Decentralization and corruption: evidence across countries

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Abstract

The relationship between decentralization of government activities and the extent of rent extraction by private parties is an important element in the recent debate on institutional design. The theoretical literature makes ambiguous predictions about this relationship, and it has remained little studied by empiricists. In this paper, we systematically examine this issue empirically, by looking at the cross-country relationship between fiscal decentralization and corruption, as measured by a number of different indices. Our estimates suggest that fiscal decentralization in government expenditure is strongly and significantly associated with lower corruption; these results persist when decentralization is instrumented for by the origin of a country’s legal system.

Introduction

In recent years, there has been considerable debate on the merits of government decentralization. Those in favor of devolving powers of revenue collection and expenditure to local authorities have been guided to a large extent by the rationale, first expressed by Tiebout (1956), that decentralization leads to greater variety in the provision of public goods, which are tailored to better suit local populations. On the other side, Prud’homme (1995) and Tanzi (1996) have argued that there exist many imperfections in the local provision of services that may prevent the realization of benefits from decentralization. For example, local bureaucrats may be poorly trained and thus inefficient in delivering public goods and services.

More recently, however, Besley and Coate (1999) have shown that, with the exception of heterogeneity of preferences, there is relatively little theoretical support for claims of differential provision of services. Hence, they assert, decentralization must be justified by political economy explanations. One such possibility, which has received much attention, is that accountability and behavior of bureaucrats may differ between centralized and decentralized systems.

Recent theoretical models make opposing predictions on the relationship between decentralization and corruption: models that emphasize interjurisdictional competition or direct monitoring of bureaucrats generally favor decentralization, while those that focus on coordination of rent-seeking or bureaucratic competence often take a negative view of decentralization. Furthermore, the type of decentralization often matters in these models: in particular, whether revenue generation and expenditure, or just expenditure, is decentralized, will influence the extent of bureaucratic corruption. Thus, while there is a general belief that decentralization and government corruption are closely linked, theories differ in their predictions of what the net relationship between them should be.

It would therefore be useful to assess the empirical link between decentralization and corruption, an exercise that has yet to be undertaken in any systematic way. A couple of previous papers examine related issues, but we believe in a somewhat partial manner. The only previous work that, to our knowledge, looks directly at the issue of fiscal decentralization is by Huther and Shah (1998), who note a negative correlation between corruption and decentralization. However, they look only at the unconditional correlation between fiscal decentralization and corruption. There are many factors that would obviously be highly correlated with both variables: in particular, income is highly correlated with quality of governance, however measured, and is also strongly correlated with decentralization (it is well known that development is generally accompanied by decentralization). Hence, problems of omitted variable bias are extreme in such an analysis. A second related paper, by Treisman (2000), finds that federalist countries have higher rates of corruption. Treisman’s measure of decentralization is a simple dummy variable, reflecting whether a country has a federal structure, which may not accurately reflect the true extent of decentralization of powers and resources in a given country. We discuss this issue further in the data section.

In this paper, we provide a more systematic examination of the cross-country relationship between decentralization and corruption. We find that fiscal decentralization in government expenditure is consistently associated with lower measured corruption across countries. This result is highly statistically significant, is not strongly affected by outlier countries, and is robust to a wide range of specifications, including all of those that have been used in the recent cross-country literature on corruption. Moreover, we find the origin of a country’s legal system to be a good instrument for the extent of government decentralization, and our results suggest that the effect of decentralization on corruption persists when decentralization is instrumented for in this way. Our work supports the idea that the continuing trend toward greater decentralization may be justified based on the greater accountability of government bureaucrats that this government structure may engender.

The rest of this paper is organized as follows: Section 2 reviews the theories relating decentralization to corruption, and examines their predictions of this relationship. Section 3 describes the variables used in our analyses. In Section 4, we provide regression results on the relationship between corruption and decentralization, using cross-country data. Section 5 concludes the paper.

Section snippets

Theories of decentralization

A variety of models have been developed to examine the political economy of decentralization, leading to very different implications for the relationship between decentralization and corruption. Broadly speaking, these models emphasize several basic factors: (a) interjurisdictional competition; (b) monitoring and direct accountability; (c) dispersion of decision-making powers; (d) competence and bureaucratic ‘quality’.

The first of these, initially developed by Brennan and Buchanan (1980),

Data description

The data for our test are drawn from a wide range of sources. Appendix A provides a detailed description of the variables and their sources.

As our principal measure of corruption, we use the International Country Risk Guide’s corruption index (CORRUPT); this is the measure that has been most commonly used in previous work in the economics literature. This variable is meant to capture the likelihood that government officials will demand special payments, and the extent to which illegal payments

OLS estimation

Our basic specification is:

CORRUPTi=α+β1*DECENTRi+β2*ln (GDPi)+β3*CIVILi+β4*ln (POPi)+ β5*GOVSHAREi+ϵi

Table 2 reports coefficients from OLS estimation on data from a cross section of 55 countries. Significance of the estimates is based on White-corrected standard errors.

Our measure of decentralization enters the regression with a negative and strongly significant sign, indicating that countries with more decentralized expenditure have better corruption ratings. The size of the coefficient

Conclusions

In this paper, we have made an initial assessment of the relationship between decentralization and corruption. We find a very strong and consistent negative association between the two variables across a sample of countries, thereby providing some support for theories of decentralization that emphasize its benefits. This association is robust to controlling for a wide range of potential sources of omitted variable bias as well as endogeneity bias.

Although data availability limits the

Acknowledgements

We thank Shantayanan Devarajan for useful conversations, and Paolo Mauro, seminar participants at the IX Conference of the Italian Society of Public Economics and the World Bank, two anonymous referees, and the editor for valuable comments. All errors are our own. The views expressed here do not necessarily reflect those of the World Bank or its member countries. Please send correspondence to [email protected] or [email protected].

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