FISCAL DECENTRALIZATION: AN EFFECTIVE TOOL FOR GOVERNMENT REFORM?
| Published date | 01 September 2013 |
| Author | OSUNG KWON |
| Date | 01 September 2013 |
| DOI | http://doi.org/10.1111/j.1467-9299.2012.01982.x |
doi: 10.1111/j.1467-9299.2012.01982.x
FISCAL DECENTRALIZATION: AN EFFECTIVE TOOL
FOR GOVERNMENT REFORM?
OSUNG KWON
The theory of fiscal federalism asserts that fiscal decentralization increases government effectiveness,
reduces government budgets, and reduces corruption when used as a means of government reform.
However, counter-arguments have been made that such an approach has diverging effects according
to the level of national development. We have attempted herein to carry out an empirical analysis to
examine these theories. Data from 17 developed and 17 developing states were obtained in order to
conduct a regression analysis of various indicators. The results revealed that fiscal decentralization
reduced government effectiveness in developed countries. Important determinants for government
effectiveness were the quality of regulation and the rule of law. When responsibility for expenditure
and revenue were devolved, budgets expanded in both developed and developing countries. Fiscal
decentralization deterred corruption in advanced states, whereas greater autonomy in spending
increased malfeasance in the developing world.
INTRODUCTION
During the course of the last few decades, many different states have used decentral-
ization as a means of reforming their public sectors. The backdrop to, and the reasons
behind, decentralization vary considerably. African states, for example, have pursued
decentralization in their efforts to introduce multi-party political systems. In Latin Amer-
ica, decentralization is part of an effort to advance democracy, whereas in Eastern Europe
it has been part of the transition to a market economy. In East Asia, greater autonomy has
been given to sub-national governments to improve the provision of public goods and
services. South Asian states have also sought to use decentralization as a means to enable
different races to coexist peaceably (Bird and Vaillancourt 1998; Shah 2004).
Whatever the reasons underlying this approach, the implementation of decentralization
has had a significant impact on the performance of public bodies. According to the theory
of fiscal federalism, fiscal decentralization is an effective tool for increasing the efficiency
of public expenditures. It improves economic and cost efficiency, accountability, and
the mobilization of resources (Bird and Vaillancourt 1998). Fiscal decentralization is also
considered to be an effective means for improving the quality of governance. It serves
to address or prevent corruption by making systems more transparent (Joumard and
Kongsrud 2003).
Contrary to the theory of fiscal federalism, some have argued that decentralization might
generate undesirable outcomes (Prud’homme 1995). Davoodi and Zou (1998) warned
against the possible consequences when new systems are introduced in developing
countries without sufficient monitoring or review. In this respect, Prud’homme took a
critical view in describing policies that are aimed at decentralization not as a panacea, but
as an effective drug (Prud’homme 1995, p. 201). His argument was that even the most
effective drug may be toxic if the correct dosage is not prescribed for the right disease at
the right time.
The aim of the present study is to analyze empirically the effects of fiscal decentralization
on the performance of the public sector, using international data as a case study. Indeed,
Osung Kwon is a Research Fellow at the Korea Institute of Public Administration in Korea.
Public Administration Vol. 91, No. 3, 2013 (544–560)
©2012 John Wiley & Sons Ltd.
FISCAL DECENTRALIZATION545
in practice, the transfer of government functions and authority is often effectively a
fiscal matter (Oates 1972). Specifically, the present study is an investigation of how
fiscal decentralization impacts three important variables of public performance, namely
government effectiveness, budget size, and corruption.
THEORIES AND HYPOTHESES
Fiscal decentralization as a tool for government reform
A growing body of literature has begun to investigate whether fiscal decentralization is an
appropriate tool for governmental reform. Typically, research of this kind evaluates the
effect of fiscal decentralization on a range of characteristics within the public sector, which
include the level of corruption (Fisman and Gatti 2002), the response of government to
local needs (Faguet 2004), access to public services (Litvack and Seddon 1999; Lieberman
2002), budget size (Oates 1985; Marlow 1988; Grossman 1989; Kwon 2003), the level of
economic growth (Kim 1995), fairness between communities (Shah and Thompson 2004),
and the degree of political stability (World Bank 2000).
Some have considered fiscal decentralization to be a crucial part of good governance
(Nyiri 2002). Vengroff and Salem (1992) suggested that the correlation between successful
decentralization and good governance is quite high. VanSant (1997) argued that a
decentralized institutional setting is an important factor in the improvement of governance
in developing countries.
Some scholars have posited that there are certain prerequisites that must be in place
before fiscal decentralization can have a positive impact. For example, Bahl (1999) asserted
that the competence of sub-national governments is critical if decentralization is to have
a positive impact. Guess (2005) set out certain cultural, institutional, and technical factors
as key variables, whereas Jutting et al. (2004) suggested the importance of the will and
capability of the central policy maker, in addition to the continuity of the policy-making
process itself.
At the same time, others have argued that the decentralization of expenditure and
revenue has an asymmetric effect on government spending due to vertical fiscal imbalance
and the particular characteristics of such government expenditure as social security or
government consumption (Fiva 2006). Consequently, appropriate attention must be paid
to the design of the current research to determine the real impacts of fiscal decentralization
policy. In the present study, we consider separately the impacts of the two types of fiscal
decentralization: expenditure and revenue. A number of hypotheses are tested that seek
to explain whether fiscal decentralization is appropriate as a tool for government reform
under certain conditions. Due to the limitations of the present empirical approach, the
focus of the study is on the three dependent variables of government effectiveness, budget
size, and level of corruption.
Fiscal decentralization and government effectiveness
The main positive outcomes of greater fiscal autonomy include increases in economic
efficiency, cost efficiency, and accountability, and the better mobilization of resources in
the public sector. The logic that fiscal decentralization can raise economic efficiency is
better proved through Oates’ (1977) analysis on consumer surplus. He found that local
governments that cater to diverse resident needs can distribute public goods and services
more efficiently than central governments if economies of scale do not apply or external
impacts are minimal.
Public Administration Vol. 91, No. 3, 2013 (544–560)
©2012 John Wiley & Sons Ltd.
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