"Information Sharing, Neighborhood Demarcation, and Yardstick Competition: An Empirical Analysis of Intergovernmental Expenditure Interaction in Japan"

Hayashi, Masayoshi and Wataru Yamamoto

December 2014

The Japanese government provides information on local fiscal performance through the Fiscal Index Tables for Similar Municipalities (FITS-M). The FITS-M categorize municipalities into groups of “similar localities” and provide them with the fiscal indices of their group members, enabling municipalities to use the tables to identify their “neighbors” (i.e., those in the same FITS-M group) and refer to their fiscal information as a “yardstick” for fiscal planning. We take advantage of this system to estimate municipal spending function. In particular, we examine if the FITS-M help identify a defensible spatial weights matrix that properly describes municipal spending interactions. Our analysis shows that they do. In particular, geographical proximity is significant only between a pair of municipalities within a given FITS-M group, and it does not affect competition between pairs belonging to different groups even if they are located close to each other. This would suggest that the FITS-M work as intended, indicating that spending interaction among Japanese municipalities originates from yardstick competition and not from other types of fiscal competition.