Fiscal decentralisation and inclusive growth: An overview

Abstract

Inclusive growth is now high on government agendas in many countries. This chapter provides an overview of the role of fiscal decentralisation for inclusive growth. Considering the large size of sub-national spending, the potential of fiscal decentralisation to enhance efficiency and equity is significant. But there are competing theories on the effect of fiscal decentralisation: according to normative public finance theory, fiscal equalisation has an important role to play for equity and efficiency. On the other hand, political economy theory suggests that reducing the vertical fiscal gap is good for government performance and economic growth. The empirical literature also shows mixed results. However, many empirical studies show that the interaction between fiscal decentralisation and institutions, the stage of economic development and political economy constraints exercise important roles in determining the success of fiscal decentralisation. Rather than rely on “one size fit all” prescriptions, policymakers should consider the importance of institutional complementarities to reap the full potential of fiscal decentralisation.