How Government Cares for Urban Economic Growth: the Impact of Different Fiscal Grant Schedules in the German Federal States on the Development of Urban Areas

In recent years, in the public discussion on (regional) economic policy, the importance of urban districts or cities for regional and for national economic growth has been strongly emphasized. It is an usual assumption that agglomeration economies may be found inside urban areas. For making best use of agglomeration economies, there have been proposals for changing the traditional scheme of regional policy from an orientation on "interregional equalization“ and "aid" for the regions lagging behind“ towards support for the strongest“ and "stimulating economic growth conditions in urban areas“. The paper has the intention to bring more light into the question how a country’s government could efficiently support the economic conditions in larger cities or urban areas. There are of course several instruments for this. One quite common instrument in most countries are the Systems for Local Fiscal Equalization (LFE), by which the national (federal) government or the states (within federations) are allocating different categories of grants in aid to the local level of government. As the LFE-systems differ strongly not only between different countries, but also between the states within a country, it seems necessary to focus on some countries or even on some states within a country. As a first approach to analyse the existing LFE-rules, this paper is concentrating on the conditions in six selected German states. For this sample, the paper is analyzing the current fiscal position of urban areas within the federal states (or Lander) of Germany and is trying to give some first answers to the following questions: Do some states care more than other states for urban areas? What is the institutional setting for spending state money for urban areas: Are the grants per capita higher for the more agglomerated urban areas? Have the grants the potential to stimulate urban growth – or are they supporting public functions without positive impacts on the economy? How are the urban centres compensated for their function as central places? The analysis is done on the basis of the states‘ rules on LFE, in the sense of an ex-ante evaluation of these rules, by classifying the rules according to their incidence (in favor or against urban centers). It is shown that there are quite different ways for a state to allocate grants in favour of the cities. There is an enormous lack of transparency in the LFE-systems of all states in the sample. The impression is that the LFE-rules are not trying, so far, to support the cities and their economic performance consistently. In some states, shrinking cities and cities with special problems (e. g. with a high number of welfare recipients) could be to some extent even in a better fiscal position than cities with economic growth and growth potentials.