Decentralization and Corruption

The relationship between decentralization of government activities and the extent of rent extraction by private parties is an important element in the recent debate on institutional design. The theoretical literature makes ambiguous predictions about this relationship, and it has remained virtually unexamined by empiricists. In this paper, we make a first attempt at examining this issue empirically, by looking at the cross-country relationship between fiscal decentralization and corruption as measured by a number of different indices. We find that there is a strong negative relationship between fiscal decentralization in government expenditure and corruption. We find that legal origin performs extremely well as an instrument for decentralization, and instrumenting in this way, the estimated relationship between decentralization and corruption is even stronger. Moreover, looking within the United States, we find a positive relationship between the proportion of a state's reliance on federal transfers and corruption, as measured by the number of abuse of public office convictions of government employees. While these results are somewhat weaker and sensitive to the choice of specification, they suggest that, consistent with principal-agent theories of corruption, decentralization in expenditures may be problematic unless accompanied by decentralization in revenue generation ? We thank Shantayanan Devarajan for useful conversations and Rajiv Goel for kindly sharing his data. The views expressed here do not necessarily reflect those of the World Bank or its member countries. Please send correspondence to [email protected] or [email protected].