Fiscal decentralization in Eastern Europe: a twenty-year perspective

The paper attempts to provide an overview of the fiscal decentralization process in emerging market economies in Eastern Europe in the last 20 years. Using methodology developed by Vo (2009), the paper assesses the degree of fiscal decentralization in the region. Conceptually, the measurement of fiscal decentralization focuses on fiscal autonomy and the fiscal importance of subnational governments. The empirical analysis reveals that according to our definition of fiscal decentralization the highest level of (average) fiscal decentralization (centralization) is found in Russia (Armenia) among non-EU members and in Estonia (Slovak Republic) among EU members of the Eastern European. In addition, the empirical results show that, in general, the degree of fiscal decentralization is higher in developed OECD countries than in most Eastern European countries (EECs). However, in contrast to our expectations, there has been an alarming downward trend of FDI in most of the region over the last two decades. Moreover, the paper also examines the effects of fiscal decentralization on growth and public sector size in EECs. The analysis provides some evidence that increases in public sector decentralization are associated with higher income levels. However, the growth-enhancing effects of fiscal decentralization are expected to be much greater when supported by a sound institutional environment. Therefore, EECs, in particular non-EU member states, should improve their administrative and technical capability in order to establish sound and effective fiscal decentralization. Finally, our results suggest that fiscal decentralization in EECs generally leads to an increase in the size of government, albeit there are some significant differences between EU and non-EU member states.