Decentralization and the Composition of Public Expenditures

We examine the relationship between fiscal decentralization and the functional composition of public expenditures. Using a distance-sensitive representative agent model, we hypothesize that higher levels of fiscal decentralization induce agents to demand increased production of publicly provided private goods. We test this hypothesis using an unbalanced panel data set of 59 developed and developing countries covering a 30-year period. We find that expenditure decentralization positively and significantly influences the share of health and education expenditures; this finding is robust across multiple estimators. Expenditure decentralization thus appears to alter the composition of public expenditures towards publicly provided private goods.