Doctoral Dissertation Research in Political Science: What Drives Subnational Borrowing Conditions? Social Spending and Government Size

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The world's governments are growing increasingly dependent on credit markets. This dependence is strengthening investors' capacity to reward or punish governments for their policy responsibilities, size, and other potential drivers of investor profits. This project examines sources of market punishments and rewards as they relate to local and regional governments. It addresses two questions. First, do international rating agencies penalize local and regional governments for spending on health care, education, and other core social service functions? Second, which governments borrow on the best terms: those representing large or small jurisdictions? The researcher argues that investors penalize governments for rigid social commitments: high levels of spending on health care and other politically sensitive social services. These commitments benefit large numbers of voters and unionized service providers and are correspondingly difficult to cut. This limits the fiscal flexibility that local and regional governments may require to balance budgets, causing investors to demand higher interest rates on public bonds and loans. But these reactions are offset by several national-level factors, including sub-national authority to adjust revenues and expenditures, national fiscal and economic performance, and the likelihood of national bailouts. The researcher also argues that, contrary to received wisdom, small governments often borrow on better terms than do large issuers. Although investors value the debt of large issuers for its liquidity, they also value diversification. Investing in the relatively scarce debt of small governments allows investors to diversify away from the more plentiful instruments of large issuers. But the relative advantages of size also depend on market conditions and their interactions with investors' liquidity preferences. Liquidity needs increase with market volatility, inducing flights from the securities of small to the securities of large governments. The intensity of these flights depends on investors' liquidity preferences, which vary across time and countries. This work tests these claims using a wide range of quantitative and qualitative methods and data, including broad cross-national analysis of credit ratings and methodologies, a more focused statistical look at regional borrowing costs in Canada and Germany, and semi-structured interviews with bond underwriters and investors. This work advances interdisciplinary research in political science and economics. First, it stands as the first broadly cross-national analysis of the effects of financial globalization on sub-national provision of social services. Scholarship to date has focused almost exclusively on the national level, while provision of social services has been decentralized to significant degrees. Second, this project advances research on economic agents' preferences over social spending. Third, the project contributes to work on fiscal federalism and sub-national bailout guarantees. Contrary to a large literature, it finds little evidence linking bailout guarantees to sub-national fiscal dependence, but it does find evidence linking guarantees to other factors. Finally, it advances debates about the merits of fiscal decentralization for big and small governments. This research makes several broader contributions. It sheds light on the sustainability of decentralized social spending in an age of austerity and financial uncertainty. It also enhances understanding of the links between public borrowing costs, government size, and the mark-to-market accounting practices increasingly prevalent across the globe. In addition, it illuminates the determinants of sub-national bailout guarantees.