Sustainable Development and the Optimal Level of Fiscal Expenditure Decentralization

Both excessive and insufficient levels of expenditure decentralization reduce efficiency of government and service provision, thereby exerting an adverse impact on national sustainable development. The main goal of this paper is to explore this proposition theoretically and empirically, seeking to determine the optimal level of expenditure decentralization. From a theoretical perspective, we introduce the expenditures of central and sub-national governments into Barro’s (1990) model and find a hump-shaped relationship between expenditure decentralization and sustainable development as well as striking upon the optimal expenditure decentralization on the theoretical level. To further test this finding empirically, we adopt the NSDI (National Sustainable Development Index) to measure sustainable development and use panel data for 52 countries covering the period 1991-2016 to validate the theorized hump-shaped relationship between expenditure decentralization and sustainable development both in the short and long run. These results remain significant even in two-stage least squares (2SLS) estimations with the Geographic Fragmentation Index (GFI) as the instrumental variable and are robust to alternative specifications. Finally, we also utilize the Lind-Mehlum method to determine the optimal level of expenditure decentralization and find results consistent with the other methods.