Decentralization and Economic Growth per capita in Europe

In this paper the relationship between decentralization and economic growth is investigated. The focus is on decentralization from the national government to the highest substate level in a country, which we define as regional decentralization. Section 2 discusses the different dimensions of decentralization. Political decentralization refers to the degree to which central governments allow non-central government entities to implement certain political functions. Fiscal decentralization in a regional context has to do with the total amount of regional cash flows, which are regional expenditures and regional revenues, with respect to national fiscal activity. Administrative decentralization refers to the extent of autonomy of non-central government entities relative to central control. Administrative decentralization distinguishes deconcentration, delegation and devolution, where deconcentration is the weakest form of administrative decentralization and devolution is the strongest form. An overlap between political, fiscal and administrative decentralization exists. Section 2 also discusses the advantages and disadvantages of regional decentralization. Section 3 starts with an overview of centralization and regionalism, two opposite trends that have taken place in Europe over the past decades. The decentralization history of Austria, Belgium, Denmark, Finland, France, Germany, Greece, Italy, Ireland, the Netherlands, Portugal, Spain, Sweden and the United Kingdomis is described. Countries are classified in groups using two characteristics. First countries are classified according to their institutional structure, which can be federal, unitary decentralized or unitary centralized. Second, countries are classified according to the different forms of regional administrative decentralization, which are devolution, delegation or deconcentration. Section 4 starts with an overview of the existing literature concerning decentralization and growth. Most studies used national data to investigate the impact of decentralization. None of the empirical studies find a negative statistically significant relationship between decentralization and growth, while some find a positive statistically significant relationship. Next the section uses the Solow-Swan neoclassical growth model (Solow, 1956; Swan, 1956) to test the relationship between growth and decentralization. Regional data are used of the fourteen European countries mentioned above that cover the period 1978 – 2002. We estimate a regression equation using ordinary least squares (OLS), in which we regress some decentralization variables and a set of control variables on real economic growth per capita. The conclusions are threefold. First, regions in federal states grow faster than regions in unitary decentralized states and the difference is statistically significant. Regions in centralized states have a higher growth rate than regions in federal and unitary decentralized states, but this result is not statistically significant. Second, autonomous regions have a growth rate that is 0.5% higher than in other regions, but the difference is not statistically significant. Third, a relatively high share of regional taxes compared to the regional budget has a negative and statistically significant impact on growth. Chapter 5 contains a qualitative analysis of important factors for the functioning of (fiscal) decentralization. It is examined whether these factors have contributed to the results of section 4. It is shown that regional financial responsibility is very important. Regional governments should be responsible for a significant part of their own resources, regarding both expenditures and income. A second conclusion is that central governments should be very careful with assistance to regions because it can lead to inefficient spending policies by regional governments. Section 1.01 Conclusions Some findings of this study indicate that decentralization of authority to the regional level might have positive effects on economic growth. First, in the literature overview no empirical studies showed up that find a negative statistically significant relationship between decentralization and growth, while some studies find a positive statistically significant relationship. Second, the results of the model used in this study provide indications that validate a positive relation between decentralization and economic growth: • regions in federal states grow faster than regions in unitary decentralized states and the difference is statistically significant. • the growth rate of autonomous regions is a half percent higher than in other regions given the specification of the model. Regarding a total average growth rate of 1.7% for all regions over the entire period, this effect is quite large. A possible explanation is that the administration of autonomous regions is relatively more efficient and accountable. Although the results show that autonomous regions have a higher growth rate, the evidence is not strong enough, because the result is not statistically significant. However, the following results of the used model did not validate the positive relationship: • regions in centralized states have a higher growth rate than regions in federal and unitary decentralized states, but this result is not statistically significant. • the higher the share of regional taxes in the regional revenues, the lower the growth rate. A possible interpretation is that it is more efficient to collect taxes at the country level due to scale economies. The somewhat ambiguous results can be explained by the trade-off between the advantages and disadvantages of decentralization. The negative effects of decentralization consist of: extra costs of decentralizing authority, frustration of income redistribution policy, neglecting spillover effects and the smaller economies of scale in the provision of public goods and in the collection of taxes (see section 2.2.2). The positive effect of decentralization are the efficient provision of public good due to better tailoring outputs to specific preferences of citizens, stimulating regional development and fostering intergovernmental competition (see section 2.2.1). Although it is not possible to draw any robust conclusion from the analysis that decentralization leads to higher growth rates, some findings indicate that decentralization might have positive effects. More research concerning the relationship between decentralization and economic growth is needed.