Birds of a feather need not flock together - Mitigating common pool problems and status quo bias with fiscal constraints

Abstract: The ability of decision-makers to cooperate with one another is a controversial topic in political economy. It is often hypothesized that governments and parliaments, which are fragmented in terms of size and ideology will have worse economic outcomes than their less fragmented counterparts. This paper offers an empirical analysis of the impact of fiscal constraints on collective action problems using a panel data set for Swedish municipalities covering the period 1995 to 2012. The study finds some evidence of common pool problems as well as status quo bias, but their effects on economic outcomes are mitigated by the introduction of a balanced budget rule in 2000. However, since the balanced budget rule does not constrain all types of spending, it is likely to induce a behavioral change towards the types of spending that are not bound by the policy reform. Interestingly, this paper finds (weak) evidence of fragmented municipalities starting to channel more spending through their corporations following the policy reform. Thus, while fiscal constraints may eliminate the "direct" negative side effects of political fragmentation, they may also trigger non-expected responses in other parts of the economy.