The politics of fiscal federalism: Building a stronger decentralization theorem
| Author | Jorge Martinez-Vazquez,Charles R. Hankla,Raúl A. Ponce-Rodríguez,Eunice Heredia-Ortiz |
| Published date | 01 October 2020 |
| DOI | 10.1177/0951629820956287 |
| Date | 01 October 2020 |
| Subject Matter | Articles |
Article
Journal of Theoretical Politics
2020, Vol.32(4) 605–639
ÓThe Author(s) 2020
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DOI: 10.1177/0951629820956287
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The politics of fiscal
federalism: Building a
stronger decentralization
theorem
Rau
´l A. Ponce-Rodrı
´guez
Department of Economics, UniversidadAuto
´noma de Ciudad Jua
´rez, Mexico
Charles R. Hankla
Department of PoliticalScience, Georgia State University, USA
Jorge Martinez-Vazquez
Department of Economics,International Center for Public Policy,Georgia State
University,USA
Eunice Heredia-Ortiz
Development AlternativesInc., DAI, USA
Abstract
We explore how party structures can condition the benefits of decentralization in modern
democracies. In particular, we study the interaction of two political institutions: democratic
(de)centralization (whether a country has fiscally autonomous and elected local governments)
and party (non)integration (whether powerover local party leaders flows upwards through party
institutions, which we model using control over candidate selection). We incorporate these insti-
tutions into our strong decentralization theorem, which expands on Oates (1972) to examine when
the decentralized provision of public services will dominate centralized provision even in the
presence of inter-jurisdictional spillovers. Our findings suggest that, when externalities are
Corresponding author:
Charles R. Hankla, Departmentof Political Science, Georgia State University,38 Peachtree Center Ave NE,
Atlanta, GA 30303-2545, USA.
Email: chankla@gsu.edu
present, democratic decentralization will be beneficial only when parties are integrated. In coun-
tries with non-integrated parties, we find that the participation rules of primaries have implica-
tions for the expected gains from democratic decentralization. Under blanket primaries, Oates’
conventional decentralization theorem holds but our strong decentralization theorem does not.
By contrast, when primaries are closed, not even Oates’ conventional decentralization theorem
holds.
Keywords
Decentralization; fiscal federalism; formal theory; political parties; public goods
1. Introduction
In the last few decades, numerous countries – China, Indonesia, South Africa,
India, the United Kingdom, and many others – have engaged in decentralization
reforms. These reforms, at least in the developing world, have been supported both
by the aid dollars of multilateral agencies such as the World Bank and USAID,
and by the research findings of many scholars. Central to these positive scholarly
judgments is the ‘decentralization theorem’, which was developed by Oates (1972)
and states that ‘. . . in the absence of cost-savings from the centralized provision of
a (local public) good and of inter-jurisdictional externalities, the level of welfare
will always be at least as high (and typically higher) if Pareto-efficient levels of con-
sumption are provided in each jurisdiction than if any single, uniform level of con-
sumption is maintained across all jurisdictions’ (p. 54).
However, as the process of decentralization has continued apace, some scholars
have begun to question whether devolving authority to regional and local govern-
ments is a universal good. Among other things, they have pointed out that Oates,
in developing his theorem, assumes not only the absence of economies of scale and
externalities, but also that policies are implemented by benevolent welfare-
maximizing governments. While this latter assumption may be useful for creating a
simple and elegant theory of decentralization, it hardly accords with empirical rea-
lities. More to the point, it begs the question of how different political processes
and institutions might shape the fiscal choices made by policy makers, and, with
them, the outcomes of fiscal federalism.
In this paper we seek to answer that question by analyzing the interaction of two
particular political institutions: democratic (de)centralization (whether a country
has fiscally autonomous and elected local governments) and party (non)integration
(whether power over local party leaders flows upwards through party institutions
to leaders at the national level, which we model using candidate selection proce-
dures).
1
We incorporate these institutions into a rigorous and formal extension of
Oates (1972), which we term our strong decentralization theorem.
Our findings suggest that, when public goods have externalities, a move towards
democratic decentralization will only produce the benefits predicted by Oates if
parties are integrated. When local governments are elected and autonomous, their
leaders possess the accountability necessary to incentivize public goods provision.
But when national party leaders also control access to the ballot, local leaders have
606 Journal of Theoretical Politics 32(4)
strong reasons to provide the efficient level of goods even when their benefits spil-
lover across jurisdictions. Put differently, democratic (de)centralization affects pub-
lic spending because local elections and nationwide elections create different
incentives for the officials who design public policy. Upward accountability
through integrated party mechanisms can influence these incentives.
Narrowing our focus to non-integrated parties, we also study how the institu-
tions of primary elections shape decisions over public spending. We find that the
participation rules of primaries, whether closed or blanket, have important implica-
tions for the expected gains from democratic decentralization. Blanket primaries
are an extreme form of open primary in which the top two candidates, regardless of
party, compete in the general election.
2
Under such a system, democratic decentrali-
zation only produces the expected benefits when inter-jurisdictional spillovers are
absent. By contrast, when primaries are closed, not even Oates’ conventional decen-
tralization theorem holds, meaning that democratic decentralization will produce
no consistent benefits vis-a
`-vis centralized provision. This is because, in a closed
primary system, parties will hew too closely to the specific preferences of their local
co-partisans rather than to the aggregate interests of all constituents.
This article contributes to the extensive literature on decentralization in two
important ways. First, it significantly expands the main theoretical construct in fis-
cal decentralization—Oates’ decentralization theorem—by showing that under the
right political institutions, the fiscally decentralized provision of local public goods
can be more efficient even in the presence of inter-jurisdictional externalities. It
also shows that under certain political institutions, Oates’ decentralization theorem
does not continue to hold. Second, and more generally, the paper clearly demon-
strates that different forms of decentralization—fiscal versus democratic versus
party—are closely intertwined and cannot be analyzed separately, as has been pre-
viously done in most of the literature.
Given the extensive variation in party organization that exists in the real world,
these findings are of great empirical significance. Of the 157 countries that we have
coded for our empirical work (see Hankla et al. 2019; Ponce-Rodrı
´guez et al. 2018),
106 were characterized by some degree of democratic decentralization. Of these
106, sixty-seven countries have had integrated parties for at least some years and
forty-nine have consistently had non-integrated parties.
Moreover, the results from our empirical work point—as expected—to the bene-
fits of combining democratic decentralization with party integration. Our statistical
analyses show that countries with such institutions possess an advantage in a num-
ber of primary health, primary education, and local infrastructure outcomes. The
benefits of integrated parties also show up in our comparison of party integrated
Senegal with party non-integrated Nigeria (Hankla et al. 2019).
This article provides a rigorous theoretical foundation for the empirical work
presented in Ponce-Rodrı
´guez et al. (2018). Moreover, while the models developed
here build on those in our book (Hankla et al. 2019), we introduce several signifi-
cant extensions. These include relaxing the assumption that local public goods are
homogeneous and analyzing majoritarian electoral systems with both blanket and
closed primary elections.
Ponce-Rodrı
´guez et al. 607
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