This document discusses the relationship between fiscal decentralization and inclusive growth. It outlines several channels through which decentralization can potentially impact economic growth and productivity, both positively and negatively. The document then presents results from empirical analysis showing that tax revenue decentralization is generally good for growth, while the effects of spending decentralization depend on government size. When globalization is accounted for, the impacts of decentralization on both growth and inequality become more heterogeneous across countries. Overall, the results suggest decentralization tends to be better for growth than equity, and the optimal approach depends on country-specific circumstances.

1. Fiscal decentralisation
and inclusive growth
Sean M. Dougherty
Senior Advisor to the OECD Fiscal Network
July 2018

2. Overview
• The OECD context of decentralisation
• Channels to affect productivity
• Empirical analysis of growth effects
• Main results
• Addition of equity and globalisation
2

3. Channels to affect growth and productivity
3
Intergovernmental fiscal frameworks
Economic activity
Total factor
productivity
Private investment
and capital
Human capital
Government
spending
Public investment
Taxation
Other publicly-
provided services

4. Mechanisms (I)
Decentralisation can be conducive to growth
• Inter-jurisdictional competition and public sector
efficiency:
• Boost competition for mobile production factors (Tiebout, 1956).
• Help to compete against the gravitational pull of agglomerations
(Baldwin and Krugman, 2004).
• Political economy and the preservation of markets:
• May restrain the power of special interests and reduce subsidies
(Besley and Coate, 2003)
• Reduce regulation and preserve open markets (Weingast, 1995)
• Foster encourage policy innovation and yardstick competition,
(Besley and Case, 1995)
4

5. Mechanisms (II)
Decentralisation can be harmful for growth
• Economies of scale and scope:
– lack of scale may increase the cost of public services (Spolaore, 2015)
• Spending and tax externalities:
– externalities may induce an undersupply of public goods (Zodrow and
Mieszkowski, 1986)
– can distort the tax structure and lead to excessively low sub-national
tax rates (Wildasin, 1989)
5

6. • Set-up for examining the growth impact
– Based on Barro-type regression:
– Measuring impact on both GDP level and
growth with country and/or year fixed effects
– Cyclically-adjusted per capita GDP
– Estimated over a 20-year period
Empirical estimate of the effect on growth

7. - Tax revenue decentralisation is good for growth.
Spending decentralisation has weaker effect,
except in large governments where it is beneficial
- Effect is moderate: 10 percentage point increase in
the sub-central tax share is associated with 2%
higher GDP per capita
- Intergovernmental transfers tend to be
detrimental to growth
- Balanced/coherent decentralisation is conducive
to growth
- Unitary countries would gain most from tax
decentralisation, while federal countries would
gain from tackling the sub-central spending side
77
Main results

8. Government size is a key channel
8
Expenditure decentralisation Revenue decentralisation
Source: Blochlinger and Akgun (2018)

9. Government size and globalisation
• Why globalisation?
– Dani Rodrik (JPE, 1998): government size and
openness interact, as a larger government size
helps to offset risks (i.e. terms-of-trade shocks)
– Alberto Alesina (early 2000s): gov’t size and
openness interact, with decentralisation
addressing greater heterogeneity of preferences
– Much less work looking at globalisation and
fiscal decentralisation, especially as they affect
inclusive growth
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10. Globalisation changes the picture
10
Central and local government spending responds to
globalisation (openness) in opposite ways
Source: Dougherty and Akgun (2018)

11. • Interacting globalisation and gov’t size:
– Use decile ratios to measure income inequality
– Endogeneity addressed by use of two-stage
least squares
– Differences-in-differences type of approach
Examine marginal effects of centralisation/
decentralisation on growth & inequality
Linking to Inclusive Growth (via inequality)

12. Heterogeneous effects of decentralisation (I)
12
Marginal effects of spending decentralisation on growth
Trade Openness 0.013*** 0.013***
(0.0031) (0.0030)
Government Size -0.027 -0.029
(0.023) (0.023)
T. Open. x Gov. Size -0.043*** -0.034**
(0.015) (0.015)
Exp. Dec. -0.058** -0.079**
(0.028) (0.034)
Intergov. Trans. 0.020
(0.052)
T. Open. x Exp. Dec. 0.092*** 0.11***
(0.024) (0.035)
T. Open. x Intergov. Trans. -0.033
(0.070)
Gov. Size x Exp. Dec. 0.20* 0.50***
(0.11) (0.16)
Gov. Size. x Intergov. Trans. -0.72***
(0.24)
Observations 545 545
R-squared 0.404 0.425
Source: Dougherty and Akgun (2018)

13. Heterogeneous effects of decentralisation (II)
13
Marginal effects of revenue decentralisation on growth
Trade Openness 0.013*** 0.012***
(0.0036) (0.0033)
Government Size -0.039 -0.047*
(0.024) (0.025)
T. Open. x Gov. Size -0.065** -0.062**
(0.029) (0.030)
Rev. Dec. -0.013
(0.048)
Tax Dec. -0.10**
(0.049)
User Fees 0.054
(0.093)
T. Open. x Rev. Dec. 0.13***
(0.033)
T. Open. x Tax Dec. 0.044
(0.051)
T. Open. x User Fees 0.28***
(0.10)
Gov. Size x Rev. Dec. 0.30
(0.25)
Gov. Size. x Tax Dec. 1.01**
(0.43)
Gov. Size x User Fees -1.14
(0.80)
Observations 545 543
R-squared 0.385 0.413

14. Marginal effect of globalisation on growth
14
Expenditure decentralisation Revenue decentralisation

15. Marginal effect of globalisation on inequality
15
Index of globalisation Index of globalisation
Expenditure decentralisation Revenue decentralisation

16. Main results
• Tradeoffs between growth and equity,
once globalisation is taken into account
• Broadly, decentralisation tends to be
better for growth than for equity
Many results are country-specific, with
no “easy answers” – it depends where
you are at on the policy topology (i.e. how
centralised or decentralised you are)
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17. 17
Forthcoming in the next edition of
the Fiscal Federalism Studies
• Fiscal Decentralisation and
Inclusive Growth in Asia
• New volumes following upcoming
workshops around autumn 2018
Fiscal Network Annual Meeting
Website: http://oe.cd/fiscalnetwork
Contact: fiscalnetwork@oecd.org
Twitter: @econecho
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