impact of fiscal decentralization varies across different public spending categories indicating that the composition of government expenditure is a relevant factor determining long-run economic growth. The change induced by fiscal decentralization does not necessarily determine a better allocative efficiency since it may yield incentives for lower tiers of 16

government to behave strategically in determining spending levels to influence the location of households and firms.

3. Decentralized public expenditure and regional growth in Italy In this paper, as already said, in order to deeply understand the effect of decentralization on growth, we do not simply consider the degree of decentralization in Italy but we do distinguish between current and capital decentralized expenditure at the regional level, over the period 1996-2014. The aim is to determine whether the effect of expenditure on growth changes with the type of decentralized expenditure. To carry out the analysis: Section 3.1 describe the dataset; Section 3.2 introduces the empirical methodology and Section 3.3 presents the results. Before presenting the analysis, in the following line we recall the context of the multi-level finance in Italy saying first that since the 90’s, Italy has experienced the strongest wave of decentralization reforms in its post-Second World War (see Ambrosanio et al., 2010; Ambrosanio at al.,2016). Subnational public expenditure, as a percentage of total public expenditure was almost 25% at the beginning of ‘90s and reached almost 35% after 20 years. On the revenue side, the increase has been even striking: own tax revenue as a percentage of total revenues of sub-national governments, in the same period, passed from 15% to 45%. Twofold forces inspired this radical 17

change: economic and political. On the political side, scandals and many episodes of corruptions determined a complete replacement of political leaders that in some cases had ruled the country for the previous 20 years. Old parties disappeared and new parties appeared on the political arena, some of them with a strong territorial constituency and advocating more autonomy for those territories. The political influence of Lega Nord was quite strong in asking more territorial autonomy from the Centre (as already said) but also in asking less redistributive national policies in order to reduce financial flows from the rich regions of the North to the poor region of the South5. So, in the long sequence of the “governi tecnici” as well as of the Center-Right and Center-Left coalitions that governed Italy up to the 2008-09 crisis, the “need” for more autonomy (and consequent reforms) has always been in the background of the political scene. On the economic side, the story starts during the 1980’s when the debt/GDP ratio doubled6 and brought Italy to a severe sovereign debt crisis in 1992. Also, during the 80’s soft budget constraints’ were endemic in the Italian structure of multi-level finance: deficits by local governments were always covered ex post by the central government (see Bordignon and Turati 2009). Moreover, the need to meet the Maastricht criteria imposed a number of reforms with the aim of strictly controlling public deficit and debt. Fiscal and institutional 5 6

For a discussion on fiscal flows in Italia see Ambrosanio et al.: 2010. At the beginning of 1980s’ the ratio was almost 60%. In 1992, 122%.

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decentralization were thought as important parts of these reforms. So, “fiscal federalism” ranked high on the political agenda of all Italian governments in the ‘90’s until 2000’s and not only for the political reasons we mentioned before. Indeed at that time, in the economic literature fiscal federalism “was in vogue” (see Oates 1999) Many suggestions favourable to decentralization were arriving from this flourishing branch of literature.7 In short, the main results are that decentralizing revenue raising and spending decisions are effective tool do increase the efficiency of public expenditures. And then, decentralization could reduce wastes in the public sector.8 Notice also that from a political perspective a wide consensus emerged on the efficiency-enhancing properties of the decentralization choice. It is widely acknowledged in the economic literature - as well as in the political science literature - that decentralization of decision-making can increase transparency and accountability by reducing the dis7

Actually, in section 2 we have only mentioned the efficiency properties analyzed by the theory of fiscal federalism which is also classified in two main fields: traditional theory and second generation theory. Instead in section 2 we have in more depth focused on a new field of research of this literature that, as already said, departs from the efficiency properties considered only in a static framework and instead it move on considering a dynamic framework. As seen in section 2, this new branch of research, tries to point out the properties of the dynamic effects of fiscal federalism on economic growth and on inequality across regions and across individuals. 8 Recall that many of the new national governments at the beginning of the 90’s were composed in large part of “tecnici” and many of them university professors.

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tance between politicians and their electorates and can strengthen the local democratic process. On empirical grounds these suggestions have found evidence in some studies (see Bordignon Cerniglia and Revelli 2003). The Italian decentralization process (as said starting in 1990’s) reached the apex in april 2001 when the Parliament approved a constitutional reform which modified a number of articles (from 114 to 118 in Title V of the Constitution). But, to conclude we must also say that this story of the Italian reforms relating to the multilevel structure has not come to an end, unfortunately. In December 2016 a new referendum took place to amend the second part of the Constitutions (and hence also some article of Title 5 contained in the second part of the Constitution). In some ways, two contradictory objectives were pursued by this reform: (i) to transform the Senate into a house of local representatives, and (ii) the reduction of number of responsibility of sub-level. Such reform was defeated at the national referendum9. The fiscal federalism issue in still on the agenda then. Referenda that took place in October 2017 in Veneto and Lombardia to call for more devolution is another piece of this endless story. Obviously, a lot of work has to be done in order to understand the efficiency properties of such ongoing process, but most important we be9

This also implies that - according to art. 114 of our Constitutions – in Italy sub-levels of government still are: Regions, provincens, “città metropolitane, and municipalitieswith no legal hierarchical links between the different levels of government. However Legge Delrio abolished provinces (now “enti di area vasta”) and reinforced the role of città metropolitan.

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lieve the advantages in terms of growth that categories of decentralized expenditure can enhance in the territories. This is the aim of this work

Data and variables We study the effect of decentralized expenditure on economic growth using data of Italian regions covering the period between 1996 and 2014. Economic growth is measured by the per capita GDP growth rate at regional level, obtained by the difference between natural log of real GDP (expressed in euros at constant 2010 prices) in ‫ݐ‬ and ‫ ݐ‬െ ͳǤ The source is ISTAT. Data on decentralized expenditure are from Conti pubblici territoriali 10 that provide statistical information on expenditure at central, regional, and local level. We aggregated data of regional and local level (both for current and for capital expenditure) and expressed them as percentage of total public expenditure. These are the measures of our degree of decentralization (or sub-national expenditure over total expenditure). This is the standard measure of fiscal decentralization, widely used in previous studies. The most common database come from IMF and OECD. As acknowledged by many scholars (see Ebel and Yilmaz, 2002 and Stegarescu, 2005), this index of decentralization does not perfectly reflect such complexity, given that decentralization is a complex and 10

http://www.agenziacoesione.gov.it/it/cpt/.

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multifaceted concept that spans fiscal, political, and administrative dimensions. However, the complexity of the process of fiscal decentralization is much more complicated when we consider revenue. The revenue decentralization index suffers of much more caveats than the expenditure decentralization index. Considering this index it is very difficult to assess the effective tax autonomy of local governments.11 Due to the pitfall of this index, we decided to focus only on index on expenditure especially because our main focus has been to establish a link between expenditure decentralization and growth in Italy. A set of control variables was also included in the model to account for socio-economic factors that may play a role in regional economic growth. These factors are the following (Table A1 in Appendix sets out this list of variables used in the analysis with their definition, source and reference period): x

Government size, measured by total public expenditure over GDP. (source: Conti pubblici territoriali);

x

Education, measured by the participation rate in education and (source: Eurostat);

11

Let us give an example. In Italy for instance regional surtax on income (Irpef surtax) is included among local tax revenues. Regional governments have no power on this tax rate, since it is the national government that most of the time fixes the tax rate. Actually, theoretically nothing will change if Irpef surtax would be included among transfers to sub levels from the central government. This problem is quite common everywhere, as documented by OECD data base.

22

x

Net imports over GDP, as a measure of trade openness (source: ISTAT);

x

Private investment (in fixed assets) over GDP (source: ISTAT).

Summary statistics of the whole set of variables are shown in Table 1 Table 1- Summary statistics Variable

N

Mean

Sd

Min

max

Growth rate

380

9.80e-05

0.0253

-0.0940

0.0582

Dec. cap. exp.

380

0.450

0.156

0.110

0.889

Dec. curr. exp.

380

0.288

0.0683

0.163

0.505

Tot. public exp. 380

0.5127

0.1078

0.2188

0.7566

Net imports

380

0.0882

0.140

-0.187

0.414

Education

380

5.804

1.371

3.200

12.15

Private invest- 380

0.2149

0.0364

0.1412

0.3225

ment

Empirical methodology To estimate the impact of decentralized public expenditure (capital and current) on economic growth, we use a Generalized Additive Model (GAM), which is a generalized linear model with a linear predictor involving a sum of smooth functions of covariates (Hastie and Tibshirani, 1990). In our case, decentralized public expenditure, both current and capital, is modelled non-parametrically. Let us define ݃௜௧ 23

the growth rate of real GDP per capita of region ݅ at time ‫ݐ‬, and ‫ܧ‬ሺ݃௜௧ ሻ its expected value. The GAM model is as follows: ೎ೌ೛

ீೞ೙

݄‫ܧ‬ሺ݃௜௧ ሻ ൌ ߙ ൅ ݂ଵ ൬

೎ೌ೛ ீ೟೚೟

൰

ீ ೎ೠೝ

௜௧ିଶ

൅ ݂ଶ ቀீೞ೙ ೎ೠೝ ቁ ೟೚೟

௜௧ିଶ

൅ σ௄ ௞ୀଵ ߩ௞ ‫ݔ‬௞௜௧ିଶ ൅ ߝ௜௧

where x

݄ is a link function relating the expected value of ݃௜௧ to the covariates;

x

ߙ is a constant term;

x

൬

೎ೌ೛

ீೞ೙

೎ೌ೛

ீ೟೚೟

൰

is the sub-national capital expenditure over total

௜௧ିଶ

capital expenditure observed in region ݅ at time ‫ ݐ‬െ ʹ; x

೎ೠೝ ீೞ೙ ೎ೠೝ ቁ ீ೟೚೟ ௜௧ିଶ

ቀ

is the sub-national current expenditure over total

current expenditure observed in region ݅ at time ‫ ݐ‬െ ʹ; x

೎ೌ೛

ீ೟೚೟

ீ ೎ೠೝ

ቀீೞ೙ ೎ೠೝ ቁ ೟೚೟

x

೎ೌ೛

ீೞ೙

݂௝ ሺήሻ, with ݆ ൌ ͳǡ ʹ, are smooth functions of ൬

௜௧ିଶ

൰

and

௜௧ିଶ

, respectively;

‫ݔ‬௞௜௧ିଶ , with ݇ ൌ ͳǡ ǥ ǡ ‫ ܭ‬, are control variables including government size, education, private investment and net imports measured as specified in Section 4.2.;

x

ߝ௜௧ is the usual error term.

The lagged variables in the model allow to control for endogeneity issues. Function ݂௝ ሺήሻ is unknown and it is assumed to be continuous and differentiable. To give an idea on how ݂௝ ሺήሻ is determined, con-

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sider the following simplified version of GAM, which assumes observations ሺ‫ݕ‬௜ ǡ ‫ݔ‬௜ ሻ, with ݅ ൌ ͳǡ ǥ ǡ ݊: ௡

ଶ

ଶ

‹ ൝෍൫‫ݕ‬௜ െ ݂ሺ‫ݔ‬௜ ሻ൯ ൅ ߣ න൫݂ԢԢሺ‫ݔ‬ሻ൯ ݀‫ݔ‬ൡǤ ௙ሺήሻ

௜ୀଵ

The above equation consists of two components: the sum of the squared deviation of the fitted function from the observed values; the integrated square of second derivative that penalizes models that are too “wiggly” (Wood, 2006). The smoothing parameter ߣ is such that the Generalized Cross Validation (GCV) score is minimized.

Empirical results The estimation results of GAM (eq. 1) are reported in Table 2, which is divided in two parts: the first part shows the results for the nonparametric part of the model; the second part shows the estimated coefficients of variables entering linearly in the regression. The first part also reports the F-test assessing the overall significance of smooth terms, and the estimated degrees of freedom (edf). If edf = 1, the smooth term can be approximated by a linear term. Model (1) has been estimated using the mgcv package in R (Wood 2006). As the non-parametric part of eq. (1), the approximate p-value of Ftest indicates that decentralized current and capital expenditure have

25

a statistically significant impact on the economic growth rate.12 The estimated degrees of freedom associated with the smooth terms are different from 1 suggesting a non-linear relationship. The estimated functions are shown in Figure 1 where the dotted lines give 95% confidence intervals. Notably and differently from previous studies, we find that the relationship between decentralization and growth has two different slopes according to the category of expenditure. As for decentralized capital expenditure the slope is positive: an increase in decentralization increases economic growth. As for decentralized current expenditure the slope is negative: an increase in decentralization decreases economic growth. In the concluding section, we provide an economic intuition on how to interpret these results. 12

The p-value of smooth terms is an approximate value (for details, see Ruppert et al., 2003 ch. 4.8).

26

Table 2 - Estimation results of GAM Non-parametric part of GAM Coefficient

Variable

(F statistics)

௖௔௣

݂ଵ ቆ

‫ܩ‬௦௡

2.402*

௖௔௣ ቇ ‫ܩ‬௧௢௧

݂ଶ ቆ

(2.451)

௖௨௥ ‫ܩ‬௦௡ ௖௨௥ ቇ ‫ܩ‬௧௢௧

4.366***

edf

1.876 3.466

(3.913) Parametric part of GAM

Variable Government size

Coefficient (Std. Err.) -0.0136** (0.0023)

Net imports

-0.0388*** (0.00245)

Education

0.0052** (0.0027)

Private investment

0.0259*** (0.0061)

Intercept

0.0373** (0.0190)

Adjusted R

2

Number of observations

0.165 340

Note: Significance levels are denoted by *** (1%), ** (5%), and * (10%). In non-parametric estimation, we reported the F-test and the EDF in parentheses. F-test assesses the significance of smooth terms. EDF reflect the flexibility of the model. An EDF = 1 means that the smooth term can be approximated by a linear term. In parametric estimation, std. errors are in parenthesis.

27

Figure 1 - Estimated functions for the effects of decentralized expenditure on growth

Decentralized capital spending

Decentralized current spending

Finally, looking at the empirical results for the parametric part of eq. (1), variables are all statistically significant. Government size and net-imports over GDP have a negative effect on growth, while education and private investment have a positive effect.

4. Conclusions: how to interpret the empirical results The main focus of this paper has been to analyse the dynamic effects of the decentralization process in Italy over the period 1994-2014. As we have stressed in section 2, in the literature there is not a unanimous consensus about the sign of the effect of decentralization on growth. As mentioned above, in one of our previous studies (Carniti et al. 2017), we have shown to what extent (from both a theoretical 28

and empirical perspective) this relationship may be non-monotonic in a large group of European countries. Focusing only on the Italian decentralization process we have found that the relationship between decentralization and growth is monotonic

But, very interestingly, this relationship has two different

slopes according to different categories of decentralized expenditure, namely i) as for capital expenditure, the slope is positive, namely an increase in decentralization increases economic growth; ii) as for current expenditure, the slope is negative, namely an increase in decentralization decreases economic growth. These findings constitute a novel result on the Italian case, and obviously the question is: can we draw some conclusions on how to interpret these results? Firstly from a theoretical point of view there is a unanimous consensus on the fact that in general these two categories of expenditure exert different effects on growth, as also shown by a paper by Di Giacinto et al. (2010)13. Secondly, borrowing from the literature on decentralization and growth (reviewed in Section 2), we may argue that a marginal increase in the degree of expenditure decentralization has a twofold effect in terms of growth: 13

In particular, they focus on capital expenditure and find that investment in public capital is a powerful instrument to stimulate economic growth in the long run, a result to which a strong and sustained positive response of private capital clearly contributes; in other words, public and private capital appear to be complementary.

29

1. a decreasing “marginal benefit” (MB hereafter), since decentralization increases the saving rate, and enhances the efficiency of the public sector; 2. an increasing “marginal cost” (MC hereafter), since, as expenditure increases, taxes increase. This implies that, if the category of expenditure is not growth enhancing, a distortionary effect of the tax burden may arise. Algebraically, the derivative of the rate of economic growth g ,

§ Gsn · ¸ , is equal to the difference be© G ¹

with respect to decentralization ¨ tween MB and MC:

wg G w sn G If MB ! MC , then

MB  MC

(2)

wg ! 0 and the rate of economic growth inGsn w G

creases as decentralization increases. If MB  MC , then

wg  0 and the rate of economic growth deGsn w G

creases as decentralization increases.

30

Equation (2) allows us to depict Figure 2, where many different scenarios, about the relationship between decentralization and growth, arise. Figure 2 - different scenarios, according to the prevailing effect between MB and MC

a) Positive monotonic relationship between decentralization and growth (panel A in Fig. 2) This scenario arises if MB ! MC and is much more plausible with capital expenditure decentralization, since this category of expenditure is the most productive one and, by this token, it is growth en31

hancing14. Our econometric results are in line with this underpinning: we have found that an increase in the degree of decentralization of capital expenditure in Italy promotes the rate of regional growth.

b) Negative monotonic relationship between decentralization and growth (panel B in Fig. 2) This scenario arises if MB  MC and is more plausible if an unproductive category of expenditure is decentralized. Our econometric results also are in line with this underpinning: an increase in the degree of decentralization of current expenditure implies a decrease in the rate of regional economic growth.

c) Concave non-monotonic relationship between decentralization and growth (panel C in Fig. 2) This scenario takes place if MB ! MC up to a turning point, after which MB MC . This scenario implies a non-monotonic “inverse U”-shaped curve between decentralization and growth. The findings of this paper do not come in accordance with this scenario which is also plausible.15 To sum up, results of this paper fit quite well with scenarios a) and b) and suggest some remarks. As it is widely known, in Italy the decen14

See Blochliger H. e Egert B. (2013) and Fredriksen K. (2013). In other words this scenario can be also plausible as found - for instance in a cross-countries studiy carried out by Carniti et al. 2017.

15

32

tralization process has not come to an end. Both in the political and in the academic debate, it emerges the request of a review of some institutional aspects of this process experienced in our country in the last twenty years. But also capital expenditure is a subject of growing attention (both in Italy and in Europe) in order to promote growth after the crisis. Turning the attention to the findings of this paper, it emerges that, the debate and possible reforms should be particularly focused on the dynamic effects of the decentralization process which implies also that a deeper analysis of different categories of expenditure to be decentralized is needed. The aim of this study is to provide a first insight on that, and a basis for further analyses.

33

Appendix Table A1 - Description and sources of variables Variable Growth rate

Dec. cap. exp.

Dec. curr. exp.

Tot. public

Definition Real GDP per capita growth rate (base year: 2010).

ISTAT

Decentralised capital expenditure on total public

Conti pubblici terri-

expenditure.

toriali

Decentralised current expenditure on total public

Conti pubblici terri-

expenditure.

toriali

Total public expenditure over GDP

Conti pubblici territoriali

exp. Net imports Education

Imports minus exports over GDP

Private in-



34

ISTAT

Participation rate in education and training in the last 4 weeks

vestment

Source

Private investment over GDP

Eurostat ISTAT

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Working Paper 04/17

Decentralization of public expenditure and growth in Italy: Does the composition matter? Floriana Cerniglia, Riccarda Longaretti, Alessandra Michelangeli