Scandinavian Working Papers in Economics

Working Papers,
Lund University, Department of Economics

No 2012:24: Assist or Desist? Conditional Bailouts and Fiscal Discipline in Local Governments

Jens Dietrichson () and Lina Maria Ellegård ()
Additional contact information
Jens Dietrichson: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden
Lina Maria Ellegård: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden

Abstract: Central government bailouts of local governments are commonly viewed as a recipe for local fiscal indiscipline, as local governments learn that the center will come to the rescue in times of trouble. However, little is known about the consequences of bailouts granted conditional on local governments first making efforts to improve the situation. We examine a case in which the Swedish central government provided conditional grants to 36 financially troubled municipalities. We use the synthetic control method to identify suitable comparison units for each of the 36 municipalities. To compare the development of costs and the fiscal surplus of admitted municipalities to that of their most similar counterparts during the decade after the program, we then estimate fixed effects regressions on the resulting sample. The analysis suggests that conditional bailouts did not erode, and may even had induced greater fiscal discipline.

Keywords: Bailouts; local governments; fiscal performance; synthetic control method

JEL-codes: D23; H61; H62; H72; H77

38 pages, First version: September 20, 2012. Revised: February 12, 2015. Earlier revisions: October 28, 2013.

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