Fiscal decentralization and its effects on macroeconomic performance

Abstract

Decentralization has become an important policy issue in recent years. International organizations allocate more space for fiscal decentralization in their agenda. In the literature, there are vast amount of studies that concentrate on the advantages or disadvantages of fiscal decentralization. The literature suggested that with a good policy design of the fiscal decentralization, especially developing countries might achieve desired outcomes. In contrast, poorly designed fiscal decentralization may lead to a variety of undesirable outcomes, such as macroeconomic imbalances, low growth and corruption. In this study, using a panel data of up to fifty-nine countries and year’s range 1972 to 2000, we empirically investigate whether there is any evidence for the effect of fiscal decentralization on inflation, budget deficits and growth. The general conclusion of our empirical work is that developing countries may reduce inflation with enhancement of fiscal decentralization, provided that the size of government expenditures is not large. But our results are not robust for budget deficit and growth. Besides, the association of fiscal decentralization and macroeconomic performance indicators is not statistically significant in developed countries.