Economic Integration and Fiscal Decentralization: Evidence from OECD Countries

Abstract

Die Discussion Papers dienen einer möglichst schnellen Verbreitung von neueren Forschungsarbeiten des ZEW. Die Beiträge liegen in alleiniger Verantwortung der Autoren und stellen nicht notwendigerweise die Meinung des ZEW dar.Discussion Papers are intended to make results of ZEW research promptly available to other economists in order to encourage discussion and suggestions for revisions. The authors are solely responsible for the contents which do not necessarily represent the opinion of the ZEW.Download this ZEW Discussion Paper from our ftp server:ftp://ftp.zew.de/pub/zew-docs/dp/dp0486.pdf Nontechnical SummarySince the 1970s and especially during the last decade a process of decentralization of the public sector has taken place in several countries, while at the same time the globalization and integration of the world economy is rapidly progressing. This parallel is even more striking with regard to European Union countries. In the course of economic and political integration, fiscal and political powers have been transferred from the national governments both to a supranational authority and to lower levels of government. According to the "Sandwich" hypothesis, national governments are expected to be further pushed back in the course of European integration. Given this background, this paper addresses the question whether economic and political integration of countries fosters the decentralization of the public sector.According to the traditional theory of fiscal federalism, the optimal degree of decentralization of the public sector is determined by the costs and benefits of the decentralized provision of public goods. On the one hand, decentralization allows for the differentiation of public goods according to local preferences and conditions. On the other hand, it implies costs in form of inter-jurisdictional spillovers and foregone economies of scale. However, the theory of fiscal federalism fails to give an adequate explanation of the recent process of decentralization. Inspired by the spread of political separatism throughout the world, recent literature explores the economic determinants of the creation and disintegration of countries. By increasing the market size and reducing political and economic transaction costs, economic integration is shown to raise the benefits of secession or regional autonomy. Furthermore, according to the New Economic Geography literature, integration generates agglomeration and specialization effects at the regional level. Local governments could exploit these benefits by demanding more autonomy in the provision of local public goods and taxes in order to compete for mobile factors. Political integration, too, might contribute to public sector decentralization, since the costs of supplying certain public goods now in the competence of the supranational level are reduced. On the other side, by increasing the economic risk, economic integration is also expected to enhance the demand for inter-regional risk-sharing or policies carried out by the central government, such as ...

Centralizing Tendencies in the Public Sector in Germany

“…The time series analysis for Germany therefore mostly supports the results of the panel analysis for OECD countries in Stegarescu (2004b) with respect to the role of economic development, urbanization and integration. There, economic and European integration were shown to have fostered fiscal decentralization particularly in case of strong preference heterogeneity and missing participation of subnational governments in central policymaking which prevents the establishment of tax cartels.…”

“…Focusing instead on the reverse causation between the vertical structure of the public sector and economic growth in Germany, Behnisch et al (2002) detect a positive impact of the share of federal government expenditure in total public expenditure on productivity growth after World War II. On the other hand, Stegarescu (2004b) reveals a decentralizing effect of both per capita income and economic and European integration in a majority of OECD countries since 1970. The influence of economic development and of global and European integration on the degree of public sector decentralization is therefore investigated empirically in the present work for the specific German context after World War II.…”

“…On the other hand, by increasing the economic risk, economic integration is also expected to enhance the demand for interregional risk-sharing or other policies carried out by the central government, such as income redistribution. In a recent empirical panel analysis, Stegarescu (2004b) provides evidence for a significant relationship between integration at the global and at the European level, and fiscal decentralization during the last three decades, especially among OECD countries with strong preference heterogeneity.…”

“…In order to account for changes in the degree of fiscal decentralization related to the business cycle, the contemporaneous value of the rate of growth of real per capita income is included, too. As in Stegarescu (2004b), economic integration is captured by the degree of trade openness, whereas European integration is represented in terms of the share of EU expenditure in total public expenditure of EU member countries and, respectively, the share of EU trade in total German foreign trade.…”

Supranational integration and national reorganization: On the Maastricht treaty’s impact on fiscal decentralization in EU countries

“…They find that economic integration is correlated with increases in fiscal centralization. Finally, the study by Stegarescu (2004), which is probably the one most closely related to this paper, investigates both the consequences of globalization in general and European integration in particular. He finds relatively weak evidence that globalization has increased fiscal decentralization in OECD countries, but no evidence indicating a relationship between European integration and fiscal decentralization.…”