FRAGMENTATION AND GOVERNMENT SPENDING: BRINGING IDEOLOGICAL POLARIZATION INTO THE PICTURE. Marcela Eslava Oskar Nupia 1

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1 FRAGMENTATION AND GOVERNMENT SPENDING: BRINGING IDEOLOGICAL POLARIZATION INTO THE PICTURE Marcela Eslava Oskar Nupia 1 Abstract Governments adopt projects targeting the constituencies of legislators, either because legislators participate in the budget design, or because they demand those projects in exchange for supporting government initiatives in Congress. We study empirically the idea that, where the latter is operative, the effect of fragmentation on government spending is positive only if there exists a high level of polarization. We indeed find that the effect of fragmentation is intermediated by the degree of polarization, but only for presidential democracies. These results suggest that governments use of pork spending for gathering legislative support is more prevalent in this type of democracy. JEL Classification: E62, H61. Key words: Common-pool resource problem, government spending, fragmentation, ideological polarization. 1 Both authors are at Universidad de Los Andes. Contact information: meslava@uniandes.edu.co, onupia@uniandes.edu.co. We are grateful to Alejandra Jimenez and Angela Fonseca for their excellent research assistance and to participants at the 9 th Meeting of LACEA s Political Economy Group for their very useful comments. The comments on Carlos Scartascini and Mónica Pachón on earlier drafts are also greatly appreciated. 1

2 1. Introduction Considerable attention has been given in the literature to the idea that political fragmentation affects the amount of government spending. Fragmentation in this context refers to the number of different interests whose demands are reflected in the budget. Greater fragmentation is expected to increase government expenditure through a standard common pool of resources problem. While government expenditures tend to generate benefits that are concentrated, they are funded from a common pool of taxation. Those groups benefiting from specific expenses thus do not fully internalize their costs, as they are shared by all of the groups. The greater the number of agents participating (and thus sharing the costs), the lesser the degree to which any particular agent internalizes the costs of the goods provided to him or her by the government. As a result, the total amount of spending demanded by participating agents grows with their number. This idea was put forward a long time ago (e.g., Weingast et al. 1981) and has since been the subject of a large literature. While the above discussion explains why greater fragmentation leads to greater demands for spending by different interests, it is relevant to ask about the mechanism that translates those demands into actual government expenses. One approach in the empirical literature has been to think of political parties in the legislature as representing different groups in society. Underlying this idea is that each party s constituency should be a relatively cohesive group. Moreover, legislators are expected to have some possibility of affecting the budget. The demands of different groups are thus brought into the budget discussion by the parties representing their respective interests and that in turn play a role in the decision making process. There is, in fact, a variety of ways by which the demands of legislating parties at least those that are part of the governing coalition eventually come to be reflected in the budget. These mechanisms can be divided into two broad categories. First, political parties in the legislature participate in the general process of policy design, and an important share of policies carry expenditures. In a very stylized manner, one can thus think of the budget as the sum of the policy demands of those parties with representation. In fact, while in general the budget is initially designed by the executive, formal budget rules in several countries give the legislature the ability to amend the government s proposal. 2 In addition, political practices in several countries are such that politicians from the ruling coalition are, in practice, able to participate to a great extent in the drafting of the budget Japan is one example. 3 A second reason why expenditures reflective of the interests of legislators constituencies make it into the budget is that the government may use targeted expenses to build legislative support for its projects. Anecdotal evidence suggests the extensive use of government expenditure in exchange for legislative support (see, for example, several case studies from Latin 2 For instance, in 33% of the 97 countries surveyed by the 2007 Budget Practices and Procedures Survey, the legislature has unlimited powers to amend the government s proposed budget. Source: retrieved on April 19th, 2010 (question 40.) 3 For instance, in measuring the quality of budget institutions in Japan, Von Hagen (2006) assigns a low score in the category of budget negotiations as a result of involvement...of politicians from the ruling parties. Moreover, a strong position of the parliament vis-a-vis government in the approval stage generates incentives for the government to take into account legislators demands during the drafting stage to facilitate approval later in the process. 2

3 America in Hallerberg et al., 2009). We refer to this mechanism for the transmission of legislators demands into government spending as the pork barrel mechanism. Both mechanisms imply a link between legislative fragmentation and the budget size through the common pool problem mentioned above. However, when the demands of political parties are included in the budget in exchange for their support for other government initiatives, the extent of the fragmentation-spending relationship is likely to depend on the degree of political polarization. Where there exists a high degree of political cohesion, it is unlikely that the parties in Congress will exercise their powers to block government initiatives. Pork barrel spending to build coalitions around government initiatives should thus only really be a problem where there exists some degree of polarization. By the same token, when the pork barrel mechanism is in play, greater fragmentation should affect government spending if there exists polarization. Nupia (2007) formalizes this argument in a model where the government spends on pork barrel in order to get its initiatives approved. This paper aims at providing empirical evidence substantiating the above claim regarding the effect of political fragmentation on government spending that is, that it depends on the degree of political polarization. We focus here on countries where we expect legislators demands to affect the budget mainly due to the government s attempts to gain support for its projects, inasmuch as it is in exactly such an environment that we expect polarization to affect the fragmentation-spending link. We argue that the pork barrel mechanism is more prevalent in presidential democracies than in parliamentary ones. Governing coalitions in parliamentary systems are in general stable over the course of a government s term, inasmuch as the breaking apart of the coalition generally brings the government down. By contrast, governments in presidential democracies are confronted with less stable coalitions, even to the point whereby coalition building becomes project-specific. We thus expect that the need to target expenditures as a means of gluing together ad-hoc coalitions will be more pressing in presidential systems. At the same time, in parliamentary systems, the close relationship between the government and the legislating parties in its coalition should bring those parties closer to the budget process. Parliamentary systems should thus better fit the stylized conception of the budget as a sum of parties demands. There is, in fact, some evidence that legislators have a more direct influence over the budget s design in parliamentary democracies. For instance, in 2007, the proportion of countries reporting in the Budget Practices and Procedures Survey that the legislature has unrestricted powers to amend the budget was 51% among parliamentary democracies, but only 14% among presidential systems. 4 The focus on presidential democracies is also interesting because most of the empirical literature has focused on country samples consisting mostly of parliamentary democracies. 5 This is the case, for instance, with the OECD. For those countries, studies 4 An interesting related figure is that the fraction of countries where the executive branch does not have the power to veto the budget approved by the legislature is much larger among parliamentary than presidential democracies 87% vs. 57%. Source: retrieved on April 15th, 2010 (questions 40 and 44). 5 Though part of a related literature examining the relationship between fiscal outcomes and the degree of centralization of the budgeting process has focused on the Latin American case (e.g. Alesina et al., 1999; Hallerberg and Marier, 2004; Stein t al ) 3

4 tend to find a positive, though not completely robust, linear relationship between fragmentation and spending. The link between legislative fragmentation and government spending has been widely studied in the past. Several authors find that either government spending or budget deficits increase as legislative fragmentation increases (Mukherjee, 2003; Bawn and Rosenbluth, 2006). Others find that political systems where fiscal decision-making presumably exhibits greater fragmentation, such as parliamentary systems, also show higher levels of spending or greater budget deficits (Persson and Tabellini, 2004). A few studies have introduced measures of fragmentation and polarization as simultaneous determinants of fiscal policy (Elgie and McMenamin, 2008; and Volkerink and De Haan, 2001). These studies have found that polarization does not have a statistically significant effect on fiscal outcomes. In this paper, we not only examine the impact of both legislative polarization and fragmentation on spending levels, but also allow for interdependence between their effects. As stated above, our hypothesis is that fragmentation should matter for public spending only to the extent that political polarization is high enough that the government needs to worry about building support for its projects, and for countries where targeted expenses are used to build this support. We use a panel of data consisting of annual observations for a set of developed and developing presidential democracies for the period Consistent with the discussion above, we measure fragmentation based on the number of political parties in the governing coalition, and polarization based on the ideological distance between them. (The details are discussed below.) Our idea of fragmentation is thus closest to what the literature has called size fragmentation (e.g., Volkerink and de De Haan, 2001; and Perotti and Kontopoulos, 2002). 6 We also focus on the effects fragmentation and polarization have on central government spending, as opposed to deficits. As noted by Perotti and Kontopoulos (2002), the theoretical arguments outlined above link fragmentation with government spending; arguments translating the pressure derived from fragmentation into greater deficits are less general. 7 6 The term fragmentation has been used in this literature to imply different things; likewise, fragmentation has been measured in different ways. A more or less general concept of fragmentation might be the degree to which the different agents participating in the decision-making process internalize the costs of their demands, generally thought to be inversely related to the number of such agents. Even sticking to this definition, studies differ regarding the set of relevant agents considered (for instance, political parties versus spending ministers), and in terms of how they measure their number (e.g., the actual number of agents versus the number of agents weighted by their influence). Moreover, and most confusing, fragmentation has also been used to refer to the ideological distance between the agents involved in policymaking, not only their numbers. For instance, Volkerink and De Haan (2001) use the term political fragmentation to denote ideological difference. By contrast, throughout this paper, we use the term political polarization to indicate ideological distance. 7 The spending bias translates into deficit bias if revenues are exogenous, but the empirical results about the effects of fragmentation on deficits, mentioned further below, question this possibility. Velasco (1999, 2000) presents perhaps the best known models linking fragmentation with fiscal deficits. In the model, groups have preferences over net transfers from the government, rather than over spending of gross transfers (Velasco, 1999). This assumption contrasts with the more traditional view that individuals have preferences over consumption (of public goods in this case), while taxes affect consumption in a nonlinear manner and through the budget constraint. As a result of assuming that preferences are defined over net transfers, the over-spending bias becomes a deficit bias. 4

5 Our findings support our initial predictions. We find that the effect of fragmentation on government spending is increasing in polarization and is significantly different from zero (either in a statistical or economic sense) only when there is some degree of polarization. These findings indicate that ignoring the possible interaction between the effects of polarization and fragmentation in a context where the pork barrel mechanism is important may lead to a false rejection of the hypothesis that fragmentation affects government spending. We also test both the standard linear fragmentation-spending relationship and our extended model for a set of parliamentary democracies. Assuming that in this system legislators have the necessary tools at their disposal to influence the budget in a direct way, we expect to find a direct relationship between fragmentation and spending, one not necessarily intermediated by the degree of polarization. In fact, we find that fragmentation has a positive and significant effect on spending, the evidence suggesting that, in this context, a model that includes an interacted effect is probably missspecified. Our finding that the direct effect fragmentation has on spending (i.e., an effect not intermediated by the degree of polarization) is more important in parliamentary democracies than in presidential ones, is consistent with Mukherjee s (2003) findings. His results indicate that the effective number of parties in a legislature has a greater effect on spending in parliamentary democracies than in presidential ones. The remainder of the paper is organized as follows. In section 2, we discuss related literature. Section 3 describes the data set, introduces the econometric baseline model, and presents the model estimations for our sample of presidential democracies. Continuing with the analysis of presidential systems, section 4 presents different tests of our main hypothesis concerning the joint effect of fragmentation and polarization on government spending. In section 5, we discuss the results obtained for parliamentary democracies. The final section presents our conclusions. The appendix describes the data set in detail. 2. Related literature Several contributions in the theoretical literature have implications that link either the degree of political fragmentation or the degree of political polarization to the size of government spending. A first relevant strand of this literature follows Weingast et al. (1981). The basic argument in their paper is that when geographically concentrated interests are represented in the legislature, and projects with local impact are funded from a common pool of resources, the size of the budget is larger than optimal. Moreover, the size of this inefficiency increases with the number of interests represented in the legislature. A similar result is obtained by Baron (1991) in the context of a minimal winning coalition (non-universal) setting. More generally, the fact that a pool of common resources is used to finance public projects with concentrated benefits leads to a common property problem that implies overspending. Such overspending increases with the number of different interests with an influence over the choice of the government budget; this is where political fragmentation comes into play. Political polarization has also been tied to the size of a government s budget. Alesina and Tabellini (1990) present a model wherein incumbent politicians strategically raise 5

6 spending and run deficits in order to tie their successors hands. Their argument is based on the presence of heterogeneous preferences across politicians regarding the composition of government spending. If an incumbent politician faces a high risk of being replaced by someone from a different party, she may increase spending on her preferred goods. Since the cost of the resulting deficit will likely be paid by her successor and will thus fall disproportionately on that successor s preferred goods the long-run pattern of government spending will be tilted toward the incumbent s preferred items. Greater polarization increases an incumbent s incentives to raise spending, as it implies a greater distance between the incumbent s preferences and those of her challengers. 8 More recently, Nupia (2007) has used a model of legislative bargaining to show that the effect of legislative fragmentation (i.e., the number of parties in a legislature) on government spending may depend on the degree of ideological polarization. In his model, spending on pork barrel programs is used by the governing party to promote a particular public policy, one regarding which all parties in the governing coalition have a different ideological position. It is shown that, in the absence of a common pool problem, only ideological polarization and not legislative fragmentation, affects government spending. Nevertheless, if political parties face a common pool problem and pork barrel spending is used to promote a government s policies, then fragmentation will affect spending, though only when the polarization is sufficiently high. This is because the governing party does not need to resort to pork barrel spending to promote its preferred policy if the degree of ideological polarization among parties is sufficiently low to ensure that all parties are in agreement with the government. Following this idea, the basic hypothesis we examine in this paper is that the effect of legislative fragmentation on government spending depends on the extent to which the political system is polarized. In particular, polarization should affect the link between fragmentation and spending when pork barrel spending is used to construct coalitions in support of government projects. Hence, we concentrate on a sample of presidential democracies, where we believe the pork barrel mechanism to be most prevalent. We later repeat our exercises for a group of parliamentary democracies. To the extent of our knowledge, no previous empirical study has evaluated the joint and interdependent effect of fragmentation and polarization, and the degree to which this interdependence depends on the type of political system. A large body of literature has tested empirically whether fragmentation leads to larger public spending or greater deficits. Most of these studies have concentrated on OECD democracies, which, with few exceptions, have parliamentary systems. Some of the studies concentrate on the effect of legislative fragmentation understood as the number of parties in a governing coalition on government spending (Kontopoulos and Perotti 1999; Mukherjee 2003; and Bawn and Rosenbluth 2006). Others emphasize the effect of executive fragmentation corresponding to the number of spending ministers in the cabinet on government spending (Volkerink and De Haan 2001; and Perotti and Kontopoulos 2002). Regardless of the type of fragmentation being analyzed, a positive effect on government spending has been found, though the effect is more robust for executive fragmentation (Perotti and Kontopoulos, 2002). Findings concerning the 8 Some models of delayed fiscal adjustment similarly tie the length of delays to adopt the necessary adjustment to either the degree of political fragmentation or that of polarization, although for different sets of reasons (Alesina and Drazen 1991; and Spolaore 2004). 6

7 effect on fiscal deficits are less conclusive. For instance, Volkerink and De Haan (2001) find that the (positive) effect of increasing numbers of parties in parliament is much smaller for deficits than for spending. Kontopoulos and Perotti (1999) find that increasing numbers of parties in a governing coalition positively affect spending but not deficits (except for a specific subperiod at the end of their sample). These findings suggest that revenues are not exogenous to the degree of fragmentation. 9 On the other hand, only a few studies have analyzed the effect of political polarization on fiscal outcomes. Two examples are Volkerink and de Hann (2001), and Elgie and McMenamin (2008). These studies find that legislative polarization has no statistically significant effect on fiscal outcomes. 3. The baseline empirical model and data Our aim is to estimate the effect of legislative polarization and fragmentation on government spending. As mentioned above, we concentrate on a panel of annual observations for a set of presidential democracies for the period The sample, dictated by data availability, includes 22 developing and developed countries. We will also show the results for a sample of parliamentary democracies for the same period of time. (See the appendix for a complete list of the countries included in our analysis). We classify democracies into presidential and parliamentary following the World Bank s Database of Political Institutions (see the appendix). We begin by estimating the effects of political fragmentation and polarization assuming, as in previous empirical literature, that these effects are independent (equation 1): g = β ' X + u it 0 + β1fit + β 2Pit + γ it it, (1) where g it is central government expenditure as a proportion of GDP in country i at time t, F it is the level of fragmentation in the legislature, P it is the level of ideological polarization in the legislature, X it is a vector of control variables, and u it is a random error term. Our data for government expenditure is based on the dataset created by Brender and Drazen (2005), which brings together information from the IFS, GFS and OECD for We update Brender and Drazen s data using the same sources. The details are provided in the appendix. The advantages of using this dataset compared to each of the original sources are greater coverage and greater consistency (see Brender and Drazen, 2005). As discussed in the introduction, fragmentation refers conceptually to the extent to which groups involved in government expenditure decisions do not internalize the costs of spending. A usual approach has been to measure fragmentation by the number of 9 A related literature has focused on the relationship between centralization of the budget process (inversely related to fragmentation in that process) and fiscal outcomes. The issue has been extensively studied for Europe by Jürgen von Hagen, Mark Hallerberg and others (Hallerberg et a present an excellent review of this work). Alesina et al. (1999), Hallerberg and Marier (2004), and Stein et al. (1999) analyze this relationship for Latin America. Findings support a positive effect of centralization on budget discipline. 7

8 political parties involved in the legislature s approval of the budget, it being assumed that different political parties represent different groups with different interests. 10 In this vein, we use two different measures of fragmentation the raw number and effective number of legislative parties in the governing coalition (RAW and ENP, respectively). The ENP measure, proposed by Laakso and Taagepera (1979), adjusts the number of parties by taking into account the number of seats each party holds in Congress; the ENP measure is effectively equal to the inverse of a Herfindal-type concentration index. The ENP index takes values above one, where one represents legislatures in which a single party holds all of the seats. 11 We also follow two different traditional approaches to measure ideological polarization. First, we use the measure of polarization proposed by Keefer and Stasavage (2003), which corresponds to the ideological distance in a left-center-right scale between the chief executive s party and other parties in the governing coalition (POLAR). We utilize information about the ideology of the executive party and the three largest parties in the governing coalition. POLAR is measured using integer values between zero and two, where zero indicates that the three main parties in the coalition score the same for ideology, and two implies that at least one of the main parties is to the left of the scale and another is to the right. Following Franzese (2008), our second measure of polarization is the weighted standard deviation of the ideologies of the three largest parties in the governing coalition (SD), the number of seats in the legislature being used as weights. As in much of the literature, all of our measures of fragmentation and polarization are computed using only the information for the lower chamber of the legislature. We use the information contained in the Database of Political Institutions, produced by the World Bank, to compute the different measures. The complementary details of the construction of our measures for fragmentation and polarization are provided in the appendix. For control variables, we first include an array of political and institutional determinants of government expenditure that have been suggested in the relevant literature. The inclusion of these institutional variables is particularly important in the context of our exercise, as fragmentation is likely to highly correlate with many of them. Ignoring these variables in our analysis could thus bias the results we are most interested in. Specifically, we control for the electoral rule in the lower house; the extent to which electoral competition revolves around individual candidates rather than political parties, measured by a personalism index (Carey and Shugart, 1995); the number of chambers 10 Kontopoulos and Perotti (1999) point out that this approach of measuring fragmentation refers to the size fragmentation of the legislative part of the budget process. One might also be interested in size fragmentation of the executive part of the process (e.g., the number of spending ministers participating in the design of the budget proposal). Other interesting sources of fragmentation apart from the number of participating forces, are those originating from the rules governing the budget process, what has been termed procedural fragmentation (Perotti and Kontopoulos, 2002). Given our direct interest in the nature of budget negotiations between the executive branch and legislators, this paper is solely concerned with size fragmentation in the legislature. We follow the general practice of concentrating on those parties participating in the governing coalition, under the usual view that it is mainly with these parties that the government negotiates both the budget and support for other government projects. 11 Franseze (2008) argues that common pool theories must be tested using the effective number of parties to capture the number of agents that actually intervene in the process. We take a more general approach, and evaluate the effects of both the RAW and ENP. 8

9 in the legislature; and the total number of seats in the lower house. Proportional electoral rules have been found to generate higher government spending than majoritarian ones (Persson and Tabellini, 2004). Electoral systems that provide incentives for politicians to cultivate personal votes should generate greater fragmentation and should thus lead to higher government spending (Hallerberg and Marier, 2004). In turn, Bradbury and Crain (2001) show that the number of seats and the number of cameras in Congress are relevant with respect to fiscal outcomes. All of these factors capture different dimensions of fragmentation within the policy-making process, and can thus be expected to correlate with our measures of party fragmentation. We show below that, generally speaking, we find positive, though not overwhelmingly high, correlation coefficients for our sample. Besides the controls just described, we also include standard economic controls used in previous studies: GDP growth, an index of openness to trade, lagged debt and dependent population. Finally, we include a dummy for cases in which the government s party has the majority in Congress and a dummy for presidential election years. The majoritarian government dummy is meant to control for the fact that pork barrel spending to build support for government projects may be less important when the government controls the parliament. The electoral dummy is included in recognition of a large literature suggesting that government spending may systematically grow during election years. The appendix contains a complete description of our control variables and the corresponding sources. Table 1 shows descriptive statistics for the variables included in the analysis. Notice that most of the variability in our fragmentation and polarization measures is across countries (the last column in Table 1). Given the limited variability that political fragmentation and political polarization exhibit over time within any particular country, our focus is on differences in government expenditure and political characteristics across countries. In other words, we do not include country fixed effects in most of our estimations. We do include time effects and regional fixed effects to account for as much unobserved heterogeneity as possible in this context (see the appendix for details on how regions are defined). Moreover, we do report a set of results from fixed effects specifications, and contrast these with what is obtained in the absence of such effects. Table 2 presents the correlation coefficients between the main variables in our analysis. It is worth noticing that there is high correlation between the two measures of polarization and the two measures of fragmentation (in both cases, above 0.9). Our measures of fragmentation and polarization are also positively correlated with central government expenditure, which in principle is consistent with our expectations, although at this point, we have not controlled for other relevant and related effects. Moreover, the ENP and RAW positively correlate with the number of legislative chambers, the degree of personalism during electoral competitions, and the proportional electoral rule dummy, though it is only with respect to the number of chambers that the correlation is high. The baseline results Table 3 presents the results from estimating equation 1. We find no significant effect for either measure of polarization, and no significant effect for the RAW. We do find a positive and significant effect for the ENP on government spending. A one standard 9

10 deviation increase in the ENP is found to lead to an increase of between 1.3 and 2.1 percentage points in spending (columns 2, 7 and 8). This finding would appear to be consistent with the view that the ENP is a better measure than the RAW of the extent of party fragmentation that could lead to common pool problems (Franzese, 2008). An alternative interpretation, however, is that the results are inconclusive concerning the effects of fragmentation for this sample. Our discussion in the introduction, in fact, would suggest that the model is miss-specified, as the effect of fragmentation for this sample of countries could be non-linear and depend on the degree of polarization. Is the effect of fragmentation on government spending always positive regardless of the degree of polarization? Is there no effect of polarization on government spending? Could it be that it depends on the degree of fragmentation? We address these issues in the following section. Table 3 also shows the effects estimated for our control variables, whereby we emphasize our findings for political characteristics other than party fragmentation and polarization. First, we find that the number of chambers is positively related to the size of government spending. Similarly, proportional systems are found to generate larger governments than majoritarian ones. We also find positive, though not significant, effects for the total number of seats in Congress and the degree of personalism in electoral institutions. Our findings for the number of chambers and the proportional system dummy, which are robust to the changes in specification discussed below, are consistent with previous findings. It is also worth mentioning that we find no evidence that the electoral cycle affects the size of government spending The interaction between fragmentation and polarization Our basic hypothesis In this section, we evaluate the hypothesis that the level of political fragmentation in a government coalition is a relevant determinant of government spending only in the presence of some degree of ideological polarization. To test this hypothesis, we augment equation 1 by including the interaction between the measure of fragmentation and a dummy variable ( DP it ) that takes the value of one when there is some degree of polarization (i.e., DPit = 1if POLAR 0 or SD 0, depending on the specification), and 0 otherwise. We also include a level effect of the corresponding polarization dummy to make sure that it does not drive our estimates for the interaction term. The econometric specification in equation 1 is now replaced by the following specification: g = β ' X + u it 0 + β1fit + β 2Pit + β3dpit + β 4DPit * Fit + γ it it. (2) This specification, wherein the effect of fragmentation depends solely on whether or not polarization differs from zero, directly reflects the results from Nupia s (2007) model. 12 The common view of political fiscal cycles is that, during elections, government spending increases. However, political fiscal cycles can also take the form of changes in the composition of spending rather than its overall level (e.g., Drazen and Eslava, 2010). In fact, the finding that voters are fiscal conservatives (Peltzman, 1992; Brender and Drazen, 2008) suggests that incumbents should try to avoid increasing overall spending during election years. Our results for the election year dummy are consistent with this view. 10

11 Further below, we explore more general forms of the interaction between fragmentation and polarization. Table 4 presents the results of our estimation of equation 2. Columns 1 and 2 present the results when POLAR is used as the measure of polarization; in columns 3 and 4, polarization is captured by SD. To keep the size of the table manageable, we report the results for the interaction term in a single row, though obviously the fragmentation and polarization variables interacting in each case vary across the table s columns. Let us start by considering the effect of fragmentation. The coefficients for the ENP and RAW, which represent the effects of these variables in the absence of polarization, are not significantly different from zero that is, we cannot reject the hypothesis that greater fragmentation in a government coalition has no effect on government spending if there is no polarization. On the other hand, we find that greater fragmentation leads to greater spending when there is some degree of polarization within the coalition that is, β 1 +β 4 is positive. A one standard deviation increase in the ENP generates an increase in government spending of close to 5 percentage points. The corresponding effect of a one standard deviation change in the RAW is an increase of about 4 percentage points in government spending. Notice that these effects more than double those observed when we assume that the effect of fragmentation on spending does not depend on the degree of polarization. The finding that fragmentation in a coalition with some degree of polarization has a positive effect on spending is consistent with theories suggesting that fractionalization in the fiscal decision-making process leads to larger governments (Weingast et al., 1981). These theories have motivated much of the work on the relationship between political fragmentation and government spending. On the other hand, we also find that, for our sample of presidential democracies, some degree of division within the coalition is necessary if the number of participants is to affect spending. These results are clearly consistent with our initial hypothesis. In terms of polarization, we find that an increase in polarization leads to greater spending when the initial level of polarization is positive ( β 2 is positive). This message is also consistent with what the literature suggests. However, the estimated effect of polarization becomes negative for most values of the ENP and RAW when the initial level of polarization is zero, a result that is intuitively hard to explain, but that is robust with respect to other specifications. (See below.) Extending the basic hypothesis: linearity The argument that the level of fragmentation should only affect spending in the presence of some polarization can be extended to consider the possibility that the effect of fragmentation increases in a more general way with the level of polarization. A higher degree of polarization implies more severe distributive conflicts, plausibly making it more difficult and costly for the government to negotiate with the different parties in its coalition support for its programs. To capture this possibility, we estimate the following model (equation 3), which includes linear effects of the measures of polarization and fragmentation, as well as the interaction between the two: g = β + F + P + F * P + ' X + u it 0 β1 it β 2 it β3 it it γ it it. (3) 11

12 Our results from estimating equation 3 are presented in Table 5 and Figure 1. Figure 1 depicts the marginal effect of fragmentation on government spending, given by β 1 +β 3 *P it, for different degrees of polarization. We also include 95% confidence bands. Each panel in Figure 1 represents one possible combination of fragmentation/polarization variables, using our two measures of fragmentation (RAW and ENP) and our two measures of polarization (POLAR and SD). The results are more clearly seen in Figure 1 than in Table 5, so our following discussion is based on the former, though the message from the latter is obviously the same. We find that fragmentation has a negligible effect on government spending in the absence of polarization. Moreover, the effect increases steeply with the degree of polarization and becomes positive and significant within the relevant range of polarization. For instance, a one standard deviation increase in the ENP increases government spending by 1.3 percentage points when the SD is at is mean, and by 7.4 percentage points when the SD is at its maximum value. If, instead, we consider POLAR as our measure of polarization, the effect of a one standard deviation increase in the ENP ranges from a 3.6 percentage point increase in government spending when POLAR=1 to a 6.6 percentage point increase when POLAR=2. Figure 2 depicts the effect of polarization on spending. Similar to some of our findings when estimating equation 2, we find that polarization may have a negative effect on government spending when fragmentation is low enough. However, this effect increases as fragmentation increases and becomes positive for relatively low values of fragmentation. Though opposed to our expectation, the negative effect of polarization on spending for low values of fragmentation is quite robust. We leave this an open issue. 13 Given the fact that most of the variability in polarization and fragmentation occurs across countries rather than within them, our baseline results do not control for fixed country effects. It is worth examining, however, to what extent the patterns we have described above wash out when we concentrate solely on within-country variation. In order to do this, we include country fixed effects in our estimation of equation 3, which is our most parsimonious specification (and take out all other covariates without overtime variability). Figure 3 presents the estimated marginal effect of fragmentation. Consistent with our expectation, all of our point estimates are less precise. We still find, however, that the effect of fragmentation on spending increases with the level of polarization. Furthermore, even with this specification, we find that the positive effect of fragmentation becomes significant for sufficiently large, but reasonable, levels of polarization Parliamentary systems As discussed in the introduction, we have focused on presidential democracies because it is in these that we expect pork barrel to be more important as a currency of exchange for legislative support. In this context, and in contrast to parliamentary democracies, we 13 As a robustness check, we also run an alternative estimation, where we allow the effect of fragmentation to vary with each possible level of POLAR. The results are consistent with those reported in Tables 4 and 5, and are available from the authors upon request. 14 Point estimates for this specification are available from the authors upon request. 12

13 expect to find the interaction between the effects of party fragmentation and ideological fragmentation we investigate. It seems natural at this point to ask whether our results in fact differ between the two types of democratic systems. Correspondingly, we now test our main hypothesis for a set of parliamentary democracies. We focus on the results derived from estimating equations (1) and (2) for this particular set of countries. 15 Tables 6 and 7 report the results for our sample of parliamentary democracies. We find that in this case, fragmentation has a direct and positive effect on government expenditure. We do not find any interaction with ideological polarization. For this set of countries then, we find that the evidence is consistent with the traditional common pool problem emphasized in much of the literature, whereby the direct participation of legislators in the budget s design drives the effects of fragmentation on government spending. It is worth noticing that when we restrict our sample to OECD countries, we obtain similar results to those reported in this section. 16 The previous literature has suggested that the effects of fragmentation and polarization might differ between developed and developing countries (Woo, 2003). Our discussion in this paper suggests that those findings may be driven by differing negotiation processes between the executive and legislative branches in presidential versus parliamentary democracies, and by the underrepresentation of presidential democracies in samples of developed countries. 6. Conclusions We have discussed and tested new hypotheses about the effect of legislative fragmentation on fiscal outcomes. Departing from the previous literature, we have focused on the idea that, when government resources are used to build legislative support for government projects, fragmentation should only affect public spending if political polarization is sufficiently high. Our results support this hypothesis for a sample of presidential democracies, but not for parliamentary regimes. While ideological polarization makes it difficult and costly in any type of democracy, coalition building occurs at different time intervals in parliamentary versus presidential systems. In the former, the configuration of a stable coalition is a pre-condition for the formation of a new government. Once this government is in place, parties in the governing coalition all have a say in designing government projects, including the budget. The configuration of a new, project-specific coalition is not required to have a given project sanctioned by the parliament. Consequently, polarization matters mainly during the initial stage of government that is, with its formation. By contrast, in presidential democracies, stable governing coalitions are not a precondition for a government staying in power. Coalition building may thus occur on a more projectspecific basis, implying that its fiscal costs are on-going, thus making polarization relevant at each stage. Our findings suggest that the differences between presidential and parliamentary democracies in terms of budget negotiations between the executive and legislative branches have crucial implications in terms of the channels via which party 15 As was the case with our sample of presidential democracies, we find similar results if we estimate equation (3) instead of equation (2). The results are available from the authors upon request. 16 The results are available from the authors upon request. 13

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