Abstract
Most countries pay substantial intergovernmental transfers to poor regions. Since these transfers are often paid with the aim of achieving regional convergence, they should have a positive effect on economic growth. However, it is equally possible that transfers perpetuate under-development by diminishing regional incentives to implement growth-enhancing policies. In this paper, we study empirically the effect of intergovernmental transfers on economic growth using the German federation as an institutional laboratory. Our findings, which are based on a panel dataset covering the West German States over the period 1975-2005, suggest that transfers are irrelevant or possibly even harmful for economic growth. The results of our analysis of transmission channels are consistent with the notion that transfers fail to foster growth because states use them to subsidize declining industries.
Highlights
Most countries redistribute public resources between regions through intergovernmental transfers
We study econometrically how transfer dependence affects economic development with a dataset covering the 10 West German states over the period 1975-2005.2 we explore the effect of transfers on economic growth and potential transmission channels such as retarded structural change and distortions in state fiscal policies
We study the effect of intergovernmental transfers on economic development based on the West German States
Summary
Most countries redistribute public resources between regions through intergovernmental transfers. It is difficult to link transfers causally to low levels of growth based on anecdotal evidence because it is unclear whether economic development in transfer-dependent regions would have been even worse without the transfers. We construct an instrument based on an arguably exogenous reform of the intergovernmental transfer scheme in 1995 that increased the intensity of equalization and led to higher transfer dependence in the net-recipient states. This reform was necessitated by the need to integrate the East German States into the transfer system, but the changes in the equalization law affected all states. This paper contributes to the research on the link between fiscal decentralization and economic growth (Xie et al, 1999; Stansel, 2005; Thornton, 2007; Baskaran and Feld, 2013; Asatryan and Feld, 2015; Baskaran et al, 2016)
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