Fiscal Decentralization and Structural versus Cyclical Unemployment Levels

The literature on fiscal federalism has long debated whether fiscally decentralized countries are inherently more economically and fiscally unstable. This paper contributes to this literature by analyzing the impact of fiscal decentralization on one of the most important dimensions of macroeconomic stability, the unemployment level. This is the first study in the literature to address the relationship between fiscal decentralization and unemployment rate at the country level, especially using the decomposition between its structural and cyclical components. The fundamental relationship is explored empirically by using an instrumental variable approach on a panel of 52 countries between 1991 and 2012. The main result is that more fiscally decentralized countries in general tend to experience lower unemployment rates. We also find, as theoretically anticipated, that the impact of fiscal decentralization is mostly on structural unemployment compared to cyclical unemployment. The results are robust to alternative specifications.