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Decentralization will increase economic efficiency because local government are better positioned than the national government to deliver public services as a result of information advantages (Oates' Decentralization Theorem). Consequently, it was thought that decentralized finance would appear to have a potentially useful role to play in economic development (Oates [1993]). From the empirical viewpoint, however, it remains controversial whether there is any relationship between decentralization and economic growth. For example, as pointed out by Ebel and Yilmaz [2002] and Iimi [2005], it has been argued that fiscal decentralization can serve as a means to promote economic growth. On the other hand, there is some empirical evidence that fiscal decentralization is negatively associated with economic growth (e.g., Davoodi and Zou [1998], Zhang and Zou [1998]). Various reasons can be given for the differences in empirical estimations. In particular, the selection of fiscal decentralization variables is thought to be a cause of differences. A widely accepted measure of fiscal decentralization is the subnational share of total government spending. However, this is an imperfect measure of fiscal decentralization because it does not identify the degree of local expenditure autonomy. Ebel and Yilmaz [2002] defined the degree of local expenditure autonomy as the share of subnational own-revenues in total revenues. Though this indicator might capture subnational autonomy, it is difficult to represent the empowerment of people and communities through fiscal decentralization. However, it is important to be able to define fiscal decentralization as the empowerment of people and the community through fiscal empowerment of their local government. People and the community must be able to direct their subnational government officials to use their financial resources in accordance with local needs and preferences (Bahl [2005]). Boex and Simatupang [2008] develop a measure of fiscal empowerment to quantify fiscal decentralization as the gain in empowerment due to the devolution of fiscal power. However, this study does not examine the relationship between fiscal decentralization and economic growth. This paper sets the stage for a renewed effort to compute alternative measures of decentralization that take into account the degree of subnational autonomy and the empowerment of people and the community, and examines how fiscal decentralization viewed in terms of the empowerment of people and the community can affect economic growth. |
