Joint Discussion Paper Series in Economics 39-2013
Amalgamation incentivizes municipalities to increase public debt because it allows them to subrogate their repayment and interest burden on the entire municipality after amalgamation. Especially, the smaller municipality tends to accumulate public debt in order to free-ride. Previous literature has shown this kind of opportunistic behavior in countries where municipalities can issue bonds freely in the market. However, public borrowing by municipalities is strongly controlled in Japan. This study examines the relationship between regulation of local government borrowing and the free-ride behavior of Japanese municipalities on amalgamation. Difference-in-difference regression confirms the free-ride effect, which is however wholly counterbalanced by regulation.