Decentralization (or devolution) has potential advantages and disadvantages: while (fiscal) decentralization may strengthen the allocative and technical efficiency of the local public sector (as well as potentially strengthen responsiveness and accountability), the design of intergovernmental fiscal systems could also potentially reduce macro-fiscal stability or fiscal discipline at the local level. These tendencies may be stronger or weaker in different regions or country contexts.
A recent analysis by Suzana Makreshanska-Mladenovska and Goran Petrevski considers decentralization and fiscal performance in Central and Eastern Europe. The analysis provides empirical evidence on the association between decentralization and budget deficits of the general government for a panel of 11 former transition countries during 1991–2018, controlling for the effects of various demographic, institutional, and macroeconomic variables.
The authors find evidence that decentralizing government activities in Central and Eastern Europe (CEE) has favorable effects on the fiscal position of general government. Also, the results show that the greater reliance on intergovernmental grants as a source of finance of local governments does not have detrimental effects on the overall fiscal discipline in these countries. Therefore, the authors find no support for the so-called ‘common pool’ hypothesis, which predicts that intergovernmental transfers lead to higher public expenditure, thus exacerbating the fiscal imbalances of the general government. On the other hand, the results show that the effects of revenue decentralization depend critically on the specific measure of local government revenue.
Suzana Makreshanska-Mladenovska and Goran Petrevski (2020) Decentralisation and fiscal performance in Central and Eastern Europe, Post-Communist Economies, DOI: 10.1080/14631377.2020.1793609