The Effect of Crises on Fiscal and Political Recentralization: Large-Panel Evidence

Economic stability plays a key role in any fiscal and political decentralization process. In the face of financial and economic shocks, when revenues and expenditures are reduced, countries may decide to gather resources at the central level—creating a recentralization scenario—or may take away devolved powers and centralize political institutions. Using data for 75 countries, we examine the effects of economic crisis on fiscal and political decentralization. We find that several types of crises lead to fiscal recentralization; only in the case of domestic borrowing crises is the effect further revenue decentralization, probably reflecting the central government’s willingness to empower subnational governments to avoid similar crises in the future. In addition, we explore the effects of economic crisis on political decentralization and find that they are concordant to the fiscal decentralization effects, suggesting an alignment of effects along political and fiscal dimensions of subnational autonomy. We also examine whether economic crises trigger more permanent, rather than just transitory, changes in the level of decentralization. We generally find more long-lasting effects in the case of fiscal decentralization measured from the expenditure side. This pattern is very apparent in the cases of inflation and banking crises and less clear but still present in the cases of currency and external debt crisis. The main results are robust to different specifications, estimation methods, and measurements of decentralization.