Fiscal Decentralization and Governance

The literature on the economics of fiscal decentralization stresses the potential for both positive and negative effects on the quality of governance in a country. The empirical evidence on the issue is scant. In this paper, we add to the empirical evidence by testing for a relationship between fiscal decentralization and changes in indicators of the quality of governance in a cross-section of developed and developing economies. We find that greater fiscal decentralization is consistently associated with improvements in the quality of governance and that this result is robust to different institutional frameworks governing decentralization, to different estimation methodologies, to variations in the country sample, and to controlling for the influence of variables that other studies have identified as affecting the quality of governance. Our results support the view that one justification for greater fiscal decentralization is the beneficial impact on a country’s governance that may result.