Fiscal decentralization and governance quality: A review of the literature and additional evidence

We review theoretical and empirical work that has considered how fiscal decentralization affects the quality of governance. Theoretically, sub-central governments may be better informed about, and find it easier to adapt policies to, local needs. Decentralization allows for experimentation and learning as well as interjurisdictional competition for fiscal resources to the benefit of efficiency. But decentralization has its dangers. Economies of scale may be foregone and spill over effects ignored. It may lead to duplication and waste. Fiscal competition may reduce state capacity and drive regions towards rent-extraction. Fiscal decentralization may lead to the capture of sub-national officials by interest groups. The empirical evidence generally suggests that its impact is beneficial, especially in the presence of well-informed voters, strong national parties or appointed rather than elected sub-national governments. We provide new empirical evidence, across 47 countries over 1996 to 2016, indicating that combining fiscal decentralization with direct democracy can improve governance.