1. Introduction
Many developing countries and transition economies have a mandate to
decentralize aspects of their public finance. At the same time, many developed
economies such as the United States, the United Kingdom, and Canada are
reviving debates on devolution. Decentralizing revenue raising and spending
decisions is seen as a way to improve the efficiency of the public sector, cut the
budget deficit, and promote economic growth (Bird, 1993; Bird, Wallich, 1993;
*Corresponding author. Room N 10-075, the World Bank, 1818 H St. NW,Washington, DC 20433,
USA. Fax: 001 202 522 1154; e-mail HZOU@Worldbank.Org
0047-2727/98/$19.00 ó 1998 Elsevier Science S.A. All rights reserved.
PII S0047-2727(97)00057-1
222 T. Zhang, H. Zou / Journal of Public Economics 67 (1998) 221 –240
Bahl, Linn, 1992; Gramlich, 1993 and Oates, 1993). The argument is that
decentralization will increase economic efficiency because local governments are
better positioned than the national government (Oates, 1972) to deliver public
services that match local preferences and needs, and that over time, efficiency
gains will lead to faster local as well as national economic growth.
Such conventional wisdom is reflected in numerous studies on intergovernmental
fiscal relations in China (Bahl,Wallich, 1992; World Bank, 1990, 1992). Many
proposals favor assigning more revenue and expenditure responsibilities to local
governments. However, in China there is concern that decentralization has been
implemented too fast and has gone too far, and that this is threatening macroeconomic
control and stability (Wang, Hu, 1993; World Bank, 1995, 1996). It
seems that national priorities in public spending have often been crowded out by
local public projects.
Despite the mounting concern, there have been very few empirical studies of the
relationship between fiscal decentralization and economic growth for developing
countries in general, and for China in particular. This paper explores how the
allocation of fiscal resources between the central and local governments has been
1 associated with economic growth in China since the reforms of the late 1970s.
First, we will summarize the trend in fiscal allocation between the central and
local governments in Section 2 and then empirically test the impact on economic
growth of spending by different levels of government using provincial panel data
during the period 1978–1992 in Section 3. Section 4 concludes the paper.