DT 03/13 - Fiscal decentralization and regional disparities: The importance of good governance

In this paper we consider how government quality mediates the relationship between

fiscal decentralization and regional disparities. Previous work has argued that fiscal

decentralization has the potential to reduce income difference across regions but that

this potential may not be realized because of governance problems associated with subnational

authorities. Our empirical evidence based on a sample of 24 OECD countries

over the period 1984 to 2006 lends a measure of support to this idea. We find that fiscal

decentralization promotes regional convergence in high government quality settings but,

worryingly, it leads to wider regional disparities in countries with poor governance.

Because most poor countries are plagued with governance problems, this would caution

against fiscal decentralization with a view to reducing regional disparities in these

countries.