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Growth and Equity Tradeoff in Decentralization Policy: China's Experience

The paper uses China's recent experience to investigate the potential tradeoff between economic growth and regional equity in the design of fiscal decentralization policy. Although present in other countries, this policy tradeoff has been particularly relevant to China over the last two decades. We build a theoretical model of fiscal decentralization, where overall national economic growth and equity in the regional distribution of fiscal resources are the two objectives pursued by a benevolent policy maker. Solutions that emphasize regional equity tend to have larger central government expenditures and higher contribution to the central budget by the richer jurisdictions. The reverse is true for solutions emphasizing growth. The model is tested using panel data for 1985-98. We find that fiscal decentralization in China led to economic growth, but this relationship was non-linear. Decentralization also led to significant increases in regional inequality. Overall, the historical record shows that pushing for a more equitable distribution of fiscal resources across provinces in China is likely to lead to lower national economic growth. The tradeoff between economic growth and regional equity is the most important and difficult decision in intergovernmental fiscal reform currently facing the Chinese authorities.

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Paper provided by International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University in its series International Center for Public Policy Working Paper Series, at AYSPS, GSU with number paper0216.

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Length: 42 pages
Date of creation: 01 Jul 2002
Date of revision:
Handle: RePEc:ays:ispwps:paper0216
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  1. Benabou, R., 1996. "Inequality and Growth," Working Papers 96-22, C.V. Starr Center for Applied Economics, New York University.
  2. Barro, R.J., 1988. "Government Spending In A Simple Model Of Endogenous Growth," RCER Working Papers 130, University of Rochester - Center for Economic Research (RCER).
  3. Shantayanan Devarajan & Vinaya Swaroop & Heng-fu Zou, 1996. "The composition of public expenditure and economic growth," CEMA Working Papers 77, China Economics and Management Academy, Central University of Finance and Economics.
  4. Tao Zhang & Heng-fu Zou, 2001. "Fiscal decentralization, public spending, and economic growth in China," CEMA Working Papers 58, China Economics and Management Academy, Central University of Finance and Economics.
  5. Yingyi Qian & Barry R. Weingast, 1997. "Federalism as a Commitment to Reserving Market Incentives," Journal of Economic Perspectives, American Economic Association, vol. 11(4), pages 83-92, Fall.
  6. Paul M Romer, 1999. "Increasing Returns and Long-Run Growth," Levine's Working Paper Archive 2232, David K. Levine.
  7. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
  8. Hofman, Bert, 1993. "An analysis of Chinese fiscal data over the reform period," China Economic Review, Elsevier, vol. 4(2), pages 213-230.
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