Decentralization and Political Institutions

Does fiscal decentralization lead to more efficient governance, better public goods, and higher economic growth? This paper tests hypotheses of the theoretical literature that results of decentralization depend on features of political institutions. Using data from up to 95 countries for 25 years we show that the effect of fiscal decentralization strongly depends on two aspects of political centralization: 1) strength of national party system (measured by the age of main parties and fractionalization of government parties) and 2) subordination (whether local and state executives are appointed or elected). We find solid support for Riker’s theory (1964): in developing countries, strong parties significantly improve the results of fiscal decentralization for economic growth, quality of government, and public goods provision. There is also some evidence from developing countries that administrative subordination of local to higher-level authorities improves decentralization results. ∗ We thank Alberto Alesina, Scott Gelhbach, Sergei Guriev, James Hines, Rory MacFarquhar, Gérard Roland, Andrei Shleifer, Konstantin Sonin, Barry Weingast, Luigi Zingales, two anonymous referees and seminar participants at the University of Michigan, Center for Economic and Financial Research, New Economic School, London Business School, University of California, Berkeley, Institute for Advance Study in Princeton, Harvard University, Princeton University, and participants of CEPR-WDI 2003 Transition Conference for useful comments. The work of Ruben Enikolopov was in part supported by a program of the Bureau of Educational and Cultural Affairs, U.S. Department of State, administered by the American Council for International Education. The views expressed herein are of the authors and not necessarily shared by ECA or AC. ∗∗ Harvard University and Center for Economic and Financial Research (CEFIR), [email protected]. ∗∗∗ Institute for Advanced Study, Princeton; Center for Economic and Financial Research (CEFIR); and CEPR, [email protected].