Estimating the Effect of Direct Democracy on Policy Outcomes: Preferences Matter!

Previous studies have found large negative effects of direct democracies on government spending. Since they do not control for preference heterogeneity, these estimates suffer from omitted variable bias. If citizens in areas with stronger direct democracy have lower tastes for government, the restraining effect of institutions is overstated. Exploiting a unique dataset in Switzerland, we demonstrate substantial preference heterogeneity across cantons with different direct democratic regimes. Conditional on voter preferences, the effect of direct democracy declines by more than 40 percent relative to earlier estimates. However, access to direct democratic instruments still decreases canton expenditures by 8 percent, while raising expenditures at the local level by 20 percent. In the Swiss case, a mandatory budget referendum decentralizes expenditures, but has no effect on the size of canton and local governments combined. Our results speak against a pure median voter model and strengthen the view that political institutions have a strong and persistent influence on policy outcomes.