Less political discretion in resource allocation
06.06.2025
A study published in Econometrica analyses the impact of 26 billion euros distributed to 77,000 Italian firms, revealing that the cost of each new job increases by 42% when local politicians decide on the allocation of subsidies, compared to a system based on objective criteria.
This is the finding of the study "Making Subsidies Work: Rules vs. Discretion", published in Econometrica. Using a sophisticated "natural experiment" offered by law 488/92, which represented the largest business aid programme in Italy, researchers Federico Cingano (Bank of Italy), Filippo Palomba (Princeton University), Paolo Pinotti (Bocconi University), and Enrico Rettore (University of Padua) analysed over 77,000 projects using machine learning techniques and advanced econometric models. They compared two fund allocation logics: one based on technical rules and the other guided by discretionary political evaluations.
According to the study's results:
- An objective criteria-based system would have reduced the cost of each new job by 11%;
- A politically discretionary system would have increased the costs by 42%;
- An "optimal" allocation, constructed on the actual returns of the projects, would have halved the costs, with greater benefits in the South of Italy.
Although the research indicates that politically favoured firms were often located in disadvantaged areas with high youth unemployment, this does not justify the inefficiency observed. The research is particularly relevant in the current context, where industrial policies such as the European Green Deal and the American Inflation Reduction Act are in the spotlight. The quality of resource allocation is as crucial as the amount spent.
Paolo Pinotti and Enrico Rettore conclude on this matter, "It is not enough to spend more: we need to spend better. When funds are allocated based on political evaluations rather than objective criteria, we risk wasting valuable resources, especially in areas where they are most needed."
Spending better is certainly essential, but if allocation is based solely on political evaluations, it risks wasting valuable resources, especially in areas that need them the most. To ensure that public subsidies promote employment, innovation, and sustainable growth, greater transparency, rigorous preliminary evaluation, and less political discretion are necessary. Efficiency in public spending is a duty towards citizens.
