The Empirical Relationship between Fiscal Decentralization and Economic Growth: A Review of Variables, Models and Results

By Szabo, Septimiu-Rares | Management Research and Practice, June 2017 | Go to article overview

The Empirical Relationship between Fiscal Decentralization and Economic Growth: A Review of Variables, Models and Results


Szabo, Septimiu-Rares, Management Research and Practice


1. INTRODUCTION

The classic theory starting from Tiebout (1956) and Oates (1972) suggests that fiscal decentralization can generate a multitude of benefits including better allocation of goods, enhanced efficiency in providing services or increased local economic growth. The latter seems to be the one that has been analyzed the most in the academia and the one that probably provides the most confusion in terms of results. There are almost as many studies that find evidence for a positive, a negative, or no relationship at all. However, the topic has not been analyzed systematically especially since the theory has not yet provided a fully reliable theoretical model. In addition, scholars have analyzed the relationship in different countries and at different times.

Partially due to this ambiguity in terms of results, Baskaran, Feld and Schnellenbach (2014, 2016) and Martinez-Vazquez, Lago-Penas and Sacchi (2016) have published some very helpful meta-analyses that encompass most of the empirical studies that test the relationship between fiscal decentralization and growth. While their papers accurately review the results, the methodologies and the empirical limitations, they do not seem to make an in-depth analysis of the usage of independent and control variables. This study wants to complement their research and provide a better understanding of the components of the growth regressions. Since it also includes a couple of very recently published papers on the topic, it follows their lead in presenting and comparing the regression results and the models used to reach them. In 13 cross-country and 13 single-country studies the current article finds more than 30 independent variables and more than 60 control variables. While the usage of the classic ratios of subnational revenue and expenditure to total national revenues and expenditures is observed in almost every study, regressions assessing the impact of local autonomy or of intergovernmental transfers on growth remain rather limited. In terms of control variables, while some scholars include some country- or region-specific indicators, most continue to adhere to the classic variables included in most regressions that search for significant relationships between economic growth and various political, institutional or macroeconomic factors. The paper starts with a review of the theoretical aspects of fiscal decentralization, continues with an analysis of the results generated by the studies that tested the linkage between fiscal decentralization and growth and then it presents an in-depth review of the data, models and variables used in 26 selected studies. The paper ends with a discussion of the results and some recommendations for future studies.

2. THEORETICAL ASPECTS RELATED TO FISCAL DECENTRALIZATION

Fiscal decentralization usually means devolving authority, revenues and decision making from the central government to the subnational governments. Lately, the process has been debated intensely by both scholars and practitioners especially since it has been strongly promoted by organizations like the World Bank, USAID, the UN or various European institutions. The classic theory suggests that fiscal decentralization leads to enhanced economic efficiency because subnational governments, due to their proximity, have better knowledge of local conditions and preferences in the provision of public goods (Oates, 1972). This process also enhances interjurisdictional competition and population mobility (Tiebout, 1956) generating subnational innovations, cost reductions, increased productivity and reduced inequalities (Ezcurra and Pascual, 2008; Bodman, 2011). According to Rodriguez-Pose and Kroijer (2009), Asatryan and Feld (2015) and Gemmell, Kneller and Sanz (2013) there are other positive benefits of fiscal decentralization presented in the literature including economies of scale (Prud'homme, 1995; Rodriguez-Pose and Ezcurra, 2010), macroeconomic stability (Martinez-Vazquez and McNab, 2006), fiscal consolidation (Schaltegger and Feld, 2008), market development (Weingast, 1995), enhanced transparency and accountability (Martinez-Vazquez and McNab, 2003; Azfar et al, 1999; Ebel and Yilmaz, 2002), democratic participation (Dabla-Norris, 2006) or increased productive public investments (Kappeler and Valila, 2008). …

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