fiscal federalism, decentralization and economic growth: a meta...

Fiscal Federalism, Decentralization and Economic Growth:

A Meta-Analysis

by

Lars P. Feld

(University of Heidelberg, ZEW, CESifo, CREMA, SIAW-HSG),

Thushyanthan Baskaran

(University of Heidelberg)

and

Jan Schnellenbach

(University of Heidelberg)

Abstract:

The distribution of competencies between the different levels of a federal system may have re-markable effects on economic growth, because mainly the regions of a country contribute to na-tional economic development. Thus, a government’s economic policy is reasonably shaped along regional lines. The theoretical discussion in economics focuses however on the efficiency aspects of a decentralized provision and financing of public services; rarely the argument is raised that decentralization or federalism increases growth through a higher ability of the political system to innovate and to carry out reforms. After a discussion of the theoretical arguments on federalism and growth, we address the empirical question in this paper how important the assignment of decision making powers and the design of fiscal federalism are for economic development. Fi-nally, on the basis of existing theoretical and empirical studies on economic growth and federal-ism, open questions and possible ways of answering them are presented.

The authors would like to thank the German Science Foundation (DFG) for funding this project (DFG-SPP 1142).

Corresponding Author: Prof. Dr. Lars P. Feld University of Heidelberg Alfred-Weber-Institut Grabengasse 14 D-69117 Heidelberg Germany [email protected]

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1. Federalism and Growth: Introduction

What impact can fiscal federalism have on economic growth? If we take the perspective of the

standard, Solow-Swan growth model (Solow 1956, Swan 1956), this must appear as a peculiar

question. With a given production technology, income per capita in the steady state is fully de-

termined by the savings rate, the growth rate of the population and the rate of depreciation of the

stock of capital. Prima facie, it is difficult to see through which mechanisms fiscal federalism, as a

principle of organizing government, could have an impact on these parameters that are all exoge-

nous in the Solow-Swan world. As we will see later, there might in fact be a channel through

which federalism brings forth a different propensity to save than a unitary state if the saving deci-

sion is endogenized in a model with overlapping generations. If federalist frameworks were in-

deed associated with different propensities to save, different growth rates on the convergence

paths towards the respective steady states would be expected for otherwise identical model

economies even in the Solow-Swan model.

But, this is not the first thought that comes to mind when suspecting that fiscal federalism affects

growth. As Oates’ (1999) survey shows, it is rather the efficiency (or inefficiency) properties of

fiscal competition, fiscal equalization systems, or intergovernmental fiscal relations in a polity in

general that determine the relation between fiscal federalism and economic performance. These

properties have been focused by a large number of theoretical and empirical studies during the

last decades. And based on these microeconomic analyses, Oates (1993) argues that fiscal federal-

ism affects economic development. Those familiar with modern endogenous growth theory may

wonder which transmission mechanisms between these variables supposedly exist. Putting the

view of neoclassical growth theory at the beginning of our analysis highlights that it is anything

but easy to argue that fiscal federalism has an impact on economic growth at all. In addition, it is

even more challenging to come up with convincing evidence that it actually does. Existing em-

pirical studies may leave the impression that such a relationship cannot be empirically established.

In this paper, we thus shed some light on both issues by, first, providing a survey of the theoreti-

cal literature on fiscal federalism, decentralization and economic growth. We particularly focus on

the transmission channels by which federalism affects growth. Second, the empirical evidence on

this relation is studied. Because the results are numerous and it is difficult to obtain a clear-cut

conclusion by simply providing a survey of empirical results, we conduct a meta-analysis which

targets the main outcome of that literature and identifies the factors of the single studies that

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determine the studies’ outcomes. Finally, as meta-analytical techniques are still infrequently used

in economics, we also aim at contributing to the establishment of these methods.

The paper is organized as follows: In Section 2, the theoretical studies on the impact of fiscal fed-

eralism on economic growth are reviewed. A brief survey of the empirical studies follows in Sec-

tion 3. They are quantitatively reviewed in Section 4 and are subject to the meta-analysis in Section 5.

In Section 6, the results of meta-regressions are reported in order to give an impression which

characteristics of the single studies influence the results. This also helps to highlight in which

direction future analyses in this field could be undertaken. Section 7 provides conclusions.

2. How Could Fiscal Federalism Affect Economic Growth? The Theoretical Arguments

Returning to the Solow-Swan framework for the moment, it is well known that there only tech-

nological progress can explain persistent positive growth rates (differentials) of per capita in-

comes. With only labor-augmenting technological progress guaranteeing the existence of a steady

state (e.g. Barro and Sala-i-Martin 2001, p. 54), the steady state is then characterized by a constant

income per effective unit of labor, but income per physical unit of labor growing at the rate of

technological progress, which again is exogenous. Even with its focus on the pure mechanics of

economic growth, and with its underlying approach of holding the important parameters exoge-

nous, the Solow-Swan model thus already offers important first suggestions where to look at if

we are interested in finding channels through which federalism might affect economic growth,

and technological progress appears to be a very promising candidate.

This is certainly the case if we interpret technological progress in a rather broad sense, including

not only the entrepreneurial spirits that lead the private sector to search for and to implement

superior production technologies, but also the potential for progress in the public sector. The

latter ranges from the discovery of institutions that solve political control problems more effi-

ciently and thus reduce the scope for wasteful activities in the public sector, to actual technologies

for the production of public goods. There are already a number of contributions that link public

sector efficiency gains to federalism, such as the investigation of yardstick competition by Besley

and Case (1995). Although most of these contributions do not explicitly refer to the issue of eco-

nomic growth, they are important in offering micro-foundations of public sector innovation.

Therefore, we will return to them in detail later. But before having a closer look at endogenized

technological change, we will in the following section review some pioneering attempts of incor-

porating federalism in models that endogenize decisions on saving and investment.

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2.1 Federalism, Capital Accumulation and Endogenous Saving Decisions

The approach of incorporating fiscal federalism in growth models with endogenous saving deci-

sions goes back to Brueckner (1999), who uses a Diamond-OLG growth model that is extended

to include the provision of a publicly provided private good, financed through uniform lump-

sum taxes. Heterogeneity of the population is captured by distinguishing different demands for

the publicly provided good expressed by young and old individuals. A unitary government is as-

sumed to supply some compromise level of the good, which lies in between the utility-

maximizing levels of the two respective age cohorts. This assumption may be thought of as re-

flecting the fact that in democracies, the enacted policies often represent some bargaining solu-

tion that lies between the ideal policies of different constituencies. In a federal system, on the

other hand, Brueckner assumes a perfectly working Tiebout (1956) sorting mechanism, which

implies that in equilibrium, two jurisdictions are characterized by age-homogeneous populations

and each receives its utility-maximizing supply of the publicly provided good.

The change of equilibrium policies after the introduction of a federal system also has an impact

on the level of equilibrium savings. This is due to the fact that, under the assumed condition of

weak complementarity, an increase of the quantity of the publicly provided good would unambi-

guously increase the marginal utility of the private good consumed by both young and old indi-

viduals. If now we have a situation where the desired quantity of the publicly provided good is

greater for the young than for the old individuals, then this implies that with the switch to feder-

alism, the marginal utility of private consumption increases for the young, and decreases for the

old – compared to the benchmark of a unitary state, with an intermediate quantity of the publicly

provided good. The individuals readjust their consumption plans by saving less, in order to con-

sume more of the private good in their young and less in their old age. The converse argument

would hold if the old preferred a larger quantity of the publicly provided good than the young. In

this case, higher savings would be the result of a switch to federalism.

Brueckner then goes on to solve the Diamond-OLG model for steady state solutions, and shows

that as long as saving depends positively on the current capital intensity, the steady state capital

intensity of a federal system compared to a unitary system does indeed depend on the initial as-

sumptions on the relative demands of the young and the old for the publicly provided good. If

the young demand a higher quantity than the old, federalism reduces steady state capital intensity,

and if the young demand a lower quantity, then the steady state capital intensity increases after a

federalist system is implemented. Wages and output per unit of labor move into the same direc-

tion. Summing up, while the growth rate of total output in steady state is once again identical for

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otherwise identical unitary and federal economies, the model predicts different growth rates on

the convergence paths towards the respective steady states, and different steady state levels of

income per capita, conditional on an economy being governed by a centralized or a decentralized

political regime.

A model that assumes a perfectly working Tiebout sorting mechanism obviously presents an ex-

treme case. Nevertheless, it is useful to remember that the main justification for fiscal federalism

in the literature has always been diversity of preferences for public goods (e.g. Oates 1972) and

the ability of local governments to supply specific levels and types of public goods that are in line

with the demands of their respective populations. If this mechanism is at work in the real world,

then the argument presented by Brueckner (1999) is likely to also have some empirical relevance

– even if sorting in the real world is not perfect. Nevertheless, the ambiguity of the sign of the

growth effect – its dependence on the demands for public goods of different groups in the econ-

omy – must appear as somewhat unsatisfactory.1

Brueckner (2006) tackles this problem by using a different theoretical framework. Again, the ba-

sic approach is an OLG model as in Brueckner (1999), but following the lead of Yakita (2003), an

endogenous growth model is used, which Brueckner extends to include a publicly provided good.

Individuals can invest into human capital while being young in order to increase their productiv-

ity and earnings when being old. Therefore, they earn higher incomes in their older ages, and

correspondingly always have a lower demand for the public good when they are young. Assuming

again a perfect Tiebout sorting mechanism and the assumption that a unitary government would

supply some intermediate level of the public good, the same intuition as in Brueckner (1999) ap-

plies. The decisive difference is that now it can be shown that the young always demand a lower

demand for public goods than the old and the steady state capital intensity in a federalist system is

higher.

Another interesting issue, however, is the question of financing locally supplied public goods.

Brueckner deliberately leaves these issues out of consideration by assuming a uniform lump-sum

tax, but Zou (1994, 1996) has a closer look at the problems, albeit in a very different theoretical

framework. In Zou (1994), the focus is on the effects of federal grants-in aid in the form of

matching and non-matching grants on the investment decisions of local governments. Growth

effects are not explicitly taken into consideration here, although the accumulation of public capi-

1 Similarly, Kellermann (2007) shows that decentralization of public investment decisions under the presence of

head taxes may lead to less or more economic growth.

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tal that results from local investment decisions obviously must have some relevance for growth.

In a framework that involves a government which maximizes present and discounted future util-

ity of a representative citizen, and that also abstracts from private capital accumulation, Zou

shows that different schemes of grants-in-aid have very different effects on public sector invest-

ment decisions. In particular, only a permanent increase of non-matching grants and a temporary

increase of either matching- or non-matching grants are shown to reliably stimulate local public

capital accumulation, while other grant schemes involve different ambiguities.

Zou (1996) extends the analysis and presents a fully-equipped local growth model with both pri-

vate and public capital accumulation and consumption, and endogenous decisions on the local

level of taxation. Again, however, a government maximizing an infinitely lived, representative

citizen’s lifetime utility is at the center of the model – there are no overlapping generations. The

somewhat surprising result is that the sign of the effects of different schemes of financing public

goods crucially depends on the utility function that is used in the analysis. With a standard utility

function that includes only private and public consumption, there are no differential effects from

the composition of financing instruments on long-run economic variables. If, on the other hand,

an Arrow-Kurz utility function is used, which also includes the public capital stock, then a federal

grant that sponsors local public consumption crowds out investments into the local capital stock.

Using a local consumption tax to finance the local budget would be associated with faster accu-

mulation of both private and public capital.

As we see in the discussion of these models, both the choice between a unitary and a federal gov-

ernment, as well as the choice between different instruments of financing a local budget are char-

acterized by rather ambiguous growth effects. A harmful use of inefficient instruments to finance

local budgets can obscure a positive effect on growth that the more fundamental decision to

move from a unitary to a federal regime might in fact have. Thus, we have a strong argument

here to control for different modes of financing the local budgets in empirical studies relating

decentralization to economic growth.

2.2. Agglomeration, Heterogeneity in the Productive Sector and Economic Growth

The concept of Tiebout competition between local jurisdictions (Tiebout 1956) has at its centre a

notion of efficiency in the consumption of public goods. Sorting of individuals into jurisdictions

along the lines of their heterogeneous preferences for governmental activity is presented as a

welfare-maximizing process. While this is certainly a laudable property of fiscal federalism, a link

from here to economic growth has so far only been established in the literature via the detour of

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individual saving decisions, as we have seen in the above subsection. It would be much more

straightforward to establish such a link if heterogeneity would also be established among indi-

viduals and businesses as producers of private goods, which is quite likely an empirically relevant

case. In fact, there is a large body of literature in the realm of the New Economic Geography (see

Krugman 1991 and Baldwin et al. 2003 for surveys) that lays the theoretical foundations for ex-

plaining the spatial allocation of productive activities and that accounts for agglomeration effects.

Among the most important reasons for agglomeration effects are economies of scale, which are

traded off against transportation costs. Regional immobility of resources is another important

feature that has an influence on the spatial allocation of productive facilities in such models,

which often predict core-periphery patterns of productive activity (Ottaviano and Thisse 2004).

Another important mechanism that drives agglomeration is the existence of different types of

knowledge spillovers, which lead businesses that use similar immaterial resources to allocate in

close proximity to each other, with Silicon Valley being probably the most prominent example

(for a survey, see Döring and Schnellenbach 2006). We can expect these forces of agglomeration

to have growth effects by themselves. Countries that attract centers of productive activity benefit

from a relatively faster accumulation of physical capital (Baldwin and Martin 2004). Furthermore,

agglomeration forces may be at least partially influenced by regional policies, given the fact that

the regional conditions that drive agglomeration are not only the result of pure chance (e.g. the

presence of natural resources), but more importantly are found in the presence of specific human

capital (Camagni 1995) whose accumulation can be influenced by educational and other policies.

In this sense, regional policies will have an impact on the speed of capital accumulation, and also

on the quality of capital that is accumulated. In an important paper which links a standard notion

of fiscal competition with agglomeration effects, Justman et al. (2002) show that regional politi-

cians have an incentive to differentiate the supplies of public infrastructure in different regions, in

order to alleviate the pressures of fiscal competition. As a result, these regions will also attract

different types of private capital. Justman et al. thus offer a politico-economic rationale for the

emergence of regional heterogeneity in productive activities that does not depend on exogenous

differences between jurisdictions. In other important contributions linking fiscal competition to

agglomeration, Baldwin and Krugman (2004) analyze core-periphery models that lead to full ag-

glomeration of the mobile factor in one region, and show that the resulting existence of an ag-

glomeration rent for the mobile factor implies that further economic integration (e.g. through

declining trade costs) will be followed by rising instead of declining tax rates on the income of the

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mobile factor. Borck and Pfüger (2006) generalize this result to a model economy with only par-

tial agglomeration.

From a growth-oriented perspective, the presence of strong agglomeration effects implies that

peripheral regions that wish to develop have little other policy alternatives than to attract busi-

nesses with a suitable fiscal policy (Brakman et al. 2002). Given that agglomeration effects are

relevant empirical phenomena also in unitary states this means that political devolution is likely to

enhance the opportunities of peripheral regions to initiate catch-up processes. If this is not only a

zero-sum transfer of capital from one region to the other, but instead leads to additional capital

accumulation, then it would be plausible to assume that federal states are characterized by higher

steady-state per capita incomes, and by higher growth rates on the way to the steady state. In this

context, it is important to note that on theoretical grounds, transfers from a rich to a poor region

will have temporary effects at best in a new economic geography model (Brakman et al. 2006).

The reason is that in this class of models a stable equilibrium also serves as an attractor, i.e. the

model economy reverts to the initial equilibrium, even if a different one is theoretically conceiv-

able, as long as the departure from the status quo ante is not sufficiently large. This appears to be

in line with empirical results from the United Kingdom that transfers have only very small effects

on firm location and that these effects decrease when the number of similar firms already present

in a region decreases (Devereux et al. 2007). Put differently: when only very few similar firms are

already present in a region, then a subsidy needs to be very large in order to attract additional

firms to this region. Thus, the perspective for growth in peripheral regions is likely to be brighter

when this region can apply its own fiscal policy tailored by itself, compared to a situation in

which the same region receives grants from its neighbors or from central government.

Becker and Rauscher (2007), although not working within a New Economic Geography frame-

work, but within a standard Barro (1990) growth model, investigate the effects of fiscal competi-

tion with quadratic installation and de-installation costs for physical capital, i.e. with costs of relo-

cating the physical capital stock between regions. Furthermore, they assume benevolent govern-

ments. While their main contribution is to find optimal capital tax rates, and showing that the

impact of installation costs on the optimal rate of taxing capital is ambiguous, they also show that

equilibrium may not exist for high installation costs of capital. In this case, the tax rate chosen by

welfare maximizing governments can become so high that capital owners want to reduce the

capital stock at a rate that conflicts with the smooth consumption paths desired by consumers. In

this sense, a certain intensity of tax competition (reflected in sufficiently low installation costs of

capital) may be a prerequisite for the existence of a balanced growth path.

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This leads us to a more general point. If regions are, for whatever reason, heterogeneous – and

there are certainly also a number of reasons for heterogeneity that do not rely on agglomeration

externalities – then it is quite likely that a regional government is endowed with a greater ability to

enact a growth-promoting policy for its region vis-à-vis a central, unitary government. This point

has already been informally made by Oates (1993, 1999). Davoodi and Zou (1998) incorporate

the idea into a frugal endogenous growth model which they use as a workhorse for their empiri-

cal analysis. Similar to Barro (1990), private and public capital enter a Cobb-Douglas production

function, but Davoodi and Zou split the public capital stock into three fractions: federal, state

and local capital. This specification guarantees that there exist unique and strictly positive growth-

maximizing quantities of public goods for each level of government; it is never optimal to cen-

tralize (or to decentralize) public good provision completely. However, it is important to realize

that this result is driven entirely by the specification of the production function, so that it can at

best serve as a reduced-form sketch of much more complex, underlying processes. Xie et al.

(1999) formulate a technically more complex model that, however, in essence relies on the same

specification of the production function, and yields similar results.

But what exactly is happening behind the curtain of these reduced-form characterizations of eco-

nomic growth in decentralized political systems? Within the framework of benevolent govern-

ments, one could argue that even a unitary government must be able to supply regionally differ-

entiated quantities of public goods, as long as these have a limited spatial reach. Even a unitary,

benevolent government would thus be able to supply an efficient quantity and type of public

good to each region (Besley and Coate 2003). The unique benefit of decentralization must there-

fore be found elsewhere. An obvious choice would be informational advantages of decentralized

governments; even if a unitary government is benevolent, it may find it difficult to obtain reliable

information regarding the efficient types and quantities of public goods in regions far away from

the centre (Hayek 1948). We will return to information-related arguments at length in the next

subsection. Besley and Coate use a different argument and explain the benefits of decentralization

with a political economy argument: With a unitary government, pork-barreling and cost-sharing

on the central level, voters in the regions have incentives to strategically delegate public good

lovers as representatives to the central level – having a unitary government evokes a fiscal com-

mons problem and leads to an inefficient oversupply of public goods.

Although an oversupply of public goods can have negative effects on economic growth, a more

important causal influence of decentralization on growth, especially within the context of regional

heterogeneity in the productive sector, may have to do with the political management of struc-

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tural change. Recently, Aghion and Howitt (2006) have argued that in particular for countries

whose productive sectors are close to the world technology frontier, a high firm turnover yields

higher growth rates. This argument relies on a Schumpeterian endogenous growth model, and is

backed by empirical evidence. In a recent book, Caballero (2007) has also argued for the impor-

tance of creative destruction for economic growth, and hinted at economic policies such as labor

market regulations that may slow down processes of restructuring.

But how could federalism have an impact on structural change? This question has, to our knowl-

edge, not been subject to research so far. Nevertheless, there may be some relatively straightfor-

ward mechanisms at work. It is a well-known stylized fact that industrial policies in developed

countries tend to be directed at preserving incumbent industries. For risk-averse politicians, this

is a thoroughly rational choice: In times of a structural crisis, the demise of an unsubsidized in-

cumbent industry may be more or less certain, while the emergence of new industries is uncertain

as far as their sizes and types are concerned; preserving the incumbent may thus easily turn out to

be the dominant strategy. But if the Besley-Coate overprovision argument holds, then we can also

expect the public funds that are directed towards structural preservation to be higher under a

unitary than under a federal regime. The problem may be aggravated with sufficiently heteroge-

neous regions in a unitary state. In this case, a single or a few well-organized regions suffering

from asymmetrical shocks could engage in Olson-type interest group politics on the central level

and effectively lobby for structural preservation through a transfer of tax revenue into this region.

Furthermore, fiscally autonomous regions have a larger set of instruments with which they can

react to a crisis of incumbent industries. For example, tax incentives can be used to attract new

businesses, compensating for the demise of the old. With a unitary government that normally acts

under (e.g. constitutional) provisions to levy uniform nation-wide tax rates, this would obviously

not be possible. Thus, there is some reason to believe that local and regional fiscal autonomy

would not only enable the supply of efficient, region-specific public goods (from a static perspec-

tive) but would also be associated with swifter structural change, and thus higher growth rates.

2.3. Political Competition and Economic Growth

Closely related to the positive effects of fiscal federalism that we have discussed above – and that

principally stem from the heterogeneity of regions – are effects that have their roots in the com-

petition between sub-central governments. This is, in a sense, the other side of the Tiebout

mechanism: Individuals do not only sort into regions according to their preferences, but they can

also avoid unfavorable combinations of taxes and public good supplies by relocating themselves

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or at least their mobile capital. They become endowed with additional instruments to discipline

self-interested representatives. However, the use of these instruments may also yield effects that

deplete economic efficiency. Oates (1972) has already pointed out that efficiency requires fiscal

equivalence, i.e. that those who decide on the provision of sub-central public goods are to be

identical with those who consume and finance them.

There is a wealth of contributions to the literature that analyze how externalities between jurisdic-

tions distort efficiency, and how efficient compensating transfers might correct for these prob-

lems. Discussing these horizontal and vertical externalities in detail here would clearly be beyond

the scope of this paper (see Wellisch 2000 for a survey of the issues). Few papers have dealt with

the externality issue explicitly within the framework of a growth model. An example is Devereux

and Mansoorian (1992), who analyze an endogenous growth model of the Barro (1990) type with

two countries whose decisions on tax levels produce fiscal externalities. Whether independently

chosen tax levels are too high or too low depends on preferences in this model. In any case, co-

ordination of fiscal policies improves welfare – but not necessarily growth, because the decentral-

ized equilibrium may be characterized by too low public consumption and a too high level of

public investment. It is therefore not possible to derive clear-cut predictions regarding growth

effects of uncoordinated, decentralized policy from this model. In a different two-country en-

dogenous growth model with imperfectly mobile capital, Lejour and Verbon (1997) show that

uncoordinated source taxes on capital returns may actually imply too much redistribution. The

reason is a growth externality: If one country levies a tax, it reduces investment at home, but by

depleting the equilibrium return to capital in the entire economic union, also in the other region.

Contrary to conventional wisdom, efficient coordination would then lead to lower public con-

sumption and lower tax rates compared to an uncoordinated equilibrium.

Given the lengthy discussion in the literature of different externalities emerging from decentral-

ized policy, it is useful to recall that there is also a lengthy discussion on how to efficiently offset

these externalities. Recently, Bucovetsky and Smart (2006) have shown that pragmatically correct-

ing for horizontal fiscal externalities which lead to an inefficiently low tax effort by local jurisdic-

tions may in fact require only a rather simple fiscal equalization grant. Generally, it appears that

possible negative effects on efficiency that are associated with fiscal externalities in competitive

federalism can be dealt with by imposing an appropriate institutional framework for jurisdictional

competition. Even for the issue of economies of scale in the production of public goods, which

may not always be exploited by relatively small jurisdictions, one can argue that voluntary con-

tracts between such polities will eventually solve efficiency problems (Blankart 1996).

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On the other hand, there are a number of unambiguous benefits resulting from fiscal decentrali-

zation. A classical argument is that Leviathan tendencies in government are reduced by the pres-

sures of fiscal competition (Brennan and Buchanan 1980). While this may on first sight appear as

a pure distributive issue between taxpayers and representatives, a reduction of rent-extraction in

government essentially means that the costs per unit of public good are reduced from the per-

spective of the taxpayers. This can result in a smaller distortionary tax burden, or in a larger quan-

tity of productive public goods being supplied, which would also accelerate growth (Aschauer

1989). Having fiscal competition as a mechanism to restrict self-interested representatives may be

particularly useful if formal constitutional rules are difficult to enforce (Schnellenbach 2004). In

this case, federalism can even be thought of as a “market-preserving” institutional framework

(Weingast 1995). Given that mobile factors have the option to leave, it becomes difficult for gov-

ernments to severely intervene into private property rights, and large-scale interventions into the

market process become more unlikely.2

A related and more formal point has been made by Edwards (2005), who models a time-incon-

sistency problem. In his neoclassical growth model, human capital investment drives growth. But

a unitary government cannot commit to low tax rates in the future, and accordingly, the unitary

state is characterized by high taxes, low human capital and low growth. Local governments, how-

ever, are exposed to the threat of out-migration of fiscally expropriated factors. The exit option

helps to solve the time-inconsistency problem, and the decentralized equilibrium is characterized

by low taxes, high investment and high growth rates. Madiès and Ventelou (2004) analyze a Le-

viathan setting, and set up a model which allows them to analyze the trade-off between introduc-

ing vertical fiscal externalities, which result from different levels of government sharing the same

tax base, and having a more targeted supply of public goods (education) on the local level. They

show that under reasonable assumptions, the public good effect over-compensates the inefficien-

cies introduced by the vertical externalities, which yields positive overall growth effects.

An issue that is still very much contested is that of the influence of fiscal federalism and fiscal

competition on corruption. The question is of interest here, because corruption probably exerts a

negative effect on the efficiency of government. If it increases the costs of providing productive

public services, then it is also likely to be associated with negative growth effects. Cai and Treis-

2 Rauscher (2005) assumes a Leviathan government analyzing tax competition in an endogenous growth model

with a productive public input. A taming of Leviathan governments by more intense inter-jurisdictional com-petition induces higher economic growth if the Leviathan’s elasticity of intertemporal substitution, which is also the elasticity of substitution between rents and political support, is not substantially larger than one, i.e., if current and future utility or rents and political support are bad substitutes.

13

man (2004) even go so far as to predict a “state corroding federalism” to be the result of fiscal

competition. According to their model, local governments may decide to shield business located

under their jurisdiction from central-level law enforcement, which effectively erodes the rule of

law. In their case study for China, they argue that local governments also shielded local businesses

from investigations related to corruption. This extends an argument made by Bardhan and

Mookherjee (2000) as well as Blanchard and Shleifer (2001), stating that local governments may

be more easily captured by special interest groups. Martinez-Vazquez and McNab (2003) survey

the literature on this issue more thoroughly. These arguments can, however, be contested on the

grounds that fiscal competition will generally reduce the scope for redistributive special interest

politics, since mobile tax bases can leave when they perceive to be exploited. Furthermore, al-

ready Riker (1964) stated that simple institutions such as a strong national party system may

countervail unfavorable tendencies towards local capture. Again, it is thus possible to compensate

for the problems of federalism by choosing an appropriate institutional framework.

Finally, there is another politico-economic avenue via which federalism may have an impact on

growth, namely that of fostering political innovation. Seeing the relevance of this requires a step

back from the neoclassical standard model, where we got used to have a clear benchmark for an

optimal policy and the question is only under which conditions we can expect the optimal policy

to be executed. In a world with model uncertainty, in which neither the policymaker nor a con-

sulting economist knows the true, underlying model of the economy, the task of the policymaker

is to learn from mistakes and to gradually improve his politics in a long-term process of trial-and-

error. Oates (1990, 1999) has hinted at the fact that federalism may be useful in this respect, by

speaking of “laboratory federalism” – a system where many, parallel small-scale experiments can

be undertaken at the sub-central level. Besley and Case (1995) as well as Salmon (1987) have ar-

gued for the relevance of yardstick competition, a mechanism where voters use political results in

neighboring jurisdictions to assess the ability of their own representative. Blankart (2007) argues

in favor of federalism as a source of political (and other) creativity, and Inman and Rubinfeld

(1997) make the point that the US welfare reform of 1996 was a case of laboratory federalism.

Again, the argument is not uncontested. Rose-Ackerman (1980) argued that information resulting

from political experiments is a pure public good. Given that such experiments are risky, and that

failure may lead to a denial of reelection, sufficiently risk-averse representatives will abstain from

conducting experiments themselves and instead attempt to free-ride. Kotsogiannis and Schwager

(2006) argue that self-interested representatives can even use policy innovations to increase their

scope for extracting rents from office, because voters are uncertain about what could have been

14

achieved with a different policy. As far as free-riding is concerned, Strumpf (2002) shows that the

argument depends on the degree of heterogeneity between regions. As soon as regions become

sufficiently heterogeneous, the learning externality loses relevance, and each region has to expe-

riment to learn about policies being implemented under its specific conditions. Finally, Schnel-

lenbach (2007) shows that for rationally ignorant voters factor migration is necessary to disturb a

given equilibrium distribution of policy-related beliefs in the electorate – changing factor prices as

a result of migration induce collective learning processes that would not occur otherwise.

Only very few papers attempt to incorporate political innovation into growth models. An exam-

ple is Rauscher (2007), who analyzes an endogenous growth model with Leviathan governments.

In this model, tax competition leads to a reduced frequency of political innovation and slower

growth for reasonable parameter values. In a sense, this is a standard tax competition result car-

ried into a dynamic model: Standard tax competition models predict an undersupply of public

goods due to the increased opportunity cost of public funds, and in the model discussed here the

public good is innovation undertaken by the government. The politico-economic arguments that

hint into the opposite direction are neglected in this framework. Maybe even more importantly,

in order to keep the model tractable, Rauscher (2007) assumes that the private capital stock is

constant and that only public capital accumulation drives growth, which is a very unrealistic as-

sumption. Rauscher (2006) allows also for private sector capital accumulation, and reaches the

opposite result: Increased mobility of tax bases now yields an increased frequency of political

innovation and also higher growth rates.

3. The Results of Previous Empirical Work

The survey of the theoretical analyses on the impact of fiscal federalism on economic growth

helps to identify several transmission channels for such a relation. First, a decentralization of

public good provision and its financing allows for a consideration of heterogeneous demand for

public goods, and may thus positively affect economic growth (Heterogeneity Channel). Second,

tax competition between regions restricts Leviathan governments in the exploitation of mobile

tax bases and keeps government interventions at a low scale such that private initiative could fully

display its usefulness for economic development (Market-Preservation Channel). Third, given the

presence of agglomeration economies and knowledge spillovers, regional fiscal policies do not

have much leverage at all. But in particular tax competition is providing for the means to success-

fully attract businesses and adapt to structural change (Structural Change Channel). Fourth, policy

innovation that is induced by fiscal competition may play a role for economic growth in particular

15

in a situation of dynamic structural change when creativity and willingness for experimentation

are necessary (Political Innovation Channel).

The existing empirical evidence does not test these transmission channels explicitly, but addresses

the question from a different perspective. On the one hand, federalism or decentralization may

be favorable for economic development and structural change in a country. Then, a top-down

perspective is adopted, and the question becomes which role the lower level governments per-

form for the economic development of a country. On the other hand, it appears important to

know which type of internal arrangement of a country favors regional development. Thus, a bot-

tom-up perspective is assumed by focusing on lower level jurisdictions, regions and agglomera-

tions. Following such a distinction in cross country and single country studies, it is however pos-

sible to highlight on which transmission channels the empirical studies mainly focus.

3.1 Cross-Country Studies

The majority of the cross country studies interprets fiscal federalism as decentralized organization

of government activities and measures decentralization by the fraction of sub-federal spending

from total government spending. This approach is problematic as theoretical analyses presume

autonomy of sub-federal decision-making on provision and financing of public goods and spend-

ing decentralization might simply indicate the extent of administrative federalism with states,

provinces or cantons providing public services according to federal mandates and financed by the

federal government (Treisman 2002, Rodden 2004, Stegarescu 2005). As long as fiscal transfers

from other jurisdictions are not controlled for, the estimates for spending decentralization may be

biased. Using spending decentralization as a measure for fiscal federalism under these circum-

stances would then mainly allow for testing the Tiebout channel on economic growth.

Given the measurement problems, it is unsurprising that the authors of the cross-country studies

on the impact of federalism on economic development end up with controversial results (see

Table 1). Davoodi and Zou (1998), for instance, find a weakly significant negative correlation

between the degree of fiscal federalism and the average growth rate of GDP per capita for a

sample of 46 countries and the period from 1970 to 1989. This effect is not significant for the

sub-sample of developed countries. The negative influence for developing countries is however

robust, though only weakly significant as well. According to these estimates, an additional decen-

tralization of functions by 10 percent reduces the growth of real GDP per capita in developing

countries by 0.7 – 0.8 percentage points. Woller and Philipps (1998) do not report a robust rela-

tion between economic growth and decentralization, using a sample with a lower number of de-

16

veloping countries and a shorter period. Also, they analyze, in addition to the average growth

rates for five years, the annual growth rates in a panel. Both studies use fixed-effects models. In

contrast to Davoodi and Zou, Woller and Philipps consider a common time trend by including a

trend variable. Iimi (2005) uses the most recent data for 51 countries – average growth between

1997 and 2001 – and applies an instrumental variable technique. Spending decentralization turns

out to be highly significant such that a 10 percent higher decentralization of spending increases

growth of real GDP per capita by 0.6 percentage points.

17

Table 1: Empirical studies on the influence of fiscal decentralization or federalism on eco-nomic growth in cross-country studies

Study Countries Period Method Main results

Davoodi and Zou (1998)

46 Developing and Developed Countries

1970-1989 five and ten year averages

Fixed Effects Model, Time Dummies, Unbalanced Panel

10% higher decentralization of spending reduces growth of real GDP per capita in developing countries by 0.7-0.8%-points (10% significance level)

Woller and Philipps (1998)

23 Developing Coun-tries

1974-1991 three and five year averages and annual data

Fixed Effects Model, OLS

No robust significant effect of the decen-tralization of spending or revenue on growth of real GDP per capita

Yilmaz (2000)

17 Unitary States, 13 Federal Countries, Newly Industrialized Countries and De-veloped Countries

1971-1990 annual data

Fixed Effects Models, Time Dummies, GLS

Decentralization of expenditures at the local level increases growth of real GDP per capita in unitary states more than in federal countries. Decentralization at the regional level is not significant

Ebel and Yilmaz (2002)

6 Transition Coun-tries

1997-1999 Bivariate OLS Decentralization is in general positively related to economic growth

Eller (2004)

22 OECD Countries 1972-1996, annual and four year averages

Fixed Effects, Time Dum-mies

Decentralization is positively related to economic growth

Enikolopov and Zhurav-skaya (2003)

21 Developed and 70 Developing and Transition Countries

Cross-section of the averages 1975-2000

OLS, 2SLS 10% higher decentralization of revenue reduces growth of real GDP per capita in developing countries by 0.14%-points (5% significance level)

Thießen (2003)

21 Developed Coun-tries

Cross-section of the averages of 1973-1998

OLS Decentralization of spending by 10% increases growth of real GDP per capita by 0.15%-points (5% significance level), quadratic term is significantly negative

Thießen (2003a)

26 Developed Coun-tries

Panel data 1981-1995

GLS Decentralization of spending by 10% increases growth of real GDP per capita by 0.12%-points (5% significance level).

Iimi (2005) 51 Developing and Developed Countries

Cross-section of the average of 1997 to 2001

OLS, IV 10% higher decentralization of spending increases growth of real GDP per capita by 0.6%-points (1% significance level)

Feld, Ba-skaran and Dede (2004)

19 OECD countries Panel data 1973-1998

Fixed Effects, Time Dum-mies

No robust effect of spending or revenue decentralization, but a significantly nega-tive effect of stronger participation in revenue sharing arrangements

Bodman and Ford (2006)

18 OECD Countries Cross-section of 1996 and Panel data 1981-1998

OLS No significant effect of revenue or spend-ing decentralization on economic growth

Source: Own compilation.

Additionally considering institutional aspects, Enikolopov and Zhuravskaya (2003) present evi-

dence for average economic growth of the past 25 years in a cross-section of 91 countries that

the effects of fiscal decentralization largely depend on the structure of the party system as well as

18

on the degree of „subordination“ of sub-national levels. According to these results, the age of the

most important political parties is favorable to the positive effects of decentralization on eco-

nomic growth particularly in developing and transition countries. In countries with a – in this

respect – weaker party system a 10 percent higher decentralization of revenue decreases the

growth of real GDP per capita in developing countries by 0.14 percentage points. These results

challenge those by Martinez-Vazquez and McNab (2002) according to which the decentralization

of revenue significantly reduces growth of real GDP per capita of developed countries, but not of

developing and transition countries. Yilmaz (2000) analyses the different effects of fiscal decen-

tralization in 17 unitary and 13 federal states for the period 1971-1990 with annual data. Decen-

tralization of expenditures to the local level increases the growth of real GDP per capita in uni-

tary states more than in federal countries. However, decentralization to the regional level in fed-

eral countries is not significant.

Thießen (2003) analyses, similar to Enikolopov and Zhuravskaya (2003), the average growth rates

of real GDP per capita for a cross-section of 21 developed countries in the period 1973-1998 and

in a companion study (Thießen 2003a) for a panel of 26 countries and the period 1981 to 1995.

According to his estimates a 10% stronger decentralization of expenditures increases the growth

of real GDP per capita by 0.12-0.15%-points in high-income countries. But the relation between

federalism and economic growth might be non-linear as a quadratic term of expenditure decen-

tralization is significantly negative. His results are corroborated by Eller (2004).

Feld, Baskaran and Dede (2004) and Feld (2007) use new data provided by Stegarescu (2005) that

measure the importance of sub-federal tax autonomy by the extent to which sub-central govern-

ments can actually set tax rates or bases. The three decentralization variables, the fraction of sub-

central spending from total spending, the fraction of sub-central revenue from total revenue

stemming from taxes autonomously decided by state and local governments and the fraction of

sub-central revenue from total revenue stemming from revenue sharing systems, do not have a

robust effect on real GDP growth per capita in a panel of 19 OECD countries between 1973 and

1998. While expenditure decentralization is significantly negative in the pooled regressions, it is

not robust to the inclusion of fixed country effects. Employing a two stage method in which the

fixed effects from a first stage regression are explained by fiscal decentralization measures on a

second stage does not yield robust results. These disappointing results are basically supported by

Bodman and Ford (2006) who do however not use modern panel data methods. Although fur-

ther analyses are necessary to test the robustness of these results, the impact of fiscal decentraliza-

tion on economic growth, in particular with respect to the Tiebout channel, remains open.

19

Table 2: Empirical studies on the influence of fiscal decentralization or federalism on eco-nomic growth in China, Russia, Ukraine and India

Study Countries Period Method Main results

Zhang and Zou (1998)

28 Chinese Provinces 1987-1993 Annual Data

Fxed Effect Models without Time Dum-mies

Decentralization of expenditure to the provinces reduces growth of real GDP per capita

Lin and Liu (2000)


Fixed Effect Models, Time Dummies

Revenue decentralization by 10% increases growth of real GDP per capita by 2.7%-points (5% signifi-cance level)

Jin, Qian and Weingast (2005)


Fixed Effect Models, Time Dummies

Expenditure decentralization by 10% increases growth of real GDP per capita by 1.6%-points (10% signifi-cance level)

Qiao, Martinez Vazquez and Yu (2002)

28 Chinese Provinces 1985-1998 2SLS with Pooled Data

Expenditure decentralization in-creases growth of nominal GDP per capita significantly (5% significance level)

Feltenstein and Iwata (2005)

Central Level in China

1952-1996 VAR with Time-series data

Fiscal decentralization has adverse implications for macroeconomic stability but tends to increase growth

Jin and Zou (2005)

30 Chinese Provinces 1979-1999 Fixed Effects with Corrected Standard Errors

Divergence between local expendi-tures and revenue (i.e. centralization) increases growth


29 Chinese Provinces 1987-1993, annual data

OLS, Fixed Effects Decentralization reduces economic growth


16 Indian States 1970-1994 OLS Decentralization increases economic growth

Desai, Freink-man and Gold-berg (2003)

80 Russian Regions 1996-1999 OLS with panel corrected standard errors, 3SLS

Decentralization has a positive but non-linear effect on growth

Naumets (2003) 24 Ukrainian Oblasts and Autonomous Republic of Crimea

1998-2000 Fixed-Effects and Random Effects Models

Not robust negative impact of own revenue decentralization on growth of real gross value added


3.2 Single Country Studies

The empirical results concerning the impact of decentralization on economic growth for individ-

ual countries are no less ambiguous. Analyses have been conducted for China, the Ukraine, India,

Russia, the U.S., Spain, Switzerland and Germany (see Tables 2 and 3). Zhang and Zou (1998,

2001) report a significantly negative effect of expenditure decentralization on economic growth in

28 (29) Chinese provinces, using annual data between 1987 and 1993. Jin, Qian and Weingast

(1999), however, find a weekly significant positive effect of expenditure decentralization on the

economic growth of almost the same sample of Chinese provinces over time. The most impor-

tant difference between the studies – aside the small differences in the explanatory variables used

20

– consists in the fact that Zhang and Zou do not use time dummies. Consequently, the common

positive and negative economic shocks in China are inadequately included as compared to Jin et

al. Qiao, Martinez-Vazquez and Xu (2002) report similarly positive growth results for expenditure

decentralization even without any fixed effects. Lin and Liu (2000) corroborate the result of a

positive impact of decentralization on economic growth in Chinese provinces for the period 1970

to 1993 also for the revenue side. Moreover, a higher responsibility of public budgets at the pro-

vincial level is associated with increased economic growth. These authors, too, use time dummies

in addition to cross-section fixed effects. Jin and Zou (2005) present evidence that a higher diver-

gence between local expenditure and revenue increases growth. The relevance for the estimates

of using time dummies points to the strong economic dynamics in China. The sometimes enor-

mously high Chinese growth rates cannot be exclusively covered by structural variables such that

dummy variables for the individual years are necessary for specifying the model. The fact that

Zhang and Zou neglect them must be interpreted as a mis-specification of the model. Thus, for

China, decentralization of government activity has rather a positive impact on economic growth.

This assessment is corroborated by the time series analysis by Feltenstein and Iwata (2005).

Desai, Freinkman and Goldberg (2003) are in line with the Jin, Qian and Weingast (2005) ap-

proach of focusing on revenue retention in transition countries. For 80 Russian regions between

1996 and 1999, they report a significant positive effect of revenue retention rates on growth of

gross regional products. In addition, a conditional effect of natural resources and budgetary trans-

fers on the relation between retention rates and cumulative output growth occurs. The effect of

retention rates on growth switches from positive to negative when transfers cover more than 45

percent of total revenues, while this effect declines in magnitude, but remains positive when re-

gions become more resource abundant. Similarly, Zhang and Zou (2001) report a positive decen-

tralization effect for India. These results provide some support for the Market Preservation The-

sis. It does however not generally hold for transition countries. Naumets (2003) finds a negative,

though not robust impact of the share of own revenue from consolidated regional revenue on

growth of real gross value added in a panel of 24 Ukrainian regions from 1998 to 2000.

Much the same holds for individual developed countries. Exploring American economic devel-

opment between 1790 and 1840, Wallis (1999) argues that fiscal federalism was an important

institutional precondition that fostered economic growth of the U.S. In a time-series analysis for

the whole of the USA from 1951 to 1992, Xie, Zou and Davoodi (1999) claim that the U.S. find

themselves in a decentralization equilibrium because differences in decentralization at the state

level or at the local level do not have statistically significant effects on real GDP growth. Akai and

21

Sakata (2002), however, offer evidence to the contrary for U.S. states. Taking into account addi-

tional explanatory variables and various indicators for the degree of fiscal federalism, they under-

line the positive influence on economic growth. If expenditure decentralization increases by 10

percent, then the growth of GDP per capita increases by 1.6-3.2 percentage points. However,

decentralization on the revenue side and indicators for fiscal autonomy of sub-national levels,

measured by the share of own revenue in total revenue, do not have any significant impact. Stan-

sel (2005) develops a different approach by testing the impact of local fragmentation on growth

of local real per capita money income. This idea is related to the fragmentation hypothesis by

Brennan and Buchanan (1980) who argue that a higher fragmentation of a polity into different

jurisdictions increases the intensity of inter-jurisdictional competition and thus restricts Leviathan

governments. Hence, Stansel (2005) indirectly supports the Market Preservation Hypothesis.

Table 3: Empirical studies on the influence of fiscal decentralization or federalism on eco-nomic growth in the U.S., Germany, Spain and Switzerland

Study Countries Period Method Main results Xie, Zou and Davoodi (1999)

Central Level in the USA

1951-1992 Time Series Analysis, OLS

No significant impact of expenditure decentralization on growth of real GDP per capita

Akai and Sa-kata (2002)

50 US States 1992-1996, Cross-Section of Aver-age Growth Rates, Panel with Annual Data

OLS and Fixed Ef-fects Model, Time Dummies

Expenditure decentralization by 10% increases growth of GDP per capita by 1.6-3.2%-points (robust 10% significance levels)

Stansel (2005) 314 US Metro-politan Areas

1960-1990 Robust OLS Higher fragmentation is associated with significantly higher growth in (log) real per capita money income

Berthold, Drews and Thode (2001)

16 Laender 1991-1998 Fixed Effect Model without Time Dum-mies

Higher horizontal and vertical grants significantly reduce growth of nomi-nal GDP per capita

Behnisch, Büttner and Stegarescu (2002)

Central Level in Germany

1950-1990 Time Series Analysis Increase of federal share of expendi-ture in total expenditure has positive effect on German productivity growth

Gil-Serrate and Lopez-Laborda (2006)

17 Spanish Autonomous Communities

1984-1995 Fixed and Random Effects, Time trend

Revenue control decentralization has a positive effect on decentralization

Feld, Kirch-gässner, and Schaltegger (2004, 2005)

26 Swiss Can-tons

1980-1998 OLS, 2SLS Tax autonomy and tax competition are not harmful for economic growth


Three studies have also been conducted for Germany. Berthold, Drews and Thode (2001) ana-

lyze the effects of horizontal fiscal equalization between states and of supplementary federal

grants on regional economic development of the 16 Laender in a panel analysis with annual data

from 1991 to 1998. According to their estimates higher grants in horizontal and vertical fiscal

22

relations reduce the growth of nominal GDP per capita of the Laender significantly. However,

these econometric results suffer from severe endogeneity problems as slowly growing Laender

may receive higher grants. Berthold and Fricke (2007) thus update their study for the more recent

years until 2003 and employ an instrumental variable technique. As instruments they use the

GDP level, the unemployment and employment rates, the fraction of people receiving social as-

sistance and further variables. Unfortunately, they do not report tests on the validity of the in-

struments or on over-identification. Their selected list of instrumental variables casts some

doubts on the validity of the instruments however as they appear to be correlated with the de-

pendent variable and would thus not satisfy the orthogonality condition. If the instruments were

valid, this evidence would partly support the Structural Change Thesis as higher grants would

apparently provide incentives to adopt structural change more slowly. Behnisch, Büttner and

Stegarescu (2002) indeed contradict these results as they report a positive effect of increasing

federal activities – measured by the share of expenditure at the federal level – on German growth

of productivity in a time series analysis from 1950 to 1990.

In a study for Switzerland, Feld, Kirchgässner and Schaltegger (2004, 2005) analyze the impact of

tax competition, fragmentation and grants on economic performance more explicitly. Controlling

for expenditure decentralization in a panel of 26 cantons between 1980 and 1998, a higher inten-

sity of tax competition exerts a significantly positive impact on cantonal labor productivity. The

stronger a canton finds itself in tax competition, the higher cantonal economic performance.

Fragmentation of a canton in its communities does not have any robust effect on labor produc-

tivity. The estimation results for vertical matching grants suffer from endogeneity problems and

may thus be biased. The effects of tax competition and fragmentation are however not affected

by the inclusion of grants. Gil-Serrate and Lopez-Laborda (2006) report evidence pointing in the

same direction for Spain. Despite some differences between the studies, the results for the U.S.,

Spain and Switzerland lend some support for a positive effect of competitive federalism on eco-

nomic development. While the U.S. studies unequivocally support the Tiebout Thesis and pro-

vide only indirect support for the Market Preservation Thesis, the Swiss results are rather in line

with the latter. A rigorous analysis of German cooperative federalism is still terribly needed.

4. Quantitative Literature Review

In the next two sections, this literature on decentralization and economic growth is more thor-

oughly discussed in a quantitative review. We start with some descriptive statistics on the studies

that have been hitherto conducted. The database consists of 26 studies, listed in Tables 1 to 3,

23

which provide point estimates on the effect of a measure of decentralization on a measure of

economic growth.

4.1. Descriptive Statistics on Studies

The studies in the data set are heterogeneous in many dimensions. We coded the characteristics

of an estimated model as dummy and continuous variables. There is of course some subjectivity

in classifying idiosyncratic characteristics into distinct groups. For instance, we differentiate coun-

tries into two groups only, developed and developing, and thus classifying Transition countries as

developing countries. Even though this particular classification might be criticized, inherent sub-

jectivity is unavoidable in both meta-analyses and traditional literature reviews. The major advan-

tage of a meta-analysis compared to traditional reviews is that the subjective judgments of the

reviewer can be made explicit.

Figure 1: Subject of Studies

Source: Own calculation.

First, both single country and cross-country studies have been conducted. Within each of the two

groups, studies can be further subdivided according to whether they consider developed or de-

veloping countries. Within the subgroup of single country studies, a further differentiation ac-

cording to the particular country considered is possible. The majority of studies are single country

studies; they number 15 while 11 cross-country studies have been conducted. According to Fig-

ure 1 an equal number (i.e. eleven) of studies consider either developed or developing countries,

only four consider both simultaneously.

24

Table 4 provides cross-tabulations between single- and cross-country studies and studies on de-

veloped and developing countries. Out of the eleven cross-country studies, two are exclusively on

countries from the developing world, five are exclusively on countries from the developed world,

and four consider countries from the developing and the developed world simultaneously. Out of

the fifteen single-country studies, nine cover developing and six developed countries.

Table 4: Cross-Tabulations of Study Type (Single- or Cross-Country) and Study Subject (De-veloped, Developing or Both Types of Countries)

Cross-country

Developing No Yes Total

No 6 9 15 Yes 9 2 11 Total 15 11 26

Developed No Yes Total

No 9 6 15 Yes 6 5 11 Total 15 11 26

Both No Yes Total

No 15 7 22 Yes 0 4 4 Total 15 11 26 Source: Own calculation.

There are eleven studies (two cross-country and nine single-country analyses) which exclusively

focus on developing countries. The majority of these studies (seven) are single-country studies

for China. There are also eleven studies that exclusively focus developed countries. Five of them

are cross-country studies on OECD countries, three have been conducted for the United States,

one for Germany and Switzerland, and three for other countries (see Figure 2).

There is also a large variation on the publication status of the studies in the database. According

to Figure 3, the majority of studies, thirteen, are journal articles. Six studies are described by their

authors as unpublished manuscripts, two as either working or discussion papers, two are masters

or PhD. thesis, and one is a book chapter.

25

Figure 2: Countries Considered in Studies


Figure 3: Publication Status of Studies


4.2. Summary Statistics on Estimated Models

In each of the studies, a number of models are estimated. These regressions result in several

point estimates of the effect of decentralization on economic growth. Since we will focus on

26

these point estimates in the meta-regressions, we provide separate summary statistics for them.

First, according to Figure 4 most of the estimates, about 55%, in our sample derive from journal

articles, about 30% are obtained from unpublished manuscripts, while all other publication types

together contribute about 20% to the meta-analysis.

Figure 4: Publication Status of Models


Table 5 presents cross-tabulations on the point estimates between study type and study subject.

About 50% of estimates derive from cross-country models. The majority of these cross-country

models focus exclusively on developed countries. Out of the 50% of point estimates from single-

country studies, the majority focus on developing countries. Only about 9% of cross-country

models use data from both developed and developing countries simultaneously. According to

Table 5 and Figure 5, there are however significantly more estimates from studies on developed

than on developing economies when taken together.

27

Figure 5: Subject of Estimated Models


Table 5: Cross-Tabulations of Model Type (Single- or Cross-Country) and Model Subject (De-veloped, Developing or Both Types of Countries)

Cross-country

Developing No Yes Total

No 18.4 41.3 59.7 Yes 30.9 9.3 40.3 Total 49.3 50.7 100

Developed No Yes Total

No 30.9 13.9 44.8 Yes 18.4 36.8 55.2 Total 49.3 50.7 100

Both No Yes Total

No 49.3 46.1 95.5 Yes 0 4.5 4.5

Total 49.3 50.7 100 Source: Own calculation.

The point estimates can be further differentiated by the particular models specified. Figure 6 pro-

vides information on whether the dependent variable and the decentralization variable have been

specified in level or log form. A large majority of point estimates originate from models specified

in the level-level form, other specifications are quite rare, and not a single model was estimated

with a specification that facilitates an interpretation of the effect as elasticity.

28

Figure 6: Model Specification


Figure 7: Type of Data


In Figure 7, we collect information on the type of data used. The majority of estimates use panel

data. However, there is also a significant number of estimates deriving from cross-section mod-

els. Time-series models, on the other hand, are quite rare.

29

Table 6: Cross Tabulations Regarding the Use of Fixed Cross-Section and Time-Effects (in %)

Fixed Effects

Time Effects No Yes Total

No 45.9 24.0 69.9 Yes 7.7 22.4 30.1


Figure 8 and Tables 6 and 7 provide further information on the specification of estimated mod-

els. Almost half of the point estimates derive from models where fixed effects for cross-section

units have been included. A smaller number of estimates derive from models where time fixed-

effects are included. About 22.4% of all estimated models use both cross-section and time ef-

fects. About 17% of models take nonlinearities, notably interaction and quadratic terms, into

account. However, none use both simultaneously, i.e. about 10% of models use only quadratic

terms, and about 7% exclusively interaction effects. Only a very small number control for poten-

tial endogeneity (other than that deriving from unobserved heterogeneity for which it is possible

to control by including fixed effects).

Table 7: Cross Tabulations of Nonlinear Terms (in %)

Interaction

Quadratic No Yes Total

No 83.2 6.9 90.1 Yes 9.9 0 9.9


Several measures of decentralization have been used in the literature, for instance expenditure

and revenue shares, the divergence between central and sub-national government spending or

revenue, and the tax autonomy of sub-national governments. Figure 9 provides information on

the relative frequency of these measures in our sample. According to this figure, the expenditure

share of sub-national governments or closely related measures is used as the decentralization vari-

able in about 35% of models, tax autonomy is used in about 25% of models, and each of the

remaining measures, except the weighted average of expenditure and revenue decentralization, is

used in about 10% of all estimated models.

The distribution of the estimated coefficients is depicted in Figure 10, and summary statistics are

provided in Table 8. Since the estimated coefficient is a measure with a dimension, the spread

originating simply due to the use of particular units can be substantial. Therefore, it is not surpris-

ing that the minimum value of the coefficient is -3623 while the maximum is +5391 (see Table 8).

30

In order to maintain some informative content in the histogram, we have excluded 15 extreme

outliers, and included all coefficients with an absolute value of less than 10.

Figure 8: Model Specification


Figure 9: Decentralization Measure


31

According to Figure 10, the estimated coefficients seem to be dispersed around 0, and only a few

estimates exhibit large negative values. The majority of observations has an absolute value smaller

than 2. In generating the histogram, we had to exclude one estimate from Zhang and Zou (2001)

because the coefficient and the t-statistic are mutually inconsistent. Both the t-statistic and the

coefficient from this observation are set to missing, but values of variables that do not indicate

problems are still used for calculating descriptive statistics. Hence, the number of observations in

calculating the mean and standard deviations (including the outliers) of the coefficients in Table 8

is 374 while it is 375 for the remaining variables.

Figure 10: Estimated Coefficients


Figure 11 presents a histogram on the t-statistics. This histogram does not exclude outliers. The

number of observations is nevertheless only 346, i.e. less than the full sample of 375. This is due

to the fact that most authors (except Iimi 2005) do not provide separate t-statistics for nonlinear

terms at their average value. Nor do they provide the variance-covariance matrix of the estimated

coefficients, prohibiting us from calculating them on our own. Therefore, we have to exclude

these point-estimates, in addition to the estimate from Zhang and Zou (2001). The varying num-

ber of observations only affects the descriptive statistics, but not the meta-regressions where ob-

servations are immediately discarded if the value for one variable is missing.

32

Table 8: Summary Statistics of Continuous Variables

Variable N Mean SD Min Max

t-Stat 346 0.158 2.73 -23 22.32

Coefficient 374 15.54 370.06 -3623.8 5391.1

Coefficient without Outliers

359 -0.13 0.83 -8.84 2.43

Control Variables 375 7.42 2.82 1 16

Observations 375 184.73 168.49 14 534


As the histogram on the estimated coefficients, the t-statistic histogram is centered around zero.

However, the spread is larger, and there is a significant number of observations with absolute t-

values larger than 2.

Figure 11: Estimated t-Statistics


In Figure 12, we provide a histogram on the number of control variables other than the constant

or country and time fixed effects. On average, a model has about 7 to 8 controls. However, the

dataset also contains both estimates from bivariate regressions and from models with a more

extensive list of controls. In Figure 13, we depict a histogram on the number of observations

indicating that a large number of models have less than 100 observations. However, there are also

models with more than 300 observations. On average, a study has about 180 observations

33

Figure 12: Number of control variables


Figure 13: Number of observations


5. Meta-Analysis

The aim of a meta-analysis is to explore the true size of an effect and to evaluate its significance.

In the context of decentralization and economic growth, the idea is to pool the estimates from

several studies and to calculate an average effect. Since in economics most studies provide several

34

estimates of the effect, researchers usually choose one out of these, either the estimate preferred

by the original authors (the so called “preferred estimate”), or an estimate according to some rule,

for instance the median estimate (see for example Rose and Stanley 2005). We focus on the mini-

mum, maximum and the median estimate of each study.

There are a number of methods for summarizing results of multiple independent tests. One

widely used method for inquiring whether the accumulated evidence suggests that a significant

effect exists, is Fisher’s combined test (Jarell and Stanley 2004). It uses the fact that the p-values

of individual tests are normally distributed under the null hypothesis of no effect. Since the p-va-

lues are normally distributed, the f-statistic, calculated as the sum of the logarithms of the p val-

ues over L estimated models times minus two, has approximately a - distribution with 2L

degrees of freedom, i.e.

2χ

(1) )2(~ln2 2

1LPf

L

ii χ∑

=

−=

We calculate this statistic for all three sorts of estimates, the minimum, maximum and median

from each of the 26 studies. For the minimum estimates, we obtain an f-value of

, i.e. the null hypothesis of no significant effect is not rejected

at the five-percent level. For the median estimate, we obtain ,

and a clear rejection of the null. For the maximum estimates, we obtain

, and as expected an even clearer rejection of the null than

for the median estimates (see also Table 9). Overall, the results seem to suggest that decentraliza-

tion has in general a significant effect on decentralization.

)46(83.6203.52 295.0min χ=<=f

)48(17.6504.121 295.0χ=>=medf

)48(17.6564.230 295.0max χ=<=f

3

Note that the degrees of freedom vary between the minimum and the two other estimates, and

none are equal to the number of studies. This is due to the fact that some studies do not report

appropriate t-values for several of their estimates even though they report coefficients (see the

discussion in the last section). Without the t-values, we cannot calculate the p-values for these

estimates. By coincidence, these estimates are sometimes the median, maximum or minimum

coefficient. If this is the case, we exclude them.

3 When calculating the p-values, we take the number of “real” controls and the intercept into account in

determining the degrees of freedom. However, we do not conduct a degrees of freedom correction for models with time- or cross-section fixed effects as it does not make any difference asymptotically.

35

Table 9: f-Tests on Significance of Effects

f-Statistic

minT 05.0,03.52min >= pf

medianT 01.0,04.121 <= pfmedian

maxT 01.0,10.64.230max <= pf


Even though the f-tests suggest a significant relationship, this result should be viewed with skep-

ticism since this test has several drawbacks. First, it assumes independence across studies, and

second, that the estimated coefficients are unbiased. We expect some between-study correlation,

for example because authors tend to include controls in their models that have proven to be sig-

nificant in earlier studies. There is also no way in applied econometrics of knowing whether a

model is mis-specified. But biased estimates which seemingly suggest that there is a significant

effect even though there is none tend to have a disproportionate effect on the likelihood of re-

jecting the null. Even worse, the test does not consider the direction of the effect, i.e. a number

of significant positive and negative estimates would lead to a rejection of the null without giving

any indication on whether decentralization actually increases or reduces economic growth (see

Jarell and Stanley 2004. for a more thorough discussion of this test).

In a second step, we thus calculate the weighted average estimate across all studies. Two different

estimators are available, the random effects and the fixed effects estimator. These expressions do

not have the usual meaning in the meta-analytic literature. In the meta-analytic context, these

estimators are differentiated by the fact that they use different weights in calculating the average

estimate.

The fixed effects estimator assumes that all studies estimate a common effect and that differences

in estimated coefficients are only due to sampling errors. Under this assumption, the pooled ef-

fect size is determined according to the following formula:

∑∑

=

== L

ii

L

i iiw

w

TwT

1

1 , (2)

36

where Ti, i=1,..L, are the individual estimates and wi weights that are inversely proportional to the

precision of the estimate. The weights are defined as wi=1/vi with vi as the variance of the esti-

mated effect i.

The random effects estimator assumes that each study estimates a different effect which is ran-

domly drawn from a population of all effects. What is of interest here is the mean of the popula-

tion. Hence, the variability in estimated coefficients has two components, first the within-study

sampling error, and secondly the variance associated with the random effects error. This, in turn,

leads to different weights wi in equation (2). The weights for the random effects estimator are

given by wi=(1/vi)+z, with z as the estimated variance between studies (see Dominicis et al. 2006

or Sutton et al. 2000, for an extensive discussion).

The so called Q-test can be applied in order to explore whether heterogeneity is present among

the estimated coefficient. This test is based on the following statistic

)1(~)( 2

11

12 −−= ∑∑∑

==

= Lw

TwTwQ

L

iL

i i

L

i iiii χ , (3)

where all variables are defined as in (2) and wi are the fixed effects weights.

Table 10: Q-Statistic and Pooled Coefficients

Q-Statistic Pooled Coefficient, Random Effects,

0:0 =wTH

minT 01.0,10.633min <= pQ 01.0,097.0 <−= pTw

medianT 01.0,55.92 <= pQmedian 57.0,001.0 == pTw

maxT 01.0,10.01.596max <= pQ 01.0,128.0 <= pTw


Considering Table 10, the Q-test indicates for all three variants of the coefficients, the median,

the minimum, and the maximum the presence of considerable heterogeneity across studies, i.e.

the random effects estimator is appropriate. Hence, we only display the random effects estimates

in the following, and provide further details on our results in Figures 14, 15 and 16, in particular

on the weights each study received.

37

Figure 14: Pooled Estimate on Tmin


Figure 15: Pooled Estimate on Tmed


38

Figure 16: Pooled Estimate on Tmax


The random effects pooled estimate calculated with the minimum coefficients is -0.097 and sig-

nificantly different from zero, the median estimate is 0.001 and not significantly different from 0,

and the maximum estimate is 0.128 and significantly different from 0. As expected, the pooled

coefficient from the minimum estimates is lower than both the estimate from the median and

maximum estimate. However, the fact that the pooled estimate changes its sign between the

minimum and the maximum estimate makes it difficult to provide a consistent assertion on the

effect of decentralization on economic growth. However, it seems sensible to consider the mini-

mum and maximum estimates as outliers and to focus the median estimate. Based on the median

estimate, decentralization does not have a significant effect on economic growth.

6. Meta-Regressions

6.1. The Meta-Regression Model

In this section, the extent to which idiosyncratic characteristics of an empirical model deter-

mine the magnitude of the estimated effect is studied, i.e. we explore whether the choice of a

particular measure of decentralization, a particular subject of study, or a particular specifica-

tion changes estimated effect. The most widely used technique for explaining heterogeneous

39

findings across models is meta-regressions. The meta-regression approach to decentralization

and economic growth is based on the premise that individual studies estimate models whose

specification roughly resembles the following equation

iiii DECXY νγβ ++= (i=1,…, N) , (4)

where is a measure of economic growth, Y X a vector of control variables including a constant,

a measure of decentralization, the number of observations, and DEC N ν an error that either

conforms to the assumptions of the classical regression model or can be transformed appropri-

ately. By fitting the model to the data by some technique, usually OLS, an estimate of the true

effect of decentralization on economic growth, , is obtained. ∧

γ

This framework suggests that a meta-regression model can explain diverse findings in the original

literature. We propose a meta-regression of the form

(j=1,…,L) , (5) jjj Za εαγ ++=∧

where is the estimated coefficient and a vector of variables which describe the characteris-

tics of the estimated model, and

∧

γ jZ

jε the meta-regression error term.

The variables used in the meta-regression analysis are listed in Table 11. Most of them are

dummy variables, for example indicating whether fixed effects have been included, whether the

study uses only single-country or cross-country data, and if nonlinearities are taken into account.

Some variables are continuous, notably the estimated coefficient, the t-statistic, the standard de-

viation, the number of controls and the sample size. In contrast to the last section, where we

chose one particular estimate per study, we use the information from all estimated models in the

meta-regressions. First, including all observations provides a larger sample leading to several de-

sirable characteristics as more powerful tests and more accurate estimates. And second, with a

quasi-panel dataset, we can control for unobserved study-level heterogeneity. The potential num-

ber of point estimates is therefore 375.

Since the estimated coefficients derive from models that directly or by transformation conform to

the assumptions of the classical linear model, the meta-regression errors should be normally dis-

tributed. There might be, however, a problem with heteroscedasticity. Since the individual models

use different sample sizes, different units and different specifications, the variance of the esti-

40

mates will be related to the characteristics of a study. Indeed, the Breusch-Pagan test rejects the

null of homoscedasticity at conventional significance levels ( ).01.0,37.1525)1(2 <= pχ 4 The

White-test arrives at the same conclusion ( ). Both tests were calcu-

lated using the full set of coefficients in Table 13.

01.0,68.337)104(2 <= pχ

Table 11: Dependent Variables in the Meta-Regressions

Variable Definition Variable Definition

Dummy Variables

JART Journal Article EXPDEC Expenditure Decentralization

WORKP Working Paper REVDEC Revenue Decentralization

DISSP Discussion Paper TAXAUT Tax Autonomy

UNPMAN Unpublished Manuscript REVEXPDEC Rev. + Exp. Decentralization

INBOOK Article in Book OTHERM Other Measure

THESIS Dissertation and Masters Thesis

CONTEND Control for Endogeneity

PUB JART+INBOOK UNPUB WORKP+DISSP+UNPMAN

CCOUNT Cross-Country Study CSEC Cross-Section Dataset

DEVELOPING Developing Country PANEL Panel Dataset

DEVELOPED Developed Country FIXEDEFF Fixed Effects

TIMEEFF Time Fixed Effects QUAD Quadratic Term

INTERAC Interaction Term CHINA Estimate with data from China

USA Estimate with data from USA

GER Estimate with German Data

SWISS Estimate with Data from Switzerland

OTHERC Estimates with Data from countries except USA, SWISS, GER and CHINA

Continuous Variables

YEAR Year of Study COEF Estimated Coefficient

TSTAT t-Statistic NCON Number of Control Variables exclud-ing constants and fixed effects

OBS Number of Observations

4 This particular test was derived by regressing the squared residuals on the fitted values. We did also ex-

periment with regressing the residuals on linear combinations of the explanatory variables. The null was also rejected in this variation of the test. The test is based on pooled OLS estimates.

41

Note: Variables in the meta-regressions and their definitions; not all variables were used in the regressions because several are mutually exclusive and their inclusion would lead to perfect collinearity (for instance the country dum-mies). Consult table 13 for the set of coefficients used in the regressions.

Another problem with using the plain coefficients is that different studies apply different meas-

ures of decentralization and economic growth. They also use different units. The estimated coef-

ficients are not dimensionless and therefore not directly comparable across studies without some

standardization according to the precision of the study. Therefore, as in the last section, we use

the variability of the estimate as a scaling parameter, i.e. instead of the plain coefficient in model

(3) the t-statistic is used as the dependent variable, i.e.

jjj

j Zsd

t ηακγ

++==

∧

(j=1,…L) (6)

The t-statistic is a dimensionless measure that can be compared across different models.5

A RESET test based on the pooled OLS does not indicate that the full model in Table 13 has

omitted variables ( 29.0,26,1)317,3( == pF ). Hence, we record that the functional form of (6)

is probably correct and no omitted variables are present.

However, based on pooled OLS estimators, both the Breusch-Pagan ( )

and the White-test ( ) indicate that model (4) exhibits considerable

heteroscedasticity. This presumption is confirmed by a LR-test for panel level heteroscedasticity

based on a GLS estimate which rejects the null of panel-level homoscedasticity

( ). Hence, we record that any estimator of the coefficients in model

(4) should control for heteroscedasticity.

01.0,04.12)1(2 <= pχ

01.0,69.149)104(2 <= pχ

01.0,70.505)24(2 <= pχ

The Breusch-Pagan LM test does not reject the null of a zero variance in individual effects

( ). Hence, the random effects estimator is not preferred against the pooled

OLS estimator. Since the Wooldridge-test (2002) for autocorrelation in the idiosyncratic errors in

panel data models suggests that the null of no autocorrelation cannot be rejected

( ), we conclude that a pooled GLS estimator which takes account of

32.0,00,1)1(2 == pχ

18.0,956.1)22,1( == pF

2

2

5 It is usually recommended to divide both the left- and the right-hand size with the standard error in order to handle heteroscedasticity. However, the division of both sides by the standard error does not produce ho-mosecdastic errors even though it seemingly reduces the degree of heteroscedasticity. The Breusch-Pagan test still rejects the null ( ), and so does the White-test ( ). Since dividing both sides by the standard error has several drawbacks (for example, the dummy variables are transformed to continuous variables) but seemingly no positive consequences with regard to the heteroscedasticity, we divide only the LHS with the standard error.

1.0,67.3)1( <= pχ01.0,33.329)97( <= pχ

42

the heteroscedasticity is probably the most efficient estimator. Alternatively, the pooled OLS

estimator with a robust variance matrix can be applied.

Next, we need to explore whether there is an endogeneity problem due to unobserved heteroge-

neity. To this end, we compare the consistent fixed-effects estimates to the more efficient GLS

estimates using the Hausman approach. The traditional Hausman test cannot be applied because

the difference variance matrix deriving from our sample is negative semi-definite (presumably

because the assumptions underlying the traditional Hausman test are not valid for our data, in

particular because the errors are heteroscedastic). Instead, we use the robust artificial regression

approach proposed in Wooldridge (2002) which is equivalent to the Hausman test. The test is

obtained by estimating an artificial regression of the following form

, (7) jjjjj PXt ηβαω +++=∩∩∩∩

where and are generally the quasi-demeaned variables and the set of time-varying

fully demeaned data. Since the random effects estimator is not the most efficient estimator, there

is no need to quasi-demean the variables in , instead we use the plain values. The test rejects

the null of no correlation between individual error component and independent variables if the

set of coefficients in the vector

,,∩∩

jjt ω jX∩

jP∩

jX∩

β is statistically significant. We find that the test does reject the

null ( ), i.e. that a fixed effects specification is appropriate. 01.0,28.13)328,17( <= pF

6.2. Results

We present our results in Table 12. Since we have coded most of the study characteristics as

dummy variables, we had to exclude several variables that are mutually exclusive (for example a

study can only be either single- or cross country so that the inclusion of both variables would lead

to perfect collinearity with the intercept). The excluded variables provide the base model, and the

estimated coefficients should be interpreted as deviations. In order to save degrees of freedom,

we merge journal articles and in book publications into the variable PUB and all other publica-

tions except dissertations into UNPUB. We feel that this is feasible because there seems to be no

meaningful difference between working and discussion papers and the like. We provide in Table

12 pooled OLS estimates with robust White-corrected standard errors, GLS estimates, random

effects estimates, and finally fixed effects estimates with robust standard errors. Based on the

tests in the last subsection, we will mainly discuss the GLS and the fixed effects results. Note that

43

the robust pooled OLS and random effects estimates are identical for the full set of coefficients.

The standard errors are different, however.

Table 12: Meta-Regressions

Pooled OLS 1 Pooled OLS 2 RE 1 RE 2 GLS 1 GLS 2 FE 1 FE 2

b/se b/se b/se b/se b/se b/se b/se b/seYEAR

0.243*** 0.273*** 0.323*** 0.273*** 0.150*** 0.233*** (0.073) (0.081) (0.118) (0.083) (0.046) (0.045)

PUB

0.525 1.735 1.211 1.735** -0.608 1.188***(0.647) (1.166) (1.077) (0.831) (0.378) (0.372)

UNPUB

0.764 1.992** 1.713 1.992** -0.005 0.019(0.665) (0.922) (1.044) (0.803) (0.385) (0.412)

CROSSC

-0.915* -2.332* -1.169* -2.332** -0.682*** -1.578***(0.489) (1.301) (0.709) (0.939) (0.256) (0.389)

DEVELOPING

-0.262 0.566 0.673 0.566 0.355 0.616 0.539*** 0.490***(0.674) (1.054) (0.887) (0.880) (0.423) (0.458) (0.142) (0.119)

DEVELOPED

0.157 0.385 0.377 0.385 1.306*** 1.937*** 2.510*** 2.450***(0.681) (1.232) (0.847) (0.861) (0.386) (0.460) (0.271) (0.237)

DIV

0.297 -0.201 -0.546 -0.201 0.446 0.334 0.942** 0.811*(0.484) (0.902) (1.063) (0.845) (0.418) (0.372) (0.440) (0.444)

EXPDEC

0.840* 0.259 0.774 0.259 0.780** 0.388 0.245 0.175(0.458) (0.403) (0.601) (0.623) (0.315) (0.244) (0.411) (0.414)

REVEXPDEC

1.244* 0.709 0.626 0.709 0.554 0.552 -0.496 -0.450(0.641) (0.543) (1.300) (1.324) (0.460) (0.349) (0.526) (0.533)

TAXAUT

-0.701 -1.042 -1.034 -1.042 -1.021*** -0.694*** -2.992*** -2.916***(0.815) (0.867) (0.718) (0.734) (0.322) (0.265) (0.687) (0.676)

OTHER

1.249 1.106 -1.063 1.106 3.068*** 3.576*** -23.143** -23.067**(1.246) (1.560) (1.012) (0.885) (0.492) (0.462) (9.758)

(9.806) LOGLEV

-2.887 -3.321* -1.210 -3.321** -5.374*** -6.015***(1.875) (1.929) (1.726) (1.335) (0.905) (0.893)

LEVELLOG

0.686 1.096 0.634 1.096 0.307 -0.060 0.055 0.075(0.493) (1.185) (1.180) (0.999) (0.413) (0.490) (0.209) (0.209)

CROSS

0.988** 0.688 0.756 0.688 1.830*** 1.121*** 1.566 0.647(0.419) (0.500) (0.815) (0.567) (0.258) (0.225) (1.060) (1.082)

PANEL

-0.273 -0.530 -0.630 -0.530 -0.158 -0.460 0.047 -0.709(0.614) (0.636) (0.811) (0.747) (0.344) (0.310) (0.699) (0.656)

Pooled OLS 1 Pooled OLS 2 RE 1 RE 2 GLS 1 GLS 2 FE 1 FE 2

45

b/se b/se b/se b/se b/se b/se b/se b/seFIXED

-0.526 0.157 -0.172 0.157 -0.155 0.348 -0.321 0.554(0.360) (0.615) (0.493) (0.503) (0.256) (0.226) (0.456) (0.401)

TIME

-0.226 0.221 -0.036 0.221 -1.298*** -1.036*** -0.575 -0.325(0.539) (0.590) (0.606) (0.561) (0.274) (0.293) (0.612) (0.548)

OBS

0.004** 0.004** 0.004** 0.004*** 0.004*** 0.004*** 0.004*** 0.003**(0.002) (0.002) (0.002) (0.001) (0.001) (0.001) (0.001) (0.001)

NUMC

-0.142 -0.134 -0.145* -0.134* -0.050 -0.049 -0.082 -0.009(0.101) (0.086) (0.082) (0.079) (0.038) (0.034) (0.056) (0.054)

QUAD 1.198** 1.198** 0.470 0.484(0.567) (0.587) (0.358) (0.474)

INTERACT

3.275*** 3.275 2.774** 0.731***(1.103) (2.026) (1.335) (0.228)

CHINA

-2.727*** -2.727*** -2.907*** -4.232***(0.452) (0.683) (0.290) (0.508)

USA -0.572 -0.572 -1.478*** (2.432) (1.180) (0.534)

SWISS -2.558 -2.558 -0.678(1.579) (1.702) (0.630)

GER 0.425 0.425 1.425*** (0.872) (1.507) (0.482)

CONST -487.134*** -547.193*** -646.104*** -547.193*** -301.653***

-467.100*** 1.924 2.800*(147.213) (161.611) (237.406) (166.317) (91.666) (90.155) (1.529) (1.529)

N 346 346 346 346 346 346 346 346F

11.293 25.861 10.328 20.9382χ 36.17 89.93 547.89 970.93

R2 0.108 0.158 0.5057 0.5313Note: The dependent variable is the t-statistic. We discard 29 Observations, 28 due to the fact that the original papers did not provide separate t-statistics for interaction terms at the sample averages. One paper reports an estimated model with inconsistent coefficients and t-statistics. The original number of Observations is 375. Standard Errors are in Parenthesis. Stars indicate significance at the 10%(*), 5%(**) and 1%(***) level.

First, all estimators which can estimate within-study constant variables suggest that there is a

positive and significant time trend in the reported t-statistic, i.e. the coefficient for YEAR varies

between 0.150 and 0.323 and is significant. Both published and unpublished papers tend to re-

port higher t-statistics than dissertations and masters thesis which we use as base. This effect is

particularly strong for published studies which have a highly significant coefficient in the GLS

estimation. With regard to the study-type, we use single-country studies as base. We find that

cross-country studies tend to report significantly lower t-statistic than single-country studies.

With regard to the model specification, we use level-level models as base. We find that log-level

models report significantly lower coefficients than the base model.

Second, with regard to variables that vary between studies we find that both the fixed effects and

GLS estimates suggest that studies which consider either exclusively developing or developed

countries tend to report higher t-statistics than studies which use data on both kinds of countries

simultaneously. However, the spread is larger for studies on developed countries, suggesting that

decentralization tends to increase growth more in developed than in developing countries.

With regard to the effect of the decentralization measures, we use revenue decentralization as the

base. Both the fixed effects and the GLS estimator suggest that models that use the divergence

between the central and sub-national government revenue as decentralization measure tend to

report higher t-statistics than those which use revenue decentralization. Models that use expendi-

ture or a pooled measure of expenditure and revenue decentralization do not report a t-statistic

that is significantly different from that of the base. Both the fixed effects and GLS estimators

suggest that models which use tax autonomy report significantly lower t-statistics. The results for

models that use other measures of decentralization are a little ambiguous. Whilst the GLS estima-

tor suggests a positive effect, the fixed effects estimator suggests a negative effect. Overall, it is

thus also not decided whether the use of some measure of tax autonomy or tax competition in-

duces significantly higher or lower t-statistics.

With regard to the type of data used, the time-series characteristic serves as base. We find that

cross-section models tend to report on average higher t-statistics than the base while panel-data

models tend to report lower t-statistics. Models which use cross-section fixed effects tend to re-

port higher t-statistics while models which use time-series fixed effects report lower t-statistics.

Trivially, the number of observations is in all models positively and significantly related to the

reported t-statistic while the number of controls is negatively related. Models which take nonlin-

earities into account report larger t-statistics. Finally, single country studies on China report sig-

47

nificantly lower t-statistics than studies on other countries, which we use as base. So do studies

on the USA and Switzerland. Studies on Germany tend to report larger t-statistics.

7. Concluding Remarks

Our review of theoretical and empirical studies and the meta-analysis of the estimation results

conducted so far reveals an interesting, though still preliminary outcome. With respect to the

theoretical studies, it is possible to derive arguments as to how fiscal federalism, decentralization

or fiscal competition might affect economic growth which are related to microeconomic analyses

from the theory of fiscal federalism. First, an advantage of decentralized provision and financing

of public goods, namely tailoring them to heterogeneous preferences of individuals, shows up in

economic growth as resulting different savings rates might affect the transition to a steady state

(Tiebout channel). Second, and more importantly, decentralization allows designing regional eco-

nomic policies to the necessities of a regional economy, and thus increases growth (Structural

Change channel). If this is accompanied by sub-federal experimentation, an argument could,

third, be made that political innovation serves as another growth enhancing mechanism (Political

Innovation channel). Finally, to the extent to which fiscal federalism actually contributes to solve

political economy problems, there might as well be another way how economic growth is en-

hanced (Market-Preservation channel). It should be noted, however, that the theoretical literature

on federalism and growth is still in its beginning. Moreover, a growth-enhancing or decreasing

effect of federalism (or more precisely fiscal competition) in many cases heavily depends on par-

ticular assumptions. It is therefore still open which transmission channel is the most persuasive

one if there is an effect on economic growth at all.

Empirical studies do also not provide strong support for an impact of federalism, decentraliza-

tion or fiscal competition on economic growth. Overall, the empirical evidence is rather incon-

clusive whether there is an effect at all. The studies also suffer from the fact that often the auton-

omy of sub-federal jurisdictions is not properly measured. Moreover, the current study design

does not allow identifying particular transmission channels of the impact of fiscal federalism on

economic growth. In our survey on the empirical literature, we report a tendency in the studies

that there is a mild positive effect of fiscal federalism when it is properly measured as a type of

competitive government. This interpretation is only partly supported by the meta-analysis. While

Fisher’s combined test indicates a significant effect of fiscal federalism or decentralization on

economic growth, a more differentiated test strategy, including the Q-test, leaves us with no sig-

nificant impact on economic growth at the median.

48

The meta-regressions shed more light on which study characteristics tend towards support for a

positive impact of fiscal federalism on economic growth. Most importantly, such a relationship is

rather to be expected in developed, industrialized countries lending support to the suspicion that

fiscal federalism or fiscal decentralization is having much different effects in less developed than

in developed countries. In addition, single country studies tend to indicate a positive effect of

federalism on growth which may be the result of their possibility to consider the specific differ-

ences within a country more strongly. Finally, while it remains undecided how a switch from ex-

penditure centralization measures to tax autonomy indicators affects the results in favor of fiscal

federalism or not, it may be useful to consider the single institutions of a country’s fiscal federal-

ism in order to identify their effect.

Future research will thus need to come up with a clearer identification strategy to detect the

transmission channels by which fiscal federalism affects growth. Future empirical strategies will

consist in a further differentiation as to what federalism or decentralization actually means.

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