Does political decentralization affect income inequality? The role of governance quality

ABSTRACT

This paper examines whether an increase in political decentralization, which is a global trend, affects income inequality. It argues that the effect of decentralization on equality lies with the quality of governance, that is, how well the traditions and institutions of an authority in a country are exercised. Using an instrumental variables (IV)/two-stage least squares (2SLS) method, this paper shows that an increase in decentralization reduces inequality. However, this reduction is stronger for countries with a relatively low quality of governance, possibly because private investments in these countries reduce income inequality. A policy implication is that institutional-specific decentralization strategies can reduce inequalities.

KEYWORDS:

• political decentralization
• income inequality
• governance quality
• private investments
• world

JEL:

• H11
• H70
• D31

ACKNOWLEDGEMENT

I thank James Robinson (University of Chicago), the seminar participants at the University of California – Irvine, and the two anonymous referees for their useful comments and suggestions on an earlier version of this paper. I also thank Fulbright for my six months’ visit at the Harris School of Public Policy of the University of Chicago.

DISCLOSURE STATEMENT

No potential conflict of interest was reported by the author.

Notes

1. ‘Political decentralisation refers to the power of subnational governments to undertake the political functions of governance (Pike et al., 2012)’ (Tselios & Rodríguez-Pose, 2020, p. 5). It involves devolving political power from the central state to elected local/regional administrations, which inherit either direct or indirect responsibility and duties for the design, provision and allocation of specific public services (Khan et al., 2017). Hence, the elected local/regional administrations have self or shared responsibility for the public service provision.

2. For a review of RAI, see Dardanelli (2019).

3. These countries are: Albania, Argentina, Australia, Austria, the Bahamas, Bangladesh, Barbados, Belgium, Belize, Bhutan, Bolivia, Bosnia and Herzegovina, Brazil, Bulgaria, Cambodia, Canada, Chile, China, Colombia, Costa Rica, Croatia, Cyprus, the Czech Republic, Denmark, Dominican Republic, Ecuador, El Salvador, Estonia, Finland, France, Germany, Greece, Guatemala, Guyana, Haiti, Honduras, Hungary, Iceland, India, Indonesia, Ireland, Israel, Italy, Jamaica, Japan, Korea, Kosovo, Laos, Latvia, Lithuania, Luxembourg, North Macedonia, Malaysia, Malta, Mexico, Mongolia, Montenegro, Myanmar, Nepal, the Netherlands, New Zealand, Nicaragua, Norway, Pakistan, Panama, Papua New Guinea, Paraguay, Peru, the Philippines, Poland, Portugal, Romania, Russia, Serbia, Singapore, Slovakia, Slovenia, Spain, Sri Lanka, Suriname, Sweden, Switzerland, Taiwan, Thailand, Timor-Leste, Trinidad and Tobago, Turkey, the Ukraine, the UK, the United States, Uruguay, Venezuela and Vietnam.

4. See https://data.worldbank.org/indicator/.

5. See https://www.rug.nl/ggdc/productivity/pwt/?lang=en/.

6. ${\beta }_1$ captures the impact of $DEC$ on $INEQ$ when $GOV=0$. For example, if ${\beta }_1$ is not statistically significant, it is only when $GOV=0$, and this hypothesis may or may not be supported at other levels of $GOV$ (Braumoeller, 2004). Hence, ‘one cannot determine whether a model should include an interaction term simply by looking at the significance of the coefficient on the interaction term’ (Brambor et al., 2006, p. 74).

7. The regression results of the unconditional hypothesis do not show evidence that decentralization directly affects inequality (see Table A1 in Appendix A in the supplemental data online).

8. These results can be provided upon request.

Additional information

Funding

This work was supported by the Fulbright Foundation in Greece.