Institutions, Credit Constraint, and Fiscal Behavior: An Empirical Study of Argentina's Provincial Governments

Abstract

This paper examines the fiscal behavior Argentina's provinces during the 1990s. The issue is of particular interest because the rapidly rising provincial debt has played a crucial role in the recent financial crisis in Argentina and the experience holds important lessons for many other countries with federal systems and those in the process of fiscal decentralization. To map the forces behind the evolution of the public expenditure and debt, we develop a panel data methodology that separates the steady state effect of each factor from its influence on the adjustment rate of fiscal variables. The estimation results show that part of the rapid rise in the provincial debt may be due to inevitable economic factors. However, politics and institutional weaknesses have also played important roles by allowing provinces to raise the aggregate risks for the country by excessive borrowing and spending. Interestingly, we also find that higher borrowing and slow fiscal adjustment is not a sign of weak institutions. In fact, because of concerns of the financial markets, provinces with weaker fiscal institutions seem to have faced tighter credit constraints, which have lowered their debt-GDP ratios and forced them to adjust faster in the face of fiscal shocks.

Keywords: public debt, fiscal federalism, political economy, borrowing constraint

JEL Classification: H7, H6, H5