Decentralized Governance: Convergence or More Inequality?

Fiscal federalism research argues that decentralization causes subnational governments to promote fiscally austere policies, which leads to a downward spiral in welfare spending. To increase tax competitiveness and to avoid an in-migration of unwanted “welfare seeking” citizens, subnational governments are believed to match the reduction in welfare spending levels of fellow subnational governments, a process which will lead to a narrowing of subnational spending differentials. This paper challenges the existing fiscal federalism consensus on two grounds. On a theoretical level it argues that rather than inducing competition, decentralization increases the decision-making leeway of subnational governments and thereby enhances the variability of subnational policy choices. Hence we see an increase in within-country variation instead of a narrowing of regional differentials. Additionally, the paper offers an empirical critique by arguing that existing research is ill equipped to analyze the effect of decentralization since its focus on single highly decentralized countries has prevented it from more fully exploring variation in levels of decentralization. Departing from existing research, this paper puts forward a comparative analysis of subnational welfare spending in 14 OECD countries over a period of 20 years. The results show that decentralization is associated with more – not less – variation in welfare spending, although fiscal equalization and policy coordination mechanisms moderate the centrifugal effect of decentralization.