Political alignment and the distribution of investment subsidies:quasi-experimental evidence from Germany

Abstract

In fiscally decentralized countries, intergovernmental transfers are essential for reducing regional disparities and ensuring equitable public good provision. However, extensive research has shown that these transfers are often politicized, with higher-level governments disproportionately favoring districts governed by political allies. While this pattern is well-documented in competitive federal systems, less is known about whether party favoritism persists in cooperative federal systems, where intergovernmental interdependence and institutional constraints are designed to limit discretionary allocation. This paper investigates whether partisan alignment between local, state, and federal governments influences the distribution of public investment subsidies in Germany’s cooperative federalism. To test this, we constructed a novel dataset (1995–2018) combining data on investment subsidies to all German districts from federal and state governments with information on partisan alignment across all three governance levels. Using matching techniques and difference-in-differences estimators, we identify the causal effect of political alignment on subsidy allocation. Our findings show that partisan favoritism influences state-level investment subsidies but not federal-level subsidies. At the state level, this effect is particularly pronounced at the end of election cycles, in electorally competitive districts, for right-wing parties, and in West Germany. These findings indicate that party favoritism also influences discretionary transfers like investment subsidies under cooperative federalism but that the political economy of intergovernmental transfers is more intricate than in competitive fiscal federal systems