Decentralization has been promoted as a means to achieve greater economic efficiency and growth. Most of the literature has been concerned with fiscal decentralization rather than political and administrative decentralization. These other types of decentralization can play an important role in shaping policies, the provision of public goods and services and economic outcomes. The interaction between different types of decentralization is also likely to influence the results of these efforts.

Theoretical Overview

Proponents of decentralization claim that there is a, “positive impact of granting greater financial autonomy or transferring resources to subnational tiers of government for both allocative and production efficiency and, eventually, economic growth.”

These are theoretical mechanisms through which devolution may lead to economic growth:

• Devolving authority to subnational authorities causes them to mobilize additional resources rather than waiting for top down service provision.
•  ‘Fiscal Decentralization’ theorem: by being in closer contact with the citizens that they serve, local governments can use informational advantages to tailor the provision of public goods and services to the needs of local citizens.
• Decentralization can help to avoid costs if there are diseconomies of scale (i.e. larger is more expensive on a per capita basis).
• Fiscal decentralization could increase participation, transparency and accountability in policy-making which generate institutions (greater trust, interaction and networking), and lower transaction costs.

Decentralization carries several theoretical risks that can negatively impact economic growth:

• Many basic needs and services are universal and do not differ greatly from one region to another so the central government may be better at supplying these goods.
• Capacity constraints may limit the potential of subnational governments to benefit from fiscal autonomy.
• Some areas may lack adequate expertise and human resources to put in place viable policies and strategies, and serve the specific needs of their citizens.
• Higher salaries and the possibilities for promotion can give central governments an edge in talent, capacity and efficiency in administration.

The question of whether the positive or the negative economic effects dominate is an empirical one that until this point has led to very diverse conclusions.

Empirical Research and Results

The authors use the subnational share in total government expenditure and the subnational share in total government revenue as their primary measure of fiscal decentralization. They use OECD Data from 1990-2005. Basic statistics indicate that the most fiscally decentralized countries are Switzerland, Germany and Canada, while Portugal, Luxembourg and the UK are the most centralized. Most of the countries experienced an increase in fiscal decentralization between 1990 and 2005, which is consistent with the trend observed worldwide since the late 1970s. Of the 21 countries in the sample, 6 had a relative reduction in subnational expenditure and seven countries experienced a contraction in the relative weight of subnational revenue. Fiscal decentralization is negatively correlated with economic growth in OECD countries between 1990 and 2005.

To test this relationship further, Rodriguez et al. perform a number of regressions using economic growth as their dependent variable and various measures of fiscal and political decentralization as their independent variables. Their results confirm that there is typically an inverse relationship between economic growth and decentralization. Their results are also consistent with their suggestion that, “processes of decentralization are not limited to the transfer of resources to subnational tiers of government (fiscal decentralization), but also include varying degrees of transfers of powers (political decentralization) and the granting of autonomy to subcentral entities relative to central government (administrative decentralization).” There is often a mismatch between the types of decentralization. Overall, for OECD countries, the potential economic benefits of fiscal decentralization are outweighed by the negative risks of transferring resources to subnational government.