Does Urbanization Mean Bigger Governments?

• Author: Christopher F. Parmeter,Michael Jetter
• Published date: 01 October 2018
• DOI: http://doi.org/10.1111/sjoe.12256
• Date: 01 October 2018

Scand. J. of Economics 120(4), 1202–1228, 2018

DOI: 10.1111/sjoe.12256

Does Urbanization Mean Bigger

Governments?*

Michael Jetter†

University of Western Australia, Crawley WA6009, Australia

mjetter7@gmail.com

Christopher F. Parmeter

University of Miami, Miami, FL 33146, USA

cparmeter@bus.miami.edu

Abstract

In this paper, we introduce urbanization as an important driver of government size. Using panel

datafor 175 countries from 1960 to 2010, we find that there is a close link between urbanization and

the size of the public sector, especiallywhen looking at education, health care, and social issues.

Various robustness checks confirm this finding. An analysis of state-level public spending in

Colombia and Germany confirms our hypothesis on the subnational level.On the microeconomic

level, people in urban areas acknowledge that governments should take more responsibility,

and they are more in favor of redistribution. This finding can help to explain the evolution of

government size, and it can also predict the present and future needs of urbanizing areas.

Keywords: Government size; population concentration; urbanization

JEL classification:H10; H50; H75; R50

I. Introduction

“What I like about cities is that everything is king size, the

beauty and the ugliness”.

(Joseph Brodsky, 1940–1996, Russian poet and essayist)

The world population has more than doubled since 1960, with increasingly

more people living in urban areas. Today, 50 percent of all people live in

cities, compared with 37 percent in 1975, and urbanization is predicted

to continue (see United Nations,2014).1At the same time, government

spending for the average country has been rising consistently, from 11.7

†Also affiliated with IZA (Bonn) and CESifo (Munich).

*Wethank Susana Berrio Montoya for valuableresearch assistance. Weare also g rateful to seminar

participants at the University of Padova, Binghamton University, the Colombian Central Bank

(Banco de la Rep´ublica, Medell´ın), Universidad EAFIT, and Florida International University for

their valuable comments and suggestions. Any remaining errors are our own.

1See the article “U.N. predicts urban population explosion” by C. W. Dugger in the New York

Times on 28 June 2007 (http://www.nytimes.com/2007/06/28/world/28population.html).

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The editors of The Scandinavian Journal of Economics 2017.

M. Jetter and C. F. Parmeter 1203

percent of gross domestic product (GDP) in 1960 to 16.5 percent in 2009.2

In this paper, we argue for an intimate connection between urbanization and

the shape of the public sector, independent of the influence of potentially

confounding factors and endogeneity concerns.

Understanding a potential link between urbanization and government

spending can prove useful for several reasons, beyond the obvious

implications for the body of literature on public economics. First, the

needs of newly urbanizing areas could be anticipated better, facilitating

the implementation of appropriate policies. Second, government spending

has been shown to carry consequences for economic growth (see, e.g.,

Barro,2001;Bergh and Henrekson,2011;Jetter et al.,2013;Jetter,2014).

Thus, understanding how the public sector is shaped allows us to mitigate

potentially detrimental growth consequences.

In this paper, we document that urbanization systematically relates to

increased public expenditure. We show this in three distinct settings.

First, we analyze panel data for 175 countries from 1960 to 2010 and we

find that an increase in the urban population (migration from rural areas)

of 10 percent is associated with an increase in government spending of

3.2 percent, on average. These findings emerge when employing five-year

averages, which provides our benchmark regression structure, as well as

annual data or ten-year averages. Further, these results are derived when

including two-way fixed effects and the conventional control variables.

Although strict causality remains notoriously difficult to isolate in cross-

country settings, our results do not seem to be driven by Wagner’s law

or other, potentially confounding determinants of government size. In fact,

a three-stage least-squares (3SLS) framework, simultaneously estimating

government size and income levels, confirms our hypothesis.

Further insights reveal an interesting heterogeneity across regions. A

positive urbanization–government spending link emerges in all regional

estimations with the exception of Latin America. Here, we observe

urbanization to be associated with smaller governments. Although

speculative at this point, one potential explanation relates to the fact that

the informal sector tends to be large in Latin America (see Schneider et al.,

2011) and a number of tasks related to the provision of traditional public

goods might be carried out by informal or private organizations, absent from

official statistics. For instance, security concerns are usually addressed by

the government (i.e., police forces), but in South American cities, private

or informal companies often provide such services.3

2The numbers are derivedfrom a balanced dataset on national government spending (Wo rl d Ba nk ,

2014).

3As another example, public spending on education in Latin America is substantiallylower than

in the rest of the world. On average, only 3.9 percent of GDP is spent on education, compared

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The editors of The Scandinavian Journal of Economics 2017.