Revisiting the Relation Between Decentralization and Growth in the Context of Marketization

Abstract

Decentralization in countries in transition did not take place in isolation from other marketization reforms. Although the latter have been shown to support growth, the literature on fiscal decentralization and growth is not conclusive. Our work revisits this relationship within the wider context of reform. This article uses a generalized method of moments (GMM) on a panel of eighteen East European countries in transition for the period 2002--2008. We show that decentralization has a positive impact on growth conditional to local government’s autonomy to manage the structure of local public expenditure toward its recurrent component to open the way for more private sector engagement in service delivery. Moreover, our results confirm the reverse causality between local financial indicators and growth: A higher level of growth leads to a lower level of government intervention and a smaller public sector, which confirm previous results.