Fueling fiscal interactions: commodity price shocks and local government spending in Colombia

This paper explores fiscal interactions in a developing country. We analyze whether public expenditures in neighboring municipalities influence local spending decisions within a comprehensive set of expenditure categories. Our analysis is based on panel data covering the universe of Colombian municipalities from 2000 to 2010. We offer a quasi-experimental identification strategy exploiting exogenous variation in municipalities’ exposure to changes in the world market price of oil, depending on the municipalities’ endowment with oil resources and controlling for municipality fixed effects. While we find evidence of strong spatial autocorrelation of total local public spending as well as in almost all expenditure categories, the quasi-experimental approach reveals that there are no significant causal fiscal interaction effects between municipalities. This highlights the importance of using additional sources of exogenous variation for the identification of fiscal interactions. In the developing country context, our findings suggest that fiscal decentralization policies do not lead to a race to the bottom in local public expenditures.