The Determinants of Welfare Spending in France: A Spatial Panel Econometric Approach

This paper produces spatial panel econometric estimates of the main determinants of the disparities in local welfare expenditures for the French mid sub-national jurisdiction level of Departments during the period spanning 1992-2008 and using a very rich dataset. In the standard local public good expenditures model where geography is traditionally absent, econometric estimations confirm the importance of socio-economic and demographic characteristics as main drivers of welfare expenditures (with tax price and income) but leave a large part unexplained due to relative localization. In the augmented model with spatial interactions, we find large expenditure interactions with a reaction function that slopes positively, when a department raises its expenditures by 5% while its neighbors increase theirs by 10%. We show that the classical expenditures function suffers from mis-specification with an upward biased income-elasticity. We obtain a robust elasticity divided by 3 compared to the base-case model, with a value passing from +0.6 to +0.2. Omitting geography thus leads to unduly attributing to income changes in expenditure stemming from local interactions. Finally, a significant flypaper effect is found in the data but whose magnitude is nearly halved when the spatial factor is controlled for. Possible explanations of our results are fiscal competition and/or political yardstick competition, with important implications for public policy, notably for the optimal design of equalization policies.