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This paper examines whether the efficiency gains that allegedly accompany fiscal decentralization (FD) generate higher growth in more decentralised economies. Previous research on this relationship has failed to generate a consensus. We examine a sample of 23 OECD countries over 1972-2005, applying pooled mean group and instrumental variable techniques to a dynamic panel dataset. We find that spending decentralization decreases, while revenue decentralization increases, economic growth. Since OECD countries are substantially more spending than revenue decentralized, this evidence provides strong support for Oates (1972) hypothesis that maximum FD efficiency gains require a close match between spending and revenue decentralization. Some recent studies have concluded that increasing subnational autonomous revenue increases growth. Our conclusion is rather that convergence between spending and revenue decentralization is growth-enhancing. Our results are robust to various FD definitions and demonstrate the importance of testing simultaneously for these two FD-growth effects.
