Public Debt and Investment Under Political Competition: Evidence from Toxic Loans

By: Julien Sauvagnat and Boris Vallée

Format:Print
| Language:English
| Pages:45

Abstract

We examine how political considerations shape local government responses to a substantial rise in indebtedness. We use the delayed yet sharp deterioration of “toxic” loans held by French municipalities as a quasi-natural experiment to empirically investigate such phenomenon. Politically contested mayors reduce public investment significantly more in response to an increased debt burden compared to their less politically challenged counterparts. Consequently, the net increase in public debt is considerably more attenuated in politically contested municipalities. These results are consistent with a theoretical model of public investment, where electoral competition disciplines the budgetary decisions of local politicians, underscoring the political dimension of public indebtedness.