Political Competition and Fiscal Status: Evidence from Municipalities in Israel

Abstract

This paper analyzes the link between fiscal balance and political competition. Two conflicting hypotheses are formulated and tested in the literature, with no consensus as to which is correct. The first hypothesis states that political competition increases the accountability of politicians and thus increasing the efficiency of the public sector. The second states the opposite, suggesting that political competition leads to inefficiencies which are the result of the necessity to form a coalition. I test these hypotheses with budgetary and political data on municipalities in Israel for the years 1997-2006. The results suggest that the aforementioned hypotheses could both hold true, depending on the level of the competition. Low levels of political competition are associated with large debts. However, high levels of political competition are also associated with large debts, while the smallest levels of debt arise when political competition is intermediate. Low levels of political competition might be caused by the tendency of Arab residents to vote according to their clan affiliation. I also find evidence of political budget cycles in Israeli municipalities, where election years result in greater deficits. These cycles might be another mechanism by which the effect of political competition takes place, as they are also affected by the level of political competition.

Keywords: Political competition, political fragmentation, local governments, local government budget

JEL Classification: H72, H74, H77, E62, R51