Economic Growth by Means of Fiscal Decentralization: An Empirical Study for Federal Developing Countries

Imran Hanif,Pilar Gago-De-Santos,Sally Wallace

doi:10.1177/2158244020968088

Abstract

The impact of fiscal federalism on economic performance has largely been studied in the developed world since the seminal work of Oates. In this article, we focus on a particular set of developing countries considered to be federal (Forum of Federations), to examine how fiscal decentralization has impacted their economic growth. In this context, we study the impact of tax revenue and expenditure decentralization on economic growth in developing federations. For this purpose, a panel data of 15 developing federations from 2000 to 2015 are analyzed by using a two-step system Generalized Method of Moments (GMM) estimation method. The results show that in federal developing countries, both tax revenue and expenditure decentralization have a significant, positive impact on economic growth. What is more, our findings show that the impact of fiscal decentralization on economic growth depends upon the level of perceived corruption and on the quality of the country’s institutions. Thus, empirical evidence depicts that the positive effect of fiscal decentralization on economic growth is tempered if the country is plagued with corruption, if it has weak institutions, and/or if it suffers from political instability. By contrast, a relatively corruption-free country featuring healthy institutions and a stable political environment could take fuller advantage of the effects of fiscal decentralization to improve economic growth.

Highlights

In recent decades, many developing countries with a political federal system as varied as India, Pakistan, South Africa, Mexico, Ethiopia, Brazil, or Malaysia, among others, have shown increasing movements toward fiscal decentralization.Federations are those that have one federal government and at least one lower tier of government though commonly they have two
For federal developing countries, of the association between fiscal decentralization and economic growth, supporting the hypothesis that fiscal decentralization contributes to their economic growth, contrary to some prior research showing negative associations between those two variables, as Davoodi and Zou (1998) and Demello (2000) concluded for developing countries
We should bear in mind that one of the most reliable reasons for having yet inconclusive empirical evidence is because researchers rely mostly on the data provided by the Government Financial Statistics (GFS) of the International Monetary Fund (IMF) on revenue and expenditure decentralization but we are aware of the fact that such data do not always give us the actual degree of fiscal autonomy reached by the subnational governments (Bojanic, 2018; Ebel & Yilmaz, 2002; Martinez-Vazquez et al, 2016; Stegarescu, 2005)

Summary

Introduction

Many developing countries with a political federal system as varied as India, Pakistan, South Africa, Mexico, Ethiopia, Brazil, or Malaysia, among others, have shown increasing movements toward fiscal decentralization. Another recent research on panel data for OECD countries concludes that for those countries the impact on growth depends on the econometric strategies used and on the measurement criteria (Göcen et al, 2017) In this sense, we should bear in mind that one of the most reliable reasons for having yet inconclusive empirical evidence is because researchers rely mostly on the data provided by the GFS of the IMF on revenue and expenditure decentralization but we are aware of the fact that such data do not always give us the actual degree of fiscal autonomy reached by the subnational governments (Bojanic, 2018; Ebel & Yilmaz, 2002; Martinez-Vazquez et al, 2016; Stegarescu, 2005). The quality of instruments and of over-identification restrictions was examined by way of the Hansen J test, the differences-inHansen test, and the Arellano–Bond test for second-order autocorrelation

Results and Discussion

Method

Results

12 American Countries