The US Example to Help Municipalities Turn Around
In Europe, the local governments of cities, provinces and regions are heavily indebted and in many cases close to financial bankruptcy (see Perignon and Vallée, 2017, for the French case). What can be done to restructure local governments' liabilities and restore their credit worthiness? A lesson comes from the United States, where municipalities can access a procedure to restructure their debts known as Chapter 9, a process whereby local governments and cities are placed into receivership. If the state to which they belong has approved a Chapter 9, the municipalities in a state of insolvency may file a request for debt restructuring in court. However, access to the restructuring process is not uniform across the US, since half of the states have not yet authorized Chapter 9.
➜ The action of lobbies
Together with Hayong Yun of Michigan State University, I have studied the causes and consequences of Chapter 9 approvals in US states for the 1980-2012 period. The study finds that in the states where Chapter 9 is authorized, cities pay lower interest rates on municipal bonds and there is an additional stimulus for local business investment, because firms also benefit from access to sources of municipal funding. On the contrary, municipalities in states that have not authorized Chapter 9 have very few arms at their disposal to renegotiate their debts and get out of financial distress. In fact, creditors cannot lay claims to city's assets or tax revenues and thus are reluctant to provide additional lending.
If Chapter 9 presents these clear advantages, why is it not uniformly adopted in all states? The answer lies in the opposition of specific interest groups. In fact, a feature of Chapter 9 is that it allows to overcome the rigidity of collective bargaining in the public sector and thus contracts for public employees can be renegotiatied without consent of the subjects involved. In practice, during a debt restructuring under Chapter 9, the cost of public employment workers can be brought down to the lower levels of the private sector with local governments acting unilaterally, in the so-called cram down procedure. This raises the opposition of labor unions, which in many cases manage to mobilize enough political support to stop reform. Other factors explaining the difficulties encountered by Chapter 9 include the dearth of efficient courts as precondition for effective structural reform.
➜ If the slowness of justice acts as a brake
What are the downsides of Chapter 9? Our research shows that there are concerns that municipalities may be opportunistic in submitting bankruptcy claims, doing so not because they are in a state of financial distress, but only to benefit from federal funds at the expense of neighboring municipalities. Consequently, we find that communities where the level of mutual trust among inhabitants is greater are more responsive in adopting structural reform.
In conclusion, research findings show that economic policy factors and inadequate development of civil justice infrastructure may slow down the adoption of reforms that enhance the well-being of local communities. These lessons are applicable to the European context, where municipalities similarly face strained budgets and chronic financial difficulties.