Differential effects of decentralization on income inequality: evidence from developed and developing countries

Abstract

Using a panel data set of OECD and non-OECD countries spanning from 1980 to 2016, we investigate the effects of decentralization on income inequality. Unlike prior literature, we examine the effects of fiscal, administrative, and political decentralization on inequality both individually and in interaction. Moreover, we test for a moderating effect of economic development using the Human Development Index. We find that decentralization reduces income inequality, but the effect diminishes and eventually reverses as economic development increases, suggesting that there exists a threshold at which the equality gains of decentralization are realized. We also find that the threshold of development at which greater decentralization no longer reduces inequality is lower for non-OECD countries than for OECD countries. In addition, the results suggest that the marginal effect of a given dimension of decentralization on income inequality depends on the level of decentralization in other dimensions. These findings imply that the overall decentralization mix is important for income inequality, and both a country’s current stage in development and underlying institutional framework should be considered when determining the decentralization mix, especially if reducing income inequality is a main objective.