Decentralization and Political Institutions

Does fiscal decentralization result in more efficient governance and higher economic growth? This Paper empirically tests the hypothesis posed by theoretical literature that the effect of economic decentralization depends on features of the political institutions. Using data from 95 countries for the last 25 years, we show that the effect of decentralization on economic growth, quality of government, and public goods provision strongly depends on the following two aspects of political centralization: 1) weakness/strength of the party system (measured by fractionalization of parliament and age of main parties); and 2) subordination (whether local- and province-level executives are appointed or elected). We find solid support for Riker’s theory (1964). Strong parties in developing and transition countries significantly improve the results of fiscal decentralization for economic growth, quality of government, and public goods provision. In addition, subordination of local authorities to higher-level governments improves the effect of decentralization on growth and government quality, while its effect on public goods provision depends on the particular type of public good considered.