Using employment data for municipalities, we find strong evidence of political business cycles. Employment increases shortly before elections mainly in municipalities where the mayor´s party has a majority of deputies in the municipal assembly and where she is running for reelection. Classification-JEL: D72, H7.Political business cycles, local governments, employment, Portugal.

Cesar Alberto Campos Coelho

Francisco José Veiga

Linda Gonçalves Veiga

English

Research Papers in Economics

                              
“Political Business Cycles in Local Employment” 
 
César Coelho 
Francisco José Veiga 
Linda G. Veiga 
 
NIPE WP 13 / 2005    
   
   
   
   
“ “P Po ol li it ti ic ca al l   B Bu us si in ne es ss s   C Cy yc cl le es s   i in n   L Lo oc ca al l   E Em mp pl lo oy ym me en nt t” ”   
   
   
   
C Cé és sa ar r   C Co oe el lh ho o   
F Fr ra an nc ci is sc co o   J Jo os sé é   V Ve ei ig ga a   
L Li in nd da a   G G. .   V Ve ei ig ga a   
   
N NI IP PE E
* *   W WP P   1 13 3   / /   2 20 00 05 5   
   
   
   
   
   
   
   
   
   
   
   
   
 
URL:   
http://www.eeg.uminho.pt/economia/nipe/documentostrabalho.php 
                                                 
* NIPE – Núcleo de Investigação em Políticas Económicas – is supported by the Portuguese Foundation for 
Science and Technology through the Programa Operacional Ciência, Teconologia e Inovação (POCTI) of the 
Quadro Comunitário de Apoio III, which is financed by FEDER and Portuguese funds.   1
Political Business Cycles in Local Employment 
by  
César Coelho
(1), Francisco José Veiga
(2), and Linda G. Veiga
(2)* 
(1) NIPE; 
(2) Universidade do Minho and NIPE 
 
Abstract: 
Using employment data for Portuguese municipalities, we find strong evidence of political 
business  cycles.  Employment  increases  shortly  before  elections  mainly  in  municipalities 
where the mayor’s party has a majority of deputies in the municipal assembly and where she 
is running for reelection. 
 
Keywords: Political business cycles, local governments, employment, Portugal 
JEL classification: D72, H7 
 
1.  Introduction 
In  this  paper  we  test  for  the  existence  of  political  business  cycles  in  employment  in 
Portuguese municipalities. We use an unexplored dataset covering all mainland municipalities 
from  1985  to  2000.  Our  results  provide  strong  evidence  of  employment  increases  before 
elections,  particularly  in  municipalities  where  the  mayor’s  party  has  a  majority  in  the 
municipal  assembly  and  where  she  is  running  for  reelection.  Employment  increases  are 
notably  higher  in  construction  and  public  works  and  in  community,  social  and  personal 
services. We argue that these employment variations are a consequence of increases in local 
public expenditures that were documented by Veiga and Veiga (2004). 
                                                 
* Corresponding author: Linda G. Veiga, Escola de Economia e Gestão, Universidade do Minho, 4710-
057 Braga, Portugal. Tel.: +351-253604534; Fax: +351-253676375; Email: linda@eeg.uminho.pt.   2
2.  Political business cycles in local employment 
Although the literature on political business cycles is already extensive,
1 most studies focus 
on the behavior of central governments. However, Rogoff and Sibert (1988), Rogoff (1990) 
and Harrington (1993) have developed political business cycle models that are applicable to 
local as well as national governments. These models predict that incumbent politicians may 
increase spending prior to elections to signal greater “competence.” This occurs when voters 
are rationally, but imperfectly, informed. In contrast, Nordhaus’s (1975) well-known model of 
the  political  business  cycle  assumes  that  voters  are  myopically  responsive  to  national 
economic conditions. Testing for the presence of local political business cycles may therefore 
help to distinguish the applicability of models that would have similar empirical implications 
at a national level.  
  In this paper, we use as our laboratory all the Portuguese mainland municipalities. In a 
previous paper, Veiga and Veiga (2004) provided strong evidence of opportunistic cycles in 
municipalities’ expenditures, particularly in investment items highly visible to the electorate, 
such  as  those  included  in  spending  categories  for  Other  Buildings  and  Miscellaneous 
Constructions (especially in Overpasses, streets and complementary works, Rural road, and 
Others). Pre-election increases in these expenditures are consistent with an effort by mayors 
to signal greater competence.  Building on  these results, we now test  for the  existence of 
political business cycles in municipal employment.  
  The dependent variable in our analysis is the  change  in the number of employees 
working  in  the  firms  in  the  municipality  (￿Employment).  We  are  able  disaggregate  this 
variable  according  to  the  Portuguese  Standard  Industrial  Classification  (CAE)  system. 
Changes in national employment (￿National Employment) are used to control for the impact 
                                                 
1 For surveys of this literature see Alesina, Cohen and Roubini (1997) and Drazen (2000).   3
of the macroeconomic situation of the country. The set of political variables used consists of 
the following dummy variables: 
-  Election year (year before election): takes the value of one in election years (in the 
year before elections), and of zero otherwise; 
-  Right: equals one for municipalities run by right-wing mayors, and zero otherwise; 
-  Majority  (minority):  equals  one  for  municipalities  where  the  mayor’s  party  has  a 
majority (minority) in the Municipal Assembly, and zero otherwise; 
-  Incumbent: takes the value of one when the  mayor is running for another term in 
office, and zero otherwise;  
Three additional variables are included in all models as controls: 
-  %Pop<15: percentage of the population under 15 years old; 
-   %Pop>65: percentage of the population over 65 years old; 
-  PopDens: population density. 
Data  on  the  total  number  of  employees  in  municipal  firms,  and  according  to  the 
Portuguese Standard Industrial Classification system, from 1985 to 2000, was obtained from 
the  “Quadros  de  Pessoal”  database,  of  the  Portuguese  Ministry  of  Labour  and  Social 
Solidarity  (MTSS)
2  Data  on  national  employment  comes  from  the  IMF’s  International 
Financial Statistics. Political data, namely election dates and municipal electoral results were 
obtained from the Technical Staff for Matters Concerning the Electoral Process (STAPE). 
Finally, data on the three control variables was obtained from the Portuguese Institute of 
Statistics (INE). 
It is worth noting that election dates are defined exogenously from the perspective of 
the local authorities and that, during our sample period, there were no legal restrictions on the 
                                                 
2 The “Quadros de Pessoal” are a yearly mandatory employment survey that covers virtually all firms employing 
paid labor in Portugal.   4
number of terms a mayor could serve. In the period subsequent to the re-establishment of 
Democracy in Portugal in 1974, municipal elections have been held in 1976, 1979, 1982, 
1985, 1989, 1993, 1997 and 2001, always in December. 
The empirical model can be summarized as follows: 
  it i t i t i it y y e n a + + + = - ￿ X
'
, 1 ,   i T t N i ,..., 1    ,..., 1 = =   (1) 
where yit is the dependent variable (￿Employment),  '
it X  is a vector of explanatory variables 
(described above), b b b b is a vector of parameters to be estimated, ni is the individual effect of 
municipality i, and eit is the error term. Given the presence of individual effects, ni, the model 
above can be estimated assuming those effects as fixed or random. But, the lagged value of 
the dependent variable would be correlated with the error term, eit, even if the latter is not 
serially  correlated.  According  to  Arellano  and  Bond  (1991),  this  implies  inconsistent 
estimates of the model, when, as in our sample, there is a clear dominance of cross sections 
(275 municipalities) over time periods (16 years). These authors developed a Generalized 
Method  of  Moments  (GMM)  estimator  that  solves  the  problems  noted  above.  First 
differencing (1) removes the individual effects (ni) and produces an equation that is estimable 
by instrumental variables. In this paper, we use the extended version of the GMM estimator 
proposed by Blundell and Bond (1998).
3 
  Table 1 shows the results of estimations for changes in total municipal employment. In 
the first two columns, we can see that employment increases during electoral years (and the 
                                                 
3 Difference Sargan tests indicate that, for our data, this system-GMM estimator, which combines the first-
differenced equations with the equation in levels, is preferable to that of Arellano and Bond (1991), which only 
includes the first-differenced equations. In all estimations, the instruments used for the lagged dependent variable 
were the following: levels lagged 2 and 3 periods were used in the equations in first differences, and once lagged 
first differences were used in the equation in levels. Since the remaining explanatory variables are exogenous, 
they were used as their own instruments.   5
year before), relative to the remaining years of the electoral cycle, and that right-wing mayors 
increase  local  employment  more  than  left-wing  ones.  Then,  we  tested  for  differences  in 
opportunistic  behavior  according  to  ideology  (column  3),  the  level  of  support  the  mayor 
enjoys at the Municipal Assembly (column 4), and the mayor’s decision to run or not for 
another  term  in  office  (column  5).  Results  indicate  that  pre-election  increases  in  local 
employment occur only when the mayor is running for reelection and when the mayor’s party 
has a majority of deputies in the Municipal Assembly. In these circumstances mayors have 
both stronger incentives and greater power to manipulate spending. These effects are stronger 
in municipalities led by right-wing mayors.  
 
[Insert Table 1 about here] 
 
  When we perform the tests in employment series disaggregated by sector of activity 
(see Table 2), we find that employment increases in electoral years are stronger, and more 
significant, in Construction and Public Works and Community, Social and Personal Services. 
This result is not surprising if we take into account Veiga and Veiga’s (2004) finding of 
strong evidence of opportunistic cycles in Portuguese municipalities’ investment expenditures 
in Other Buildings, Miscellaneous Constructions and Other Investments
4. 
 
[Insert Table 2 about here] 
                                                 
4 On these series there are increases in the election year, relative to the sample mean, of 14.9%, 10.4% and 
21.7%, respectively.   6
3.  Conclusion 
Using  an  unexplored  dataset  describing  employment  in  all  mainland  Portuguese 
municipalities over a period of sixteen years, we provide strong evidence of political business 
cycles  in  local  employment.
5  Although  mayors  do  not  control  a  large  fraction  of  local 
employment directly, they affect it indirectly through municipal expenditures that generate 
jobs in local firms. By improving local economic conditions shortly before elections, mayors 
may  signal  their  competence  to  the  electorate  and  improve  their  chances  of  reelection, 
consistent with the rational political business cycle models introduced by Rogoff and Sibert 
(1988). 
 
Acknowledgements 
We acknowledge helpful comments from Henry Chappell. Financial support was provided by 
the  Portuguese  Foundation  for  Science  and  Technology  under  research  grant 
POCTI/2001/ECO/37457 (partially funded by FEDER).  
 
                                                 
5  It is  worth  noting that  results  are basically  the  same  when  we  use  employment levels  (employment  as  a 
percentage of municipal population) instead of changes in employment. These results are available from the 
authors upon request.   7
References 
Alesina, A., G. Cohen and N. Roubini, 1997, Political Cycles and the Macroeconomy (MIT 
Press, Cambridge, MA,). 
Arellano, M. and S. Bond, 1991, Some tests of specification for panel data: Monte Carlo 
evidence  and  an  application  to  employment  equations,  The  Review  of  Economic 
Studies 58, 277-297. 
Blundell, R. and S. Bond, 1998, Initial conditions and moment restrictions in dynamic panel 
data models, Journal of Econometrics 87, 115-143. 
Drazen, A., 2000, Political Economy in Macroeconomics (New Jersey, Princeton University 
Press). 
Harrington, J. Jr., 1993, Economic policy, economic performance, and elections, American 
Economic Review 83(1), 27-42. 
Nordhaus, W., 1975, The Political Business Cycle, Review of Economic Studies 42, 169-90. 
Rogoff, K., 1990, Equilibrium political budget cycles, American Economic Review 80, 21-36. 
Rogoff,  K.  and  A.  Sibert,  1988,  Elections  and  Macroeconomic  Policy  Cycles,  Review  of 
Economics Studies 55, 1-16. 
Veiga, L.G. and F.J. Veiga, 2004, Political Business Cycles at the Municipal Level, NIPE 
Working Paper, WP-4/2004, 1-26. Available in PDF format at: 
  http://www.eeg.uminho.pt/economia/nipe/WP/WP_NIPE_4_04.pdf   8
TABLE 1: POLITICAL BUSINESS CYCLES IN EMPLOYMENT 
            ￿Employment  1  2  3  4  5 
                        ￿Employment (-1)  -.131 
(-5.49)** 
-.133 
(-5.58)** 
-.130 
(-5.49)** 
-.131 
(-5.58)** 
-.131 
(-5.50)** 
            ￿National Employment  .245 
(4.74)** 
.320 
(5.19)** 
.243 
(4.73)** 
.237 
(4.49)** 
.245 
(4.74)** 
            Election Year  2.543 
(4.16)** 
3.477 
(5.14)** 
     
            Year Before Election    1.961 
(2.94)** 
     
            Right  2.010 
(3.58)** 
1.930 
(3.38)** 
1.661 
(2.75)** 
2.173 
(3.73)** 
2.006 
(3.59)** 
            Election Year*Right      3.497 
(3.59)** 
   
            Election Year*Left      1.808 
(2.26)* 
   
            Majority        .917 
(1.49) 
 
            Election Year*Majority        3.610 
(3.63)** 
 
            Election Year*Minority        1.326 
(1.64) 
 
            Election Year*Incumbent          2.952 
(4.28)** 
            Election Year*NotIncumbent          .986 
(.69) 
                        # Observations  3847  3847  3847  3847  3847 
# Municipalities  275  275  275  275  275 
Sargan test (p-value)  .308  .294  .322  .314  .298 
           
Sources: IMF(IFS), INE, MTSS and STAPE. 
Notes:  -  Estimations of system-GMM linear models for panel data (which combine the equations in first-
differences with the equation in levels), using the econometric software Stata 8.2. 
- The coefficients and t-statistics for the control variables %Pop<15, %Pop>65, and PopDens 
(included in all estimations) are not shown in order to economize space. 
-  Two-step results using robust standard errors corrected for finite samples. 
-  T-statistics are between parentheses. Significance level for which the null hypothesis is rejected: 
**, 1% and *, 5%. 
-  Sargan is a test for the validity of the over-identifying restrictions for the GMM estimators, 
asymptotically c
2. P-value is reported. The hypothesis of no second-order serial correlation in 
the first-differenced residuals is never rejected. 
   9 
TABELA 2: POLITICAL BUSINEES CYCLES IN EMPLOYMENT BY ECONOMIC ACTIVITY 
                      CEA 1 
Agriculture, 
Sylviculture, 
Hunting and 
Fisheries 
CEA 2 
Extractive 
Industries 
CEA 3 
Transforming 
Industries 
CEA 4 
Electricity, 
Gas and 
Water 
CEA 5 
Construction 
and Public 
Works 
CEA 6 
Commerce, 
Restaurants 
and Hotels 
CEA 7 
Transportation, 
Storage and 
Communications 
CEA 8 
Banks, 
Insurances, Real 
Estate, and 
Services to 
Firms 
CEA 9 
Community, 
Social, and 
Personal 
Services 
                                        Dep. Var. (-1)  -.063 
(-4.06)** 
-.035 
(-4.61)** 
-.120 
(-6.99)** 
-.049 
(-3.57)** 
-.067 
(-3.70)** 
-.166 
(-7.35)** 
-.176 
(-2.94)** 
-.146 
(-5.26)** 
-.066 
(-4.19)** 
                    ￿National 
Employment 
1.004 
(2.78)** 
.591 
(0.98) 
.122 
(.70) 
.934 
(3.00)** 
1.243 
(4.56)** 
.001 
(.02) 
.875 
(4.00)** 
.352 
(2.52)* 
1.504 
(5.32)** 
                    Election Year  6.559 
(1.08) 
19.569 
(2.19)* 
1.190 
(.74) 
10.094 
(2.26)* 
11.283 
(4.48)** 
.818 
(1.00) 
-4.489 
(-.97) 
8.742 
(9.00)** 
15.155 
(5.24)** 
                    Year Before Election          7.023 
(2.06)* 
      10.638 
(2.10)* 
                    Right  -7.958 
(-1.41) 
-10.666 
(-0.90) 
1.110 
(.97) 
-9.746 
(-1.25) 
4.114 
(1.86)* 
1.791 
(2.63)** 
1.572 
(.61) 
.994 
(1.37) 
-2.935 
(-.83) 
                                        # Observations  3690  2399  3844  3571  3782  3690  3844  3838  3828 
# Municipalities  274  226  275  274  275  274  275  275  275 
Sargan test (p-value)  .238  .835  .478  .165  .342  .238  .221  .194  .072 
                   
Sources: IMF(IFS), INE, MTSS and STAPE. 
Notes:  -  Estimations of system-GMM linear models for panel data (which combine the equations in first-differences with the equation in levels), using the econometric 
software Stata 8.2. Two-step results using robust standard errors corrected for finite samples. 
-  The dependent variable is the percentage change in municipal employment for the classification of economic activity indicated in the respective column. 
- The coefficients and t-statistics for the control variables %Pop<15, %Pop>65, and PopDens (included in all estimations) are not shown in order to economize 
space. T-statistics are between parentheses. Significance level for which the null hypothesis is rejected: **, 1% and *, 5%. 
-  Sargan is a test for the validity of the over-identifying restrictions for the GMM estimators, asymptotically c
2. P-value is reported. The hypothesis of no second-
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