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Article

The Demographic and Economic Determinants of Financial Sustainability: An Analysis of Italian Local Governments

by
Serena Santis
Department of Political Science “Jean Monnet”, University of Campania “Luigi Vanvitelli”, viale Ellittico, 31, 81100 Caserta, Italy
Sustainability 2020, 12(18), 7599; https://doi.org/10.3390/su12187599
Submission received: 19 August 2020 / Revised: 9 September 2020 / Accepted: 11 September 2020 / Published: 15 September 2020
Versions Notes

Abstract

:
The aim of this study was to analyze the influence of demographic and economic variables on financial sustainability in Italian local governments (ILGs). Many international organizations have highlighted the importance of pursuing financial sustainability, and identifying what the factors impacting financial sustainability are, allowing to manage risk and opportunities as well as to support the decision-making process better. A total of 104 ILGs with more than 60,000 inhabitants were investigated for the year 2018. The adjusted income statements served as the dependent variable of a regression model for testing several demographic and economic variables. The results showed that demographic factors did not influence financial sustainability while, regarding the economic variables, there was a negative influence of financial autonomy and positive influence of the level of indebtedness. These values indicate a pathological scenario where local governments pursue short-term strategies that will impact future generations.

1. Introduction

In recent decades, large amounts of research have focused on the financial sustainability of public sector entities because of the financial crisis and the related austerity policies. Many international organizations have investigated the financial sustainability of governments as they have to provide public services while satisfying their present and future obligations [1,2]. The International Public Sector Accounting Standards Board (IPSASB) has highlighted the significant role of sustainability in public sector entities’ finances.
The importance of monitoring financial sustainability is particularly relevant at the local level, as local governments do not have national indicators to capture different performances [3]. Furthermore, information on financial sustainability is able to support the decision-making process of public managers and politicians regarding public service delivery [4,5]. Scholars and practitioners have explored these issues at both the central and local levels, ensuring the capacity to continue providing services including the use of public resources to cover citizens’ demands without incurring deficits. Accordingly, it has been claimed how important it is to examine the variables that may influence financial sustainability to identify and understand the risk factors, and if they have positive or negative effects. In this way, public managers and politicians can monitor and maintain the sustainability of public services over time. Of the factors influencing financial sustainability, scholars [6] have distinguished internal and external factors. Internal factors regard political and managerial aspects, while external factors concern demographic and socio-economic conditions. In particular, several international organizations [7,8,9] have focused on the importance of socio-demographic and financial-economic variables to achieve financial sustainability.
Using public choice theory as a framework, the aim of this study was to evaluate if demographic and economic variables do affect the level of financial sustainability.
As the Italian public administration has suffered financial difficulties in the last decades, experiencing fiscal stress [10], the focus here was focused on Italian local governments (ILGs), investigating a sample of 104 municipalities with more than 60,000 inhabitants for the year 2018. A regression model was implemented to test if several independent variables affect the financial sustainability. Financial sustainability was measured using a different approach from those implemented by the vast majority of previous studies. Income statements were used to represent this concept to assess the capability of public administrations to maintain the level of public services over time. The independent variables included in the model were: population density, population under age 15 years, population over age 65 years, and level of immigration as demographic factors; and revenues (current on capital revenues), and expenditure (current on capital expenditure), financial autonomy, current equilibrium, and level of indebtedness and investments as economic variables
The main findings that emerged from the analysis showed that there was no influence concerning demographic factors while observing that the economic variables, financial autonomy, and the level of indebtedness influenced financial sustainability. These results are very interesting and in counter-trend. Financial autonomy had a negative impact on financial sustainability while the level of indebtedness had a positive effect on it. Per public choice theory, politicians choose to act in the public interest instead of their own under the “pressure of competition” axiom. In fact, the results demonstrate that public administrations, to provide services, have to resort to external resources by increasing the level of indebtedness. These results also highlight a lack of respect for intergenerational equity, providing an alert as to the health condition of local governments.
Therefore, this study contributes to the financial sustainability literature evaluating the role of demographic and economic variables by showing an interesting result with regards to the Italian context.
The rest of the paper is structured as follows: Section 2 will review the literature regarding the concept of financial sustainability and define the research hypotheses within the theoretical framework, while Section 3 will describe the Italian context. Section 4 will define the methodology, while Section 5 will present the results. The last section will offer some concluding thoughts, also proposing future prospects for research.

2. Literature Review and Theoretical Framework

2.1. Definitions and Literature Review

The concept of financial sustainability has been defined in different ways [11]. The literature has investigated financial sustainability, financial condition, and financial health with a risk of overlapping between these different but related concepts.
For a long time, scholars have studied how to define and measure financial sustainability, and different approaches have been proposed. According to the first strand of literature [2,4,5,12,13,14,15,16,17,18,19], sustainability is considered a component of financial condition. In particular, some variants are used to measure the financial condition. Initially, indicators of the financial condition were [2,12,20,21]: (i) cash solvency; (ii) budgetary solvency; (iii) long-run solvency; and (iv) service-level solvency.
Cash solvency indicates the relationships between cash inflows and outflows, expressing the ability of a public sector organization to generate enough liquidity to pay its short-term debts. Budgetary solvency is the ability of a public sector organization to raise sufficient revenues to cover its legally-required expenditures without entering into deficit. Long-term solvency considers the capacity to satisfy long-term obligations. Finally, service-level solvency refers to the capacity to provide essential services to stakeholders.
Zafra-Gómez et al. [14] calculated three ratios to express short-run solvency, service-level solvency, and budgetary solvency. The last one describes three features, at the level of:
  • Sustainability, defined as the ability of an entity to preserve the social welfare of citizens with the available resources;
  • Flexibility, defined as the capacity to adapt to economic and financial changes; and
  • Vulnerability, defined as the capacity to be independent of external financing resources.
On the other hand, several institutions and different standard-setters seem to prefer using the term “financial sustainability”. The PricewaterhouseCoopers [22] report stated that “the financial sustainability of a council is determined by its ability to manage expected financial requirements and financial risks and shocks over the long term without the use of disruptive revenue or expenditure measures”. In general terms, many international organizations, such as the European Commission [7], the European Union [9], and the International Federation of Accountants [23], have issued guidelines to improve financial sustainability with the use of accrual accounting systems. Financial sustainability is the ability to provide public services while satisfying their present and future obligations [1,13]. Similarly, the International Public Sector Accounting Standards Board (IPSASB) [24] published a recommended practice guideline entitled “Reporting on the Long-Term Sustainability of an Entity’s Finances”, which offers information on the impact of governmental decisions on the future long-term financial sustainability. The IPSASB’s definition considers three inter-related dimensions of long-term fiscal sustainability, namely services, revenues, and debt. For each, the following are described: the definition, the capacity to manage the dimension, and the level of dependency of external factors that the entity cannot control (vulnerability), as summarized in Table 1.
Starting with IPSASB’s definition, another crucial point is introduced: respect for intergenerational equity. To reach adequate levels of sustainability in the allocation of resources, future effects have to be taken into account [25]. Referring to the concept of sustainability, it is necessary to not compromise the ability of future generations to meet their needs [26], and therefore, agents have to consider the long-term consequences of their actions [27].
Although there is no consensus on assessment of financial sustainability, Rodríguez-Bolívar et al. [28] highlighted the fundamental role played by the income statement, as it reports the necessary resources to fulfill the public services delivery [29]. In fact, the income statement represents two fundamental dimensions of financial sustainability, revenues and services, and, indirectly, the debt dimension, due to its strong link with the volume of expenditure [30].
According to scholars [28,31,32,33], to measure financial sustainability, the income statement must be corrected by extraordinary items and those revenues and expenses that are unlikely to be repeated in the future. Obviously, this approach can be adopted only if public governments use an accrual-based accounting system.
Previous research [6,21,34,35,36,37,38] analyzed several factors influencing financial sustainability, classifying them into internal and external factors.
The demographic and socio-economic conditions characterize the external factors whereas political and managerial conditions describe the internal factors. When making decisions, managers and politicians can contribute to supervision, as well as to pursuing financial sustainability, namely the ability of the entity to meet service delivery and financial commitments [24]. Additionally, other studies [4,16,30,32,33,39] have emphasized the relevance of socio-demographic and financial-economic variables in achieving financial sustainability, reporting different results.

2.2. Research Hypotheses

The public choice theory can represent a useful lens for interpretation. Under the public choice theory, it is possible to understand how a public sector entity operates, at the same time, analyzing and mapping the behavior of the individuals such as voters and politicians observing outcome [40]. According to Boyne [41], the municipalities are industries composed of “buyers” and “sellers”, and two contrasting characteristics can be observed. On the one hand, politicians can pursue their own interests rather than that of the public, according to the so-called “self-interest axiom”. On the other hand, politicians can choose to act in the public interest instead of their own under the “pressure of competition” axiom, as they want to be re-elected. Furthermore, politicians and other stakeholders do not have the same information, therefore this asymmetric information can create fertile ground for earnings management practices [42].
As financial sustainability and, more broadly, financial condition influences the re-election [43], politicians could choose to provide service even though the local government does not have enough revenue to cover the expenditure. For this reason, the study analyzed the impact of revenue and expenditure as variables considering their nature (current and capital), the degree of financial autonomy, and the municipality’s ability to cover current expenses through current revenue with current equilibrium. Furthermore, election time gives politicians a motive to behave opportunistically [5], and these effects could also impact future generations if, for example, external resources are improperly used. Accordingly, the levels of indebtedness and of investment were investigated. There is to consider that decisions made by politicians regarding services to be provided could be influenced by the demographic characteristics of the population in order to understand and satisfy their needs. The different types of a population might condition the financial sustainability of a local government so the requests of citizens and the services may differ (dependent population, immigrant population, and unemployed) with regards to the paid taxes. As stated previously, financial sustainability is the ability of a local government to provide public services of good quality [8,44]. In fact, local governments have to guarantee adequate—in terms of quantity and quality—services to citizens without increasing the debt value. The quality and quantity of services, in their turn, may depend on the demographic characteristics of the population, and on the global financial and economic condition of the local governments.

2.2.1. Demographic Factors

In recent years, international organizations have documented demographic changes in several countries [8,9,45]. In fact, different population structures could influence the level of public services as taxes (current revenue) collected to cover (current) expenditure have become insufficient, with one of the main effects being an increase in the public debt. The demographic factors consist of several variables such as population size, population density, dependency ratio, and immigration.
The different characteristics of a population can influence financial sustainability noting that the most disadvantaged citizens will request more public services and, simultaneously, will have less capacity to contribute to the government’s finances. Furthermore, the population requires different services such as health, education, employment, social affairs, which increase the expenses [46,47]. Several scholars [30,32,33,48] have investigated the influence of these variables in the Spanish context. This study contributes to the academic debate by focusing on the Italian context.
The first hypothesis regards the size of a population. Its growth leads to an increase in expenses but not always with an increasing “ability to pay”. Therefore, the first research hypothesis is:
Hypothesis 1 (H1).
Population size negatively influences financial sustainability.
Population density is associated with the quality of life of the citizens [18,49,50] and with some dimensions of financial sustainability [6]. However, there are conflicting results about the influence on financial sustainability [46,51,52]. A high population density could have both a positive and a negative impacts on the provision of services. A dense population may increase the marginal benefits of spending if it creates unique public goods problems, and could create economies of scale, reducing the expenditures per capita. Therefore, the second research hypothesis is expressed in a null form:
Hypothesis 2 (H2).
Population density influences financial sustainability.
Another variable that can affect financial sustainability is the population ratio, also named the “dependency ratio”. This variable analyzes the relationship with the so-called dependent population, which includes the population aged under or over defined thresholds, in this case, under 15 years and over 65 years. The basic assumption is that this type of population does not actively contribute to the payment of taxes, therefore a negative influence on financial sustainability could be hypothesized. In particular, the young population requires public services without contributing which then affects public expenditures and public finances or financial capacity [46,53]. In addition, the old population necessitates many public services, contributing to public finance only minimally through the taxes applied to the pension.
Accordingly, the third and fourth hypotheses are:
Hypothesis 3 (H3).
The size of the population under 15 years of age decreases financial sustainability.
Hypothesis 4 (H4).
The size of the population over 65 years of age decreases financial sustainability.
As far as immigration is concerned, a high immigration level would increase social spending and indebtedness [47], leading to a negative influence on performance in the public sector [46]. However, the influence of immigration is controversial as the foreign population is related to an increase in the tax burden [54]. Therefore, the fifth research hypothesis is:
Hypothesis 5 (H5).
The level of immigration decreases financial sustainability.

2.2.2. Economic Factors

Several economic variables could influence the achievement of financial sustainability [7]. In the Italian context, and in many other countries as well, the recent global financial crisis has led to a progressive reduction of grants from the central government, thus local governments have to restore their financial situation by managing expenditure and revenue autonomously. In particular, ILGs have to provide services to citizens while maintaining an appropriate financial and economic equilibrium to avoid increasing indebtedness and checking for the effects of long-term investments. According to previous studies [55,56,57,58], the “warning signal” could be: the ratio between current revenue and capital revenue; the ratio between current expenditure and capital expenditure; the financial autonomy; the current equilibrium; the level of indebtedness; and the level of investment.
The public choice theory suggests that under the “pressure of competition”, politicians have to provide public services in order to satisfy the needs of citizens. In so doing, they have to consider revenue dimensions. It is the ability to vary government revenues from taxes and produce new ones, comprising income received from entities at other levels of government and international organizations [8]. However, policymakers might not ponder the equilibrium between current and capital revenue, and they might try to obtain external financing and to ensure long-term revenue [30]. However, regarding the different composition of revenue, a positive influence on financial sustainability is expected, therefore, the sixth research question tests if:
Hypothesis 6 (H6).
The incidence of current revenue on capital revenue positively affects financial sustainability.
Regarding service measurement, the assumption is that it is necessary to preserve the volume and quality of service [8]. The public choice theory suggests that the politicians could not keep in consideration the equilibrium between current and capital expenditure in the management of the resources. In fact, in order to have an impact on the impression of citizens, they could take an excessive recourse to expenses that concern both the day-to-day management of the institution and long-term projects. Therefore, the seventh research question investigates if:
Hypothesis 7 (H7).
The incidence of current expenditure on capital expenditure negatively affects financial sustainability.
Looking at the financial autonomy, it is the autonomy to impose local taxes, collect revenue, and allocate financial resources without external interference [3]. There are different interpretations of the influence of financial autonomy [58]. On the one side, high levels of independence to impose taxes might help to obtain revenue to cover citizens’ demands without damaging the solvency of a local government (LG); on the other side, politicians may not want to impose so many taxes on citizens due to their a strategic vision. The public choice theory suggests following the latter method, defining a negative influence as affecting financial sustainability. Accordingly, the research question tests if:
Hypothesis 8 (H8).
The level of financial autonomy negatively affects financial sustainability.
Current equilibrium defines the state of health of the local authority. It is represented by current revenue and current spending. In particular, there is an alert signal generated when current expenditures exceed current revenues [55,56]. Therefore, politicians should always keep in mind this value, and a positive influence is expected on financial sustainability. Accordingly, the ninth research question analyzes if:
Hypothesis 9 (H9).
Current equilibrium positively affects financial sustainability.
Several scholars have explored the influence of the level of indebtedness on the financial condition in the public sector. The investigation of debt is essential to realizing financial sustainability [30]. In providing service, the local government has to maintain a low level of indebtedness. However, a balance needs to be discovered between low debt and service delivery. This is the key question to prodiving more services and meeting citizens’ expectations, politicians could use external resources and, therefore, increase the level of debt. Under the public choice theory, the pressure to satisfy the citizens’ expectations can lead politicians to an excessive recourse through indebtedness. Therefore, the study analyzes if the level of indebtedness negatively affects financial sustainability, so the 10th research question defines if:
Hypothesis 10 (H10).
The level of indebtedness negatively affects financial sustainability.
Finally, the study investigates the impact of the level of investment on financial sustainability. Implementing long-term projects allows politicians to show a long-term strategic vision and propaganda. Additionally, scholars [57] highlight that investments could determine a reduction in operating costs (i.e., current expenses), increasing the LGs’ efficiency. Accordingly, the research hypothesis is:
Hypothesis 11 (H11).
The level of investment positively affects financial sustainability.

3. Setting the Context: The Italian Local Government

The Italian public administration is based on a three-level structure: national government, regional governments [20], and local governments (LGs) (110 provinces and 7903 municipalities).
Until 1995, ILG accounting was traditionally based on cash and modified cash-basis accounting and determined on budgetary compliance. In the 1990s, with the New Public Management paradigm, several public management reforms were implemented, coupled with important accounting innovations [59]. In fact, since 1995, a law decree (no. 77) restructured the local government accounting [60]. The key points were [61]:
  • The safeguarding of the traditional cash- and obligation-based system. The LG prepared a budget on a cash and obligation basis;
  • The double-entry bookkeeping was not mandatory. Therefore, with a complex system of year-end adjustments, ILGs developed their balance sheet and an operating statement from its budgetary accounting statements;
  • The adoption of managerial control systems.
In the last decades, the available resources were insufficient to cover the expenses, and over time, the municipal financial destabilization favored financial distress in many ILGs [62]. A municipality was considered “financially destabilized” when “it is unable to assure the provision of essential services and functions, or when its creditors’ rights cannot be protected according to the procedures permitted for preserving a balanced budget or integrating off balance-sheet debts into the annual budget” (legislative decree no. 267/2000). Meanwhile, financial distress appears when an LG cannot deliver public services and perform its essential functions, or when it is no longer able to repay its debts through ordinary means (art. 244). To manage this pathological phenomenon, the legislative decree no. 267/2000 introduced the so-called long-term financial re-equilibrium procedure. Accordingly, the representative body of the local government has to prepare a plan to restore financial equilibrium to prevent financial distress.
Afterward, given the need to achieve accounting harmonization for regions, local governments, and other public entities controlled by them, several laws were passed (Law no. 42 and no. 196 of the year 2009). Accordingly, in 2011, decree no. 118 was issued and then updated by decree no. 126/2014. The new system is based on the coexistence of two accounting methods: a modified cash-basis accounting and accrual accounting. However, accrual accounting is required only for reporting and cost accounting [63]. With these accounting systems, pathological scenarios can be recognized.
Regarding the financial condition, ILGs have to operate in equilibrium as they have to provide several fundamental public services, obtaining resources partially by transfers and grants from central and regional governments. Moreover, they have the power to both impose local taxes and manage their assets.

4. Research Methodology

4.1. Sample

The analysis was based on all Italian LGs with more than 60,000 inhabitants. The sample consisted of 106 municipalities, and the analysis covered the 2018 financial reports. Two reports were not available on the website (Caserta, Corigliano Rossano), therefore, the final sample consisted of 104 ILGs. The study focused on larger municipalities as they are required to provide larger amounts of public services, and the Italian context was investigated because of financial difficulties suffered in the last decades in the public sector [58].
Both financial and economic data were collected manually through the website of every single municipality that has the so-called “transparent administration” section, in which financial statements are made available. The socio-demographic data were obtained through Tuttitalia website (www.tuttitalia.it).

4.2. Variables and Analysis

The dependent variable is financial sustainability defined as the ability to continue current policy without changes in public services and taxation and without causing a continuously rising debt. As stated above, the literature outlines different methods to measure the value of financial sustainability [9,14,15,16,18,24,28,32,33,64,65].
In this study, financial sustainability (FS) was assessed through an income statement, as financial sustainability is strictly interconnected with income [24,65]. At the best of the author’s knowledge, this is the first study to investigate the financial sustainability with adjusted income in Italian local governments. Therefore, following Rodríguez-Bolívar et al. [28,32,33], the “adjusted income” was used as the dependent variable of the model. More specifically, the negative components for extraordinary activities were summed, while the positive components for extraordinary activities were deducted by the result of the income statement for the financial year. In this way, the income statement intends to measure intergenerational equity [28,30,31,32,33]. This value is a more comprehensive perspective, considering that it is possible to evaluate the capacity of the entity to continue delivering the same quantity of goods and services and, also, the level of resources that will be desirable in the future to continue to satisfy the public service delivery obligation [32].
Regarding the independent variables, the study focused on both demographic and financial-economic variables.
More specifically, the demographic variables were:
  • Population size (PopSize). It is described as the population residing in the municipality, and it is measured through the natural logarithm of the population.
  • Population density (PopDensity). It is measured as the population residing in the municipality divided by Km squared.
  • Dependency ratio. This variable seeks to investigate the relationship between financial sustainability and the so-called dependent population. Therefore, two sub-ratios were analyzed:
    o
    The population aged under 15 years (Young_Pop)
    o
    The population aged over 65 years (Old_Pop)
  • Immigrant population (Imm_Pop). It refers to the number of foreign residents in the municipality calculated as a percentage of the total population.
The second group of variables evaluates the role played by financial-economic factors:
  • Current revenue/capital revenue (C/K_REV). Current revenue is represented by tax, social security, and equalization revenue; revenue deriving from current transfers from the State, the regions, and other public bodies; non-tax revenue which includes all sources of financing of the municipality that are not directly linked to the collection of taxes; they include, for example, any profits of associated companies, profits from the provision of public services, or from the rental of municipal real estate to third entities. Capital revenue consists of revenues deriving from the sale of real estate of the municipality, any transfers by the State for the construction of infrastructures or other projects to long-term, and the collection of accumulated credits.
  • Current expenditure/capital expenditure (C/K_EXP). Current expenditure concerns the day-to-day management of the institution and the provision of municipal services such as personnel expenses, the purchase of consumer goods or raw materials, the provision of services, interest expense, and various financial charges. Capital expenditure consists of all the expenses that the municipality incurs for the purchase of real estate or the construction of infrastructure and long-term projects. Examples of capital account investments can be the acquisition of real estate, purchase of specific assets for economic achievements, use of third-party assets for economic achievements, and acquisition of movable property, machinery, and technical-scientific equipment.
  • Financial autonomy (F_AUT), which measures to what extent the municipality can autonomously meet its needs without resorting to transfers from the State, the Region, and other public bodies. It is calculated as a percentage, thus the higher the percentage, the higher the autonomy enjoyed by the Municipality in its budget choices. Therefore, the calculation formula is [Tax revenue (Title I) + Non-tax revenue (Title III)/Total current revenue (Title I + Title II + Title III)] × 100.
  • Current Equilibrium (C_EQ). It measures the municipality’s ability to cover current expenses (those necessary to face ordinary administration) through current revenues (based on the relationship between current revenue and current expenses). Therefore, the formula is [Tax revenue (Title I) + Current transfers(Title II) + Non-tax revenue (Title III)/current expenditure (Title I)] × 100.
  • Level of indebtedness (DEB). In a short time, to evaluate the provision of goods and services by a management view, politicians have to consider the level of indebtedness of the municipality. Accordingly, it is calculated as the ratio in the percentage of total debts to total current revenue.
  • The level of investments (INV) is represented by the portion of the expenses that the municipality decides to devote to long-term projects (i.e., capital expenditure), and it is calculated as a ratio of capital expenditure on total current expenditure, considering that the higher the percentage, the higher the ability to invest in the future.
To test the hypotheses of this study, the following regression model was carried out.
FSi = β0 + β1PopSizei + β2 PopDensityi + β3 Young_Popi + β4 Old_Popi + β5 Imm_Popi + β6 C/K_REVi + β7 C/K_EXPi + β8 F_AUTi + β9 C_EQi + β10 DEBi + β11 INVi + εi
where sub-index i refers to each LG, εi defines the disturbance error, and β are coefficients to be estimated.

5. Results

Table 2 presents the results of the descriptive statistics for all variables, showing the mean and standard deviation, as well as minimum and maximum values. The mean values of the economic variables indicates that there was an inadequate level between current revenue and capital revenue, and, above all, current expenditure and capital expenditure. However, the ILGs presented an adequate financial autonomy, but the values of other economic variables were not satisfactory: a low level of current equilibrium and an excessive level of indebtedness without a high level of investment were observed.
Table 3 illustrates the correlation matrix with the bivariate analysis of the dependent and independent variables. The results highlight that the variable “pop_size” was highly correlated with other demographic factors except “pop_density”. Therefore, in order to avoid bias, “pop_size” was removed from the model. Furthermore, there was a high correlation between “young_pop”, “old_pop”, and “Imm_pop” variables; for these reasons, three different models of regression were carried out including every factor separately in model 1, model 2, and model 3.
Model 1: FSi = β0 + β1 PopDensityi + β2 Young_Popi + β3 C/K_REVi + β4 C/K_EXPi + β5 F_AUTi + β6 C_EQi + β7DEBi + β8 INVi + εi.
Model 2: FSi = β0 + β1 PopDensityi + β2 Old_Popi + β3 C/K_REVi + β4 C/K_EXPi + β5 F_AUTi + β6 C_EQi + β7DEBi + β8 INVi + εi.
Model 3: FSi = β0 + β1 PopDensityi + β2 Imm_Popi + β3 C/K_REVi + β4 C/K_EXPi + β5 F_AUTi + β6 C_EQi + β7DEBi + β8 INVi + εi.
Table 4 shows the results of the three regression models used to test the hypotheses.
To avoid the heteroscedasticity problems, the White and Breusch-Pagan heteroscedasticity tests were performed and yielded negative results.
The three models were statistically significant. The goodness of fit of the estimated linear regression model is measured by the coefficient of determination (R2) and the adjusted coefficient of determination (R2 adj) [66]. However, to construct a perfect model, it is not necessary to enhance these values [67]. For all models, the results define that the statistically significant variables were financial autonomy and level of indebtedness beyond the constant. Regarding demographic factors, in model 1, it is interesting to note the positive coefficient of density population and the negative coefficient of young population. As expected, this type of population needs services, but they do not actively contribute to the payment of taxes, thus a negative influence on financial sustainability was observed. However, these values were not statistically significant. In model 2, the “old population” variable showed a positive coefficient. The over 65 population had less capacity to contribute to the government’s finances but required the satisfaction of more services without contributing to them. Regarding the level of immigration, in model 3, the negative coefficient indicates an increase in social spending without contributing to it, influencing financial sustainability negatively. However, it has to be noted that, differently from other countries [30,48], demographic variables were not statistically significant.
Focusing on economic variables, in all performed models, financial autonomy and the level of indebtedness influenced financial sustainability. More specifically, the estimated coefficient of the financial autonomy variable presented a negative value. This indicates that the less the LGs are financially autonomous, the more the level of financial sustainability increases. Considering that to pursue a proper level of financial sustainability, LGs must provide services, the sources of funding could derive either from transfers from the central government or outside parties with recourse to indebtedness. In the latter case, the choice to use debt may negatively impact future generations by not respecting intergenerational equity. The interpretation is consistent with the results. In fact, contrary to expectations, the level of indebtedness presented a positive coefficient. The more the debt level increased, the more financial sustainability grew. This means that the politicians of LGs to meet the expectations of the population in providing services use external financing, increasing the level of indebtedness. These results are clearly at odds with previous studies [58]. Finally, neither the nature of the structure of revenue (current revenue/capital revenue) nor the expenditure (current expenditure/capital expenditure) were statistically significant, nor were the current equilibrium and the level of investment.

6. Discussion and Conclusions

In the last years, many international organizations have pointed out the need for sustainability policies in the public sector [13,29,65]. After the crisis period, public administrations had to monitor their financial health. Extensive literature [4,14,15,16,20,36,58,68,69,70,71] has investigated the financial/fiscal/health condition or financial sustainability, also labeled as financial and fiscal distress. Therefore, the concept of financial sustainability has different degrees of magnitude [6]. Since the objective of a public entity is to deliver public services, the concept of financial sustainability is here defined as the ability of an entity to continue current public policies and public service delivery [65]. Financial sustainability is measured by income statement items, removing extraordinary items and those revenues and expenses that are unlikely to be repeated in the future [28]. Many variables can influence this value, and understanding what these determinants are and how to manage them is relevant for managers and politicians to improve their decision-making process. International organizations, which have looked at demographic changes in countries, have highlighted that these structural variations are relevant to financial health and thus financial sustainability.
Therefore, this paper aimed to investigate the influence of demographic as well as economic factors on the financial sustainability of Italian local governments from the perspective of the public choice theory. Previous studies have explored some countries, in particular Spain [14,15,16,30,32,33,48]. A regression model was carried out to test several independent variables such as population density, population under 15 years, population over 65 years, level of immigration, current revenue on capital revenue, current expenditure on capital expenditure, financial autonomy, current equilibrium, and level of indebtedness and investments.
The analysis revealed that in the Italian context the demographic variables did not influence the level of financial sustainability, unlike in other European countries [30,48]. Therefore, according to these results, the policymakers do not need to consider demographic factors in the management of financial sustainability. Currently, in the Italian context, these elements are not potential driving or risk factors. However, considering that demographic changes can occur very quickly, and international organizations’ recommendations, it is essential to work on social policies as they are as “lifeblood” in the public sector.
For the economic factors, the financial autonomy and level of indebtedness were statistically significant. Financial autonomy influenced negatively financial sustainability, showing that financial sustainability increased when the level of financial autonomy was low. As financial autonomy was calculated without resorting to transfers from the State, the Region, or other public bodies, this result might indicate that to cover citizens’ demands, the LGs used more transfers by the central government or, in an alternative way, LGs choose external sources, that increase the level of indebtedness. Bearing in mind that the results demonstrated that the level of debt increases, the last option is preferable, in the last time. Even if local governments did not have the resources to cope with services, they preferred to resort to excessive debt.
The public choice theory helps to understand the reasons that influence politicians to act in a certain way. The “pressure of the competition” axiom motivates politicians to act in the public interest instead of their own, for example, to gain approval for future re-election. They spend more than they can to provide services to retain population’s favor. In effect, scholars have shown the positive influence of financial health on the re-election of politicians [43]. Therefore, ILGs are very careful to ensure services so the population can express their appreciation through future re-elections. In fact, to pursue this aim, politicians feel under pressure for the competition, as suggested by the public choice theory and seek legitimization of their work by adopting a short-term strategy that entails an increase in the levels of indebtedness which will affect future generations also in terms of intergenerational equity. However, this management has a myopic point of view leading in the medium-long term to a financial destabilization and financial distress that is difficult to sustain. In fact, the results indicate a pathological scenario that should be modified.
A practical implication from this study reveals that the politicians are aware that accounting information can effect financial sustainability. In particular, the main aim of policymakers is to preserve the services without adopting austerity policies—even if necessary—that can cause citizen dissatisfaction. However, this view produces a distorted decision-making process.
Furthermore, the findings developed from this study would be of interest to international readers, as public sector entities, especially the local governments, have to continue to respond to the global financial crisis. Therefore, reforms aiming at increasing the autonomy and the responsibility of LGs would be desirable, thus public sector strategies can have impacts not only in the short term but also in the long term, considering intergenerational equity.
The study is not free of limitations. The research covered only one year (2018) since accrual accounting was only recently used as a criterion for preparing financial statements in Italy.
For further research, it would be interesting to increase the analysis to more years to highlight the impact of eventual changes in demographic and economic determinants not only in the Italian context but also compared with other European countries. In this way, it would be possible to evaluate, from a comparative perspective, the influence of variables to highlight the similarities and differences in and amongst to these countries. Additionally, in times of extraordinary emergency, such as that currently being experienced all over the world (the COVID-19 pandemic), the external resources provided by the central government could have a huge impact on local governments. Therefore, the analysis should be replicated in the following years to determine how and to what extent it influenced the conditions of financial sustainability comparing the physiological and post-emergency situation.

Funding

This research was funded by Department of Political Science “Jean Monnet”, University of Campania “Luigi Vanvitelli”.

Conflicts of Interest

The author declares no conflict of interest.

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Table
Table 1. Financial sustainability dimensions.
Table 1. Financial sustainability dimensions.
DimensionDefinitionCapacityVulnerability
ServicePublic services that the entity can deliver in terms of quantity and quality given the current level of taxation and debt limits.To maintain or increase the quantity and/or quality of public services.To external factors that are detrimental to the capacity to maintain or increase the quantity and/or quality of public services (e.g., if the level of public services is determined by other levels of government).
RevenueTaxation levels given debt limits and policy intentions in terms of public services delivery.To maintain or increase taxation levels or introduce new revenue sources.The willingness of taxpayers to accept the taxation levels and dependence of external sources.
DebtDebt levels given taxation levels and policy intentions in terms of public services delivery.To meet financial commitments or increase debt.To market confidence and interest rate risk.
Source: Bisogno et al. [11].
Table
Table 2. Descriptive statistics.
Table 2. Descriptive statistics.
MeanStd. DeviationMinimumMaximum
FS23,695,838.42250,964,221.04−286,613,027.912,453,100,175.48
PopSize11.670.7111.0014.86
PopDensity1539.991698.16144.968059.05
Young_Pop233.66427.347.583755.73
Old_Pop419.27739.3017.016385.23
Imm_Pop204.74469.818.493825.77
C/K_REV13.289.360.2653.82
C/K_EXP12.9232.960.31327.96
F_AUT84.8810.6248.4496.25
C_EQ201.95707.6764.017234.59
DEB193.17208.560.47965.78
INV21.6037.100.04324.65
Table
Table 3. Bivariate correlations.
Table 3. Bivariate correlations.
FSPopSizePopDensityYoung_PopOld_PopImm_PopC/K_REVC/K_EXPF_AUTC_EQDEBINV
FS10.01820.0141−0.0989−0.0613−0.0608−0.0957−0.0377−0.30390.01380.22160.2016
PopSize 10.45650.81340.83580.7610−0.0905−0.1019−0.03000.12610.3100−0.0543
PopDensity 10.38810.38500.37360.10220.14490.1236−0.00700.0323−0.0939
Young_Pop 10.98910.94420.0563−0.0131−0.03340.04120.04390.0439
Old_Pop 10.95960.0330−0.0277−0.03090.02810.0654−0.0633
Imm_Pop 10.0056−0.0282−0.0037−0.02070.0454−0.0688
C/K_REV 10.48380.13410.0106−0.1370−0.2413
C/K_EXP 10.0186−0.0416−0.0374−0.1523
F_AUT 1−0.0668−0.0599−0.3267
C_EQ 1−0.09800.2202
DEB 1−0.0567
INV 1
Table
Table 4. Regression model.
Table 4. Regression model.
VariablesModel 1Model 2Model 3
CoefficientStd. Errorp-ValueCoefficientStd. Errorp-ValueCoefficientStd. Errorp-Value
const4.87852 × 1082.26097 × 1080.0337 *4.77539 × 1082.27298 × 1080.0386 *4.65761 × 1082.26786 × 1080.0430 *
PopDensity17,919.916,822.80.289815,322.316,913.70.367513,995.616,823.90.4078
Young_Pop−89,107.263,023.60.1610
Old_Pop −38,014.036,617.20.3021
Imm_Pop −50517.257,073.50.3786
CK_REV231,3373.09858 × 1060.940786,892.93.11121 × 1060.9778−47,871.53.11202 × 1060.9878
CK_EXP−216,1898741610.8053−185,5328791570.8334−156,0698789630.8595
F_AUT−6.37806 × 1062.52119 × 1060.0132 *−6.25784 × 1062.53324 × 1060.0155 *−6.13611 × 1062.52909 × 1060.0173 *
C_EQ−1260.6835,638.70.9719−2391.9935,806.90.9469−4282.5935,846.10.9052
DEB255,900121,1950.0376 *257,298121,8940.0377 *253,576122,0240.0407 *
INV871,208742,6300.2440894,611746,4050.2340907,600747,3080.2279
R20.171065 0.162295 0.159454
R2 adj0.093955 0.084369 0.081263
F (8. 86)2.218444 0.03357 *2.082674 0.04613 *2.039303 0.05101 *
* Represent statistical relevance at 5 percent levels.

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Santis, S. The Demographic and Economic Determinants of Financial Sustainability: An Analysis of Italian Local Governments. Sustainability 2020, 12, 7599. https://doi.org/10.3390/su12187599

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Santis, Serena. 2020. "The Demographic and Economic Determinants of Financial Sustainability: An Analysis of Italian Local Governments" Sustainability 12, no. 18: 7599. https://doi.org/10.3390/su12187599

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