Decentralization and Criminal Gangs in El Salvador: Impacts on Municipal Finances and Local Economic Development

Abstract

Recent literature has argued that decentralization can create new forms of leverage for criminal gangs, increasing their territorial presence and levels of violence. In this article we reverse the causal arrow and analyze how gangs affect the performance of decentralized institutions. We study the case of El Salvador, a country with the ubiquitous presence of gangs. We find that the higher presence of gangs reduced municipalities’ fiscal revenues, thereby increasing their dependence on transfers from the central government. This result is mostly driven by mid-size municipalities, as the effect is not significant for small and large municipalities. In addition to depressing revenues, gang presence was also associated with lower municipal spending and less service provision, effectively hollowing out municipal governance. The drop in municipal spending is particularly strong in capital spending and in small municipalities. The article also finds that gangs undermine economic activity – not just in the municipalities where they operate but through spill-over effects in neighboring jurisdictions as well.