Research by: Tristan Canare, Jamil Paolo S. Francisco, & Rose Ann Camille Caliso
One of the most common public finance reforms undertaken by developing countries in the past few decades has been decentralization. Some advocates believe that greater decentralization would ultimately lead to lower income inequality.
The primary argument for decentralization is that subnational governments have better information on local needs and preferences, allowing them to deliver public services more effectively than the central government. It has also been proposed that decentralization can promote good governance by increasing stakeholder participation, improving accountability and bringing the user and provider of public services closer to each other. However, decentralization also has its disadvantages.
Local governments may be less able to provide public services at low cost compared to central governments that have better economies of scale, economies of scope and superior access to resources. Transferring responsibilities to local governments with varying capacity to raise revenues and to provide public services can lead to unequal development outcomes across different regions. These resulting regional disparities can, in turn, lead to unequal development outcomes and income growth for the general population across the country. Furthermore, decentralization can also promote local elite capture and empower local governments, where governance is usually of lower quality than in the central government.
We tested for the relationship between decentralization and inequality using both panel data and annual averaged cross-section data of countries with varying income levels, including both developed and developing countries. We conducted our analyses using four different measures of decentralization as follows: (1) expenditure decentralization measured as the ratio of subnational government expenditures to central government expenditures, (2) revenue decentralization measured as ratio of subnational government revenues to central government revenues; (3) fiscal independence measured by the ratio of own-sourced revenues of the local governments to total local government expenditures; and finally (4) a binary variable for countries with a federal form of government, which reflects the source of local government power based on a country’s constitution. Inequality was measured by the income Gini coefficient gathered from the WDI.
Overall, we found some evidence that decentralization can be weakly associated with inequality. We found that revenue decentralization in particular was associated with lower inequality. However, expenditure decentralization had no significant relationship with inequality whatsoever. This suggests that when it comes to improving inequality, decentralizing revenue collection can be more important than devolving spending responsibilities.
On the other hand, we found that fiscal independence or the ability of local government to finance its spending with its own revenues was associated with higher inequality. This suggests that when local governments are less dependent on transfers from the central government, poorer local governments may not be able provide the same services that richer local governments are able to, resulting in higher inequality. Nonetheless, we found weak evidence that government effectiveness can temper this relationship. This result may support the argument that good governance is a requirement for decentralization to be effective in promoting development outcomes.
Finally, we found that having a federal form of government was associated with higher levels of inequality. This finding suggests that inequality was higher in countries where the powers of local governments were wholly guaranteed by the constitution through the adoption of a federal form of government, rather than specifically assigned by statute or policy.
To cite this article: Canare, T., Francisco, J. P. S., & Caliso, R. A. C. (2020). Decentralization and income inequality in a panel and cross-section of countries. Journal of International Development, 32(4), 543-579. https://doi.org/10.1002/jid.3468.
To access this article: https://doi.org/10.1002/jid.3468
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