What happens when politicians face stricter budget constraints? Do they become more efficient managers of public resources, or do they find new ways to conceal misbehavior?
Following the Great Recession, many governments, particularly in Europe, enacted severe austerity measures to restore fiscal balance. These reforms sparked intense debate: critics warned of a social and economic toll, while proponents emphasized long-term sustainability. But missing from much of this conversation is a fundamental political economy question: how do tighter budgets affect corruption?
In a new study, we investigate this question by focusing on Italy’s Domestic Stability Pact (DSP), a set of fiscal rules aimed at limiting the spending of local governments. Initially applied to towns with more than 5,000 residents, the policy was extended in 2013 to include smaller municipalities. This (unexpected) expansion created a natural experiment: some towns (those below 5,000), previously exempt, suddenly had to comply with strict new rules, while others (those above 5,000) remained unchanged. We measure corruption using data on formal investigations into crimes such as bribery, graft, malfeasance/resource embezzlement, compiled from Italy’s national police records and aggregated at the municipal-year level (the figure below displays municipalities with at least one corruption episode in the period of observation, 2004-2014).
Figure 1. Geographic Distribution of Municipalities with at Least One Corruption Episode, 2004–2014
Using a local difference-in-differences design, we compare municipalities just above and below the 5,000-inhabitant threshold before and after the reform. We find a striking result: the imposition of fiscal constraints led to a significant reduction in corruption (about -11%). This effect is especially strong in municipalities where the rules were more binding, that is, where they implied a stronger decrease in public spending (with a reduction up to -50%).
How Do Fiscal Rules Curb Corruption?
At first glance, the idea that austerity could reduce corruption may seem counterintuitive. After all, reducing government capacity might limit its ability to monitor officials or provide services. But in contexts where public spending is poorly monitored or weakly institutionalized, large budgets can be a source of political rents.
Our findings support this view. We show that municipalities subject to the DSP responded by cutting back on capital and procurement expenditures, especially in areas most vulnerable to rent extraction. Importantly, the reduction in corruption was not just a byproduct of spending less. Even when we control for the amount paid, corruption per euro invested declined. In other words, public funds were not only being used more efficiently, but they were also being used more cleanly.
The timing of the reduction also tells us something about the underlying mechanism. The effect is concentrated in pre-electoral years and among mayors who are eligible for re-election. This suggests that accountability plays a key role: when politicians are facing voters and constrained by budget rules, they appear more motivated to reduce waste and avoid scandals.
One of the most striking aspects of our study is that the drop in corruption only occurs in what we call fiscally constrained regions, i.e., areas that receive modest levels of EU support. In contrast, municipalities located in fiscally unconstrained regions like Sicily or Calabria receive substantial amounts of European transfers. Because DSP rules excluded EU-financed capital projects from the spending cap, mayors in these regions could maintain their investment levels without triggering penalties. In these high-transfer areas, fiscal rules had little bite, and we observe no significant reduction in corruption.
This interaction between EU funds and national fiscal rules highlights a critical policy tension. On the one hand, European cohesion funds are designed to support infrastructure and development in economically disadvantaged regions. On the other hand, these transfers may allow local politicians to boost rent-seeking activities.
Our findings echo other research showing that the positive impact of EU funds depends on the strength of local institutions. Without mechanisms of accountability, transfers can fuel patronage and misuse of public money.
What About Local Welfare?
Naturally, one might worry that cutting capital expenditures, especially if they support infrastructure or public services, could harm citizens. To explore this, we look at a broad range of outcomes: local GDP, income inequality, and the provision of key municipal services such as waste collection, school canteens, kindergartens, and street lighting.
Across all these indicators, we find no evidence of decline. These results suggest that, at least in the short term, budget constraints led to a more efficient allocation of resources rather than a degradation of public goods.
Final Thoughts
Our findings add to the growing body of work on anti-corruption strategies. Rather than relying on audits, oversight commissions, or punitive enforcement, tools that can be costly and complex, our study shows that altering fiscal incentives can nudge politicians toward cleaner behavior. This has important implications for policymakers in settings where formal monitoring is weak or under-resourced.
Budget constraints are rarely popular. They are often framed as technocratic impositions that limit local autonomy and hinder public investment. Our research suggests a more nuanced reality: in certain institutional contexts, by promoting fiscal discipline, austerity can also lead to cleaner governance. This doesn’t mean austerity is always justified, but it does remind us that the design of fiscal rules, and the incentives they create, matter deeply.
By Gianmarco Daniele and Tommaso Giommoni