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Identifying and Disentangling the Impact of Fiscal Decentralization on Economic Growth

Author

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  • Canavire-Bacarreza, Gustavo
  • Martínez-Vázquez, Jorge
  • Yedgenov, Bauyrzhan

Abstract

This paper revisits the relationship between fiscal decentralization and economic growth by addressing the endogeneity issue stemming from reverse causality and unobserved factors that has plagued previous extensive literature on this subject. In our approach, we use the Geographic Fragmentation Index (GFI) and country size as instrumental variables, which we argue are strong and consistent instruments for fiscal decentralization. Empirically, we find that indeed both instruments are strong and valid in the first stage of estimation and that on average, a 10 percent increase in subnational expenditure or revenue shares—the conventional measures of decentralization—will increase GDP per capita growth by approximately 0.4 percentage points; however, the results differ for developed versus developing countries.

Suggested Citation

  • Canavire-Bacarreza, Gustavo & Martínez-Vázquez, Jorge & Yedgenov, Bauyrzhan, 2019. "Identifying and Disentangling the Impact of Fiscal Decentralization on Economic Growth," IDB Publications (Working Papers) 9877, Inter-American Development Bank.
    • Handle: RePEc:idb:brikps:9877
    DOI: http://dx.doi.org/10.18235/0001899
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    Keywords

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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism
    • O47 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Empirical Studies of Economic Growth; Aggregate Productivity; Cross-Country Output Convergence

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