Public Expenditure and Private Firm Performance: Using Religious Denominations for Causal Inference

We investigate the causal relationship between local government expenditure and private firm performance, using the quantity and naming of civil parishes within each municipality as an instrumental variable. Religious denominations are taken as a proxy for strong local identity, which likely increases competition for resources between neighboring parishes. We explore a dataset on the universe of private firms, local government expenditure categories and socio-economic indicators for all mainland Portuguese municipalities, in a period encompassing both normal and crisis times. The number of parishes per municipality, as exogenously set by the central government, and the number of parishes that display religious denominations are both used as instruments that explain local government spending, indirectly impacting firm performance. We find that both display considerable power in determining total primary and current spending, which then positively impacts private firms’ sales and value added. Using religious denominations is found to yield a particularly potent instrument, confirming and expanding the baseline results. In a field that mostly relies on natural experiments for instrumental variable frameworks, our proposed instruments are both easily obtainable and powerful.