Does fiscal decentralization lead to more efficient governance, better public goods, and higher economic growth? This paper tests hypotheses posed by theoretical literature that the results of decentralization depend on features of political institutions. Using data from up to 95 countries for 25 years, we show that the effect of decentralization on economic growth, quality of government, and public goods provision strongly depends on two aspects of political centralization: 1) strength of national party system (measured by the age of the main parties and fractionalization of the government parties) and 2) subordination (whether local and state executives are appointed or elected). We find solid support for Riker’s theory (1964) in developing countries: Strong parties significantly improve the results of fiscal decentralization in terms of economic growth, quality of government, and public goods provision. There is also some evidence that subordination of local to higher-level governments improves the effect of decentralization on growth and public goods provision (in developed and developing countries) and government quality (in developing countries).
Modern economic literature has little doubt that economic decentralization affects the quality of government, economic growth, and efficiency of public goods provision. The effect of decentralization depends on political and economic incentives of local public officials. Economic incentives that help to align politicians’ private interests with public goals are provided by such mechanisms as interjurisdictional competition (Tiebout, 1956; Qian and Roland, 1998; Maskin, Qian, and Xu, 1999) and fiscal autonomy (Jin et al., 1999; Qian and Weingast, 1997; and Zhuravskaya, 2000). Political incentives, i.e., local governments’ accountability, are provided by political institutions which ensure that careers of local politicians depend on whether they pursue efficient policies. In the absence of accountability, strong economic incentives at the local level may result in corruption, provincial protectionism, and capture by vested interests (Tanzi, 1996; Sonin, 2003).