Does decentralization of governance promote urban diversity? Evidence from Spain

The worldwide trend to decentralize the responsibilities and budgets of governments impacts local firm dynamics in various ways. We use the example of Spain to test empirically whether the decentralization of governance has been conducive to increased diversification and a more even city-size distribution in the Spanish urban system during a period of continuous reductions in transport costs. To this end we develop a bivariate probit regression framework to assess the probability that cities diversify or specialize over time, using a sample of 69 urban areas in Spain during the period 1995-2007. We exploit unique firm-level and time-varying transport-cost data to control for the role of a city's market potential, city size, transport costs, labor-force skill composition, product standardization and historical patterns of specialization. We find a high probability that a city will diversify if it is the capital of a regional government or located in a relatively decentralized region, while the opposite is true for the probability that a city will specialize. Also, we find that a city's status as a regional capital reinforces the positive effect of a high (low) internal market potential on the probability of diversification (specialization). A high (low) external market potential only increases the probability that a city will become specialized (diversified) if it is a regional capital. We argue that the link between decentralization and specialization patterns in the urban system deserves more attention in the empirical literature on decentralization's impact on economic growth, income inequality and regional disparities.