Federalism, Human Capital Accumulation and
Inequality
Floriana Cerniglia
University of Milan - Bicocca. Dipartimento di Economia Politica
Riccarda Longaretti∗
University of Milan - Bicocca. Dipartimento di Economia Politica
October, 2012
Abstract
In this paper we use an overlapping generations model with heterogeneous agents and an education-related public good, in order to analyze
the relationship between fiscal federalism, human capital accumulation,
and inequality in the distribution of human capital and income among
individuals and regions. We show that the more dispersed the distribution of income within a region, the more the region benefits from a
decentralized provision of the education-related public good, in terms of
higher accumulation of human capital. Nevertheless we show that, with
decentralization, there exists a trade-off between accumulation of human
capital and equality in the distribution of income among citizens within a
region: a region that accumulates more (less) human capital with decentralization, exhibits also higher (lower) interpersonal inequality among its
citizens. Results show also that federalism may reduce regional disparities.
Keywords: Fiscal Federalism, Overlapping Generations, Heterogeneous
Agents
JEL Codes: H77, I24
∗ Corresponding author. Università di Milano - Bicocca, Dipartimento di Economia Politica. Piazza dell’Ateneo Nuovo, 1 - 20126 - Milano (Italy). Phone: 00390264483017; Fax:
00390264483085. Email: [email protected]
1
1
Introduction
In the last decades, fiscal federalism policies have been largely promoted in many
countries, and the move towards greater fiscal decentralization has been generally motivated by the need for a more efficient use of public resources. Decentralization is surely a complex and multifaceted concept.1 The topic into public
finance theory mainly refers to the shifting of some expenditure and revenue
powers from the central government to local or regional governments (Tanzi,
1996). Economic efficiency is the central argument for fiscal decentralization,
based on two complementary assumptions: i) local governments are better positioned than the central government to deliver public services efficiently since
they are presumably much closer to the citizens of their respective jurisdictions,
and therefore they are more knowledgeable of both local preferences for the public good and cost conditions than a central government, ii) this efficiency gain
can be further enhanced by population mobility within national boundaries: citizens can sort themselves into the jurisdictions that best match their preferred
tax-expenditure package, and consequently this stimulates competition among
local governments to attract the mobile tax base. So, the traditional theory
of fiscal federalism spurred by the seminal contributions of Oates (1972) and
Tiebout (1956) shows that the efficient level of output of "a local" public good2
is likely to vary across jurisdictions as a result of both differences in preferences
and cost differentials, and, in order to maximize overall social welfare function,
local outputs should vary accordingly.3
Moreover, since the traditional theory on fiscal federalism simply assumes
that public decision-makers are benevolent maximizers of the social welfare,
recently the political economy approach analyzes the potential gains of fiscal
decentralization considering in more details the fiscal and political incentives
faced by subnational officials (Weingast, 2009). For instance, it turns out that
within a set of institutional arrangements, fiscal decentralization may increase
the accountability of public officials and this also reinforces the efficiency gains
that can be achieved through decentralization (Lockwood, 2006).
In summary, in the literature on fiscal federalism, there are already a number
of contributions that link efficiency gains to federalism but there are only few
papers that explicitly refer also to the issue of economic growth and territorial
disparities which are instead the main concerns of our study. So in the current state of the fiscal decentralization literature there is a paucity of research
regarding the effects of decentralization on economic growth and on territorial
disparities, and this is an important gap in the literature, we believe, since an
obvious question should be: since fiscal decentralization leads to more efficient
governance and better public good, does this also imply higher economic growth
and, eventually, a reduction of territorial disparities? Fiscal decentralization
may indeed have an impact on economic growth and on regional disparities as
1 "Decentralization seems often to mean whatever the person using the term wants to mean"
(Bird (1993), p. 208). See also Rodden (2004).
2 Which is that for which the sum of residents’ marginal benefits equals marginal costs.
3 For a survey of this literature see Oates (1999).
2
informally suggested by Oates (1993) and Qian and Weingast (1997) who first
added economic growth in the normative discussion of fiscal decentralization.
However, little effort has been made so far in this direction and the theoretical background for this relationship remains largely underdeveloped. In other
words, the contemporary economic literature (both theoretical and empirical) is
still far from clear-cut results both in terms of the sign and the size of the effects
of decentralization on growth and inequality and in terms of the mechanisms
at work beyond those links. Moreover, most of the existing studies, with only
few exceptions, basically neglect the effects of decentralization on interpersonal
inequalities.
To obtain a concise picture on the state of economic research in this field,
in the following we firstly present these pioneering attempts. We thus review
a number of studies (theoretical and empirical ) that focus - directly or indirectly - on the link between federalism and growth and between federalism
and inequality. We analyze these studies, and we try to identify and label the
mechanisms of transmission between federalism, growth and inequality. The
analysis is further developed, presenting a two-period model with overlapping
generations of heterogeneous agents and an education-related public good, in order to interpret most of the stylized facts (as collected in reviewing the papers)
in terms of human capital accumulation and inequality, both at the territorial and at the interpersonal level. In this model, the emphasis is mostly on
the link between the distribution of income among agents within a jurisdiction
and the distribution of income between different jurisdictions. Put differently,
interpersonal inequality affects territorial inequalities. The rationale relies on
the fact that interpersonal distribution of income determines the performance
of a jurisdiction and this, in turn, affects its average income both in absolute
terms and in relative (with respect to other jurisdictions) terms. Results show
that although federalism may increase interpersonal inequality, it could reduce
regional disparities.
The outline of the paper is as follows: the following section widely reviews
the literature on federalism and growth and on federalism and inequality. Section 3 introduces the model, and derives the results in terms of the effects of
decentralization on capital accumulation and on interpersonal and territorial
inequality. Section 4 concludes and gives suggestions for further research.
2
2.1
The related literature
Federalism and growth
In the last decades both the theoretical and the empirical literature has been
challenged to investigate the link between fiscal federalism and economic growth.
It is well known that, in the perspective of the neoclassical growth model, given
the production technology, the per capita income in the steady state is determined by the savings rate, the growth rate of the population, and the rate
of depreciation of capital. The rate of growth of per capita income therefore
3
is totally and exogenously given by technological progress. The literature on
endogenous growth instead identifies the factors that may guarantee endogenously a positive rate of growth of per capita income. These factors may be
broadly summarized in the following: (i) endogenous technological change; (ii)
increasing returns to scale at the aggregate level. An important result of the
endogenous growth literature is that the saving rate positively affects the long
run economic growth. In order to analyze how fiscal federalism affects growth,
we should therefore investigate if and how it could affect the saving rate, or
generate technological progress, or finally produce increasing returns to scale.
Notice that technological progress can be interpreted in a broad sense. On one
hand, it can include the entrepreneurial spirits that lead the private sector to
search for and implement superior production technologies. On the other hand,
it can be thought of as the result of a more efficient public sector, as predicted
by the normative theory of fiscal federalism (Oates, 1972; Tiebout, 1956).
Federalism and endogenous saving decisions
As stated above, if there is a channel through which federalism affects the
propensity to save, federalism may affect growth.
Firstly, federalism may increase the saving rate thanks to a provision of
public good that better suits local preferences. In this perspective, Brueckner
(2006) builds an overlapping generation model with heterogeneous agents that
are perfectly sorted through a Tiebout mechanism into different jurisdictions.
Each jurisdiction is age-homogeneous and receives a supply of public good that
perfectly fulfills its demand. Individuals can invest in human capital while being
young and this leads to higher productivity and earnings when being old. The
consumption of public good rises when old, due to the higher income, therefore
the young always demand a lower level of public good. Brueckner compares
the capital accumulation in a federal system with the capital accumulation in a
unitary system. In the latter case, a unitary government is assumed to supply
an average level of the public good, which lies in between the provision of the
public good demanded by the young cohort (which is identical to level of public
good that the jurisdiction of young individuals would receive under a federalist
system) and the level of public good demanded by the old cohort (which is identical to level of public good that the jurisdiction of old individuals would receive
under a federalist system). Brueckner embraces the traditional assumption of a
uniform provision of the public good by the unitary central government. This
assumption - as it is well known to those who are familiar with the literature on
fiscal federalism - has been justified firstly on the ground that only local governments possess knowledge of both local preferences and cost conditions, and
secondly by the fact that there are typically political pressures (or constitutional
constraints) that require uniformity in central provision.4
In Brueckner the public good is financed by a uniform (per unit of public
4 Recently, the political economy approach has endogenized such uniformity introducing a
bargaining process within the Parliament. Notice that results in terms of the efficiency gains
that can be achieved through decentralization of local public goods still hold (see Besley and
Coate 2003 and Lockwood 2002). For a survey on this strand of literature see Oates (2005),
Lockwood (2006) and Weingast (2009).
4
good) lump-sum tax. Results show that in a federalist system young agents
would receive a lower level of the public good than in a unitary system and
therefore they would pay a lower tax per head. This increases the after-tax
income of the young individuals and therefore increases their incentive to save,
fastening economic growth.
In the literature, another mechanism that has been proposed to justify the
link between federalism and the saving rate is tax competition. Under the assumption of perfect mobility of capital across regions, tax competition can lower
the tax on capital. This is the well known "race to the bottom result": decentralized tax setting in a federal union leads to inefficiently low capital income
tax rates as local governments compete with each other in order to attract
capital. Nevertheless this fiscal externality, in a dynamic model of economic
growth, can be offset, since it increases the return to savings, capital accumulation, and growth (see Lejour and Verbon, 1997; Hatfield, 2006; Koethenbuerger
and Lockwood, 2010; and Chu and Yang, 2012). Tax competition may also
imply negative externalities in the perspective of growth. Koethenbuerger and
Lockwood (2010), for example, show that tax competition is dampened down if
there are technological stochastic shocks, since households face a portfolio choice
problem. As a result, with decentralization taxes may be above the centralized
level. Therefore growth can be lower with decentralization. This happens when
the number of regions is small and when the variance of the shock is sufficiently
high. Lejour and Verbon (1997) already pointed out the possibility of these
negative externalities, modelling ad hoc imperfect mobility of capital and strict
preference of the households to invest in the foreign region.
Federalism and technological progress: federalism may enhance the market
efficiency
As said above, technological progress can be thought of as the entrepreneurial spirits that lead the private sector to search for and implement superior
production technologies. If federalism induces such technological progress, it
may foster economic growth. In this sense, there is a large body of literature,
namely the New Economic Geography5 , that explains the so called "agglomeration effect" in the productive activities. Important factors that positively
influence the agglomeration are the presence of economies of scale and knowledge spillovers that offset the presence of transportation costs. Agglomeration
of economic activities indeed have a positive growth effect, fastening the accumulation of physical capital. Under this perspective, decentralization of some
competencies of the public sector to local governments have an impact on the
agglomeration of economic activities and on the speed by which capital is accumulated and, most importantly, on the quality of capital that is accumulated. In
this sense, fiscal competition among different regions may be linked to agglomeration effects. Local governments may have the incentive to differentiate the
supply of public goods in different regions, in order to alleviate the pressure of
fiscal competition. Each different region would attract therefore different kind
of private capital (Justman et al.,2002). By the same token, peripheral regions
5 See
Krugman (1991).
5
may catch-up with the richer ones through a suitable fiscal policy (Brackman
et al, 2002).
Another argument behind the potential growth process in a federal system
can be detected in the pioneering idea of Brennan and Buchanan (1980) that
only competitive local governments can tame the Leviathan government that
expropriates rents from citizens and private enterprises. This approach to fiscal federalism has been further investigated in the so-called "market preserving
federalism" as suggested by Weingast (1995). He argues that, under certain
conditions and characteristics, a federal system can be market preserving, thus
reducing the central government’s political responsiveness to interest groups; he
documents that this form of federalism underpinned the rapid economic development in England during the 18th century, in the United States during the
19th century and in the modern China.6 Edwards (2005) also addresses the
argument of how to design institutions so that the government can commit to
not expropriate citizens in the future. He shows that federalism and regional tax
competition act as a commitment device, resolve the time consistency problem
and therefore commit the state not to expropriate in the future.
Federalism and technological progress: federalism may enhance the efficiency
of the public sector.
Oates (1993) firstly and informally recognized the effect of fiscal federalism
on growth. He conjectured that the efficiency argument put forward by himself
in the well-known decentralization theorem (1972) should display gains also in
terms of a higher growth.7 In fact a more efficient public sector contributes
to improve the environment where the economic activity takes place and, as
remarked above, this may be interpreted as technological progress. In the literature, the reason why fiscal decentralization may imply an increase in the
efficiency of the public sector can be seen in a number of considerations.
Firstly, local governments can provide an amount and quality of goods and
services that better suits local preferences and needs. This, in a dynamic perspective of economic growth, may imply higher rates of growth. In this regard,
papers to be mentioned are: Davoodi and Zou (1998), Bruecker (2006) and
Cerniglia and Longaretti (2012). We have already discussed Brueckner (2006)
as a paper that identifies the crucial link between fiscal federalism and growth
in the savings rate. As for Cerniglia and Longaretti (2012), the higher efficiency
of the public sector generates increasing returns to scale (for a detailed analysis
see below). Finally, Davoodi and Zou (1998) develops a very simple AK-model
of economic growth to introduce their empirical analysis. They present a CobbDouglas production function whose exponents capture shares of spending (introduced exogenously) by the three levels of government (federal, state, local).
This composition positively affects growth.
Secondly, fiscal decentralization implies a transfer of expenditure decisions
6 See
also Rodden and Rose-Ackerman (1997) and Montinola, Qian and Weingast (1995).
surely are strong reasons, in principle, to believe that policies formulated for the
provision of infrastructure and even human capital that are sensitive to regional or local
conditions are likely to be more effective in encouraging economic development than centrally
determined policies that ignore these geographical differences" (Oates (1993), p. 240)
7 "There
6
and taxing powers to local governments that should go hand in hand with a set of
institutions aimed to improve the accountability of local politicians (Bordignon,
Cerniglia and Revelli (2003)). If this were indeed the case, local governments
would search for and implement innovations in the production and supply of
public goods and services. Production costs and prices of public goods and
services could thus be lower and their quality better in a federalist system. This
possibility in the literature is also known as "laboratory federalism" (Oates,
1999). Moreover, the central government may be able to concentrate better
on the efficient production of those public goods still under its responsibility
(Martinez-Vazquez and Mc Nab, 2003).
Federalism and increasing returns to scale
The endogenous growth theory generally identifies the origins of increasing
returns in the presence of either externalities or imperfect competition. In this
regard, Cerniglia and Longaretti (2012) identifies instead the possibility of increasing returns in the higher efficiency of the public sector achievable through
the provision of a local public good which is education-related. Education policies at local level seem very reasonable: education is a competence of local
governments in many federal countries as documented in Sacchi and Salotti
(2012a). More precisely, in Cerniglia and Longaretti (2012), at first, a perfect
Tiebout world, when agents are completely heterogeneous, is analyzed. In this
scenario, the provision of the public good would be the efficient one, that perfectly fulfils individual demands. Since individual demands for the educationrelated public good are increasing and convex in the individual level of human
capital, increasing returns in the accumulation of human capital would arise in
the Tiebout world, and all the jurisdictions and the economy as a whole would
grow at increasing rates. The Tiebout world is studied as a benchmark case the most efficient solution - in order to focus the attention to a more realistic
scenario, that is the decentralized world, and compare it with the centralized
world. With decentralization, a local government provides a uniform level of
an education-related public good, averaging the preferences of all its citizens.
Results show that each jurisdiction benefits (in terms of growth) from being
in a decentralized economy, the larger the variance in agents’ endowments of
human capital. In this respect intra-jurisdiction heterogeneity is not necessarily
a bad thing: in the context of increasing returns, more dispersed human capital
implies higher rates of growth. Therefore, in a decentralized world, even a poor
region could grow at higher rates, with respect to a centralized world, as long as
heterogeneity in the distribution of human capital offsets its low average human
capital.
The empirical literature
The results of the empirical research on the link between decentralization and
growth are mixed (for a survey on the empirical works see also Martinez-Vazquez
and Mcnab (2003)). As for cross-countries studies, on one hand, some papers
(for instance the paper by Davoodi and Zou (1998) previously mentioned) do not
find any robust evidence on a relationship between decentralization and growth
in the developed countries, whereas the link is negative, although weakly significant for developing countries. On the other hand, other papers (see Thiessen,
7
2003) have found more robust evidence that fiscal federalism positively affects
growth in high-income countries. Single-country studies obtain more clear-cut
results in favour of a positive effect of decentralization on economic growth
in transition economies, such as China (Lin and Liu (2000); Qiao, Martinez
Vazquez and Yu (2002); Jin, Qian and Weingast (2005); Feldenstein and Iwata
(2005)), and Russia (Desai, Freinkman and Goldberg (2003)). The evidence
for developed countries (US, Germany and Switzerland) is more mixed. For
example Xie, Zou and Davoodi (1999) find no significant impact of expenditure
decentralization on growth for US during 1951-1992, whereas Stansel (2005) find
a positive link for US during 1959-1989. At this stage, it is possible to argue
that these conflicting results may be due mainly to a lack of clear theoretical
explanation as to why one should expect this relationship to exist, and therefore
a lack in the hypotheses to test empirically. Other possible explanations of the
mixed empirical results may rely on different measures of fiscal decentralization
that can be used, as well as to samples, estimation methods, etc.
As shown above, however, the analysis of the link between decentralization
and growth becomes even more relevant when decentralization deals with the
provision of an education-related public good. To the best of our knowledge,
there exist very few single-country empirical papers that analyze the link between educational decentralization and the quality of education. For instance,
Galiani, Gertler, and Shargrodsky (2008)8 conduct an evaluation of the effect of
decentralization on the quality of education in Argentina, where, between 1992
and 1994, the central government transferred all its secondary schools to provincial control. They found that this decentralization process had a positive impact
on students’ test score, which are a proxy of the quality of education. Reasonably, a better quality in education improves human capital and, by this token,
increases growth. Prima facie this result seems consistent with the theoretical
prediction of Cerniglia and Longaretti (2012).
Summing up the literature is still far from theoretically identifying and empirically testing a significant causal link between fiscal decentralization and economic growth.
2.2
Federalism and inequality
The decentralization process affects the economic performance of a country in
terms of efficiency (growth) but also in terms of equality (the distribution of
income).
The question if decentralization is associated to a lowering or rising of economic disparities, both at the regional level and at the individual level, has
been neglected for a long period by the literature on the basis that the equalization role played by a unitary government is reduced under decentralization.
Prud’homme (1995) stressed this result, and obviously a conflict beween efficiency and redistribution strongly arises with decentralization. For instance, in
8 For the small empirical single-country literature on decentralization and educational outcomes see also references therein.
8
the Italian political debate on fiscal federalism in the last twenty years, equality
concerns have been much more extensively emphasized than the efficiency argument and the achievable gains with decentralization.This argument has been
mainly motivated with the existence of a huge difference between the North
and the South of the country in terms of per-capita income, growth and quality
of public goods (see Banca d’Italia (2010)). Academic studies applied to the
Italian case are surprisingly scarce so far to support or to refute this argument.9
Recently there has been a revival of interest on this potential link, but mainly
from an empirical point of view. Notice that the causal relation between decentralization, redistribution, and inequality might even be reversed. There exists
in fact a strand of the literature that considers inequality to be among the forces
that lead to the choice of fiscal federalism as an institutional setting10 (Pommerehne (1977); Panizza (1999); Cerniglia (2003); and Alesina and Spolaore
(2003)). However, as observed by Beramendi (2009), it may be the case that "It
is not decentralization that causes inequality, but rather preexisting economic
inequalities that drive the decentralization of the welfare state, which in turn
reproduces the preexisting patterns of inequality” (Beramendi (2007), p. 786).
The rationale is the following: distributive tensions, derived from the territorial
inequality, shape the choice of institutional fiscal settings.
2.2.1
Federalism and territorial disparities
Most of the literature, both theoretical and empirical, on the link between federalism and inequality deals with territorial disparities. Despite some exceptions
that claim that decentralization is associated with a reduction in territorial
disparities, the prevailing view is that the transfer of powers and resources to
subnational governments, in particular as for developed countries, benefits in
particular the most prosperous regions, with better socioeconomic endowments
and better institutions.
Federalism and higher territorial disparities
Theoretically, the channels through which decentralization may imply greater
regional disparities are, according to Rodríguez-Pose and Gill (2005), of economic and political nature. From an economic perspective this may be due to
the differences in institutional capacities and socioeconomic endowments among
regions within any given country. In fact, decentralization may be a less efficient way of delivering basic goods and services to very poor regions, because
of the loss of economies of scale. Furthermore poor regions are more likely to
have more corrupt institutions, lower access to capital, smaller tax bases, and
weaker infrastructural, educational, and technological endowments, that represent a serious constraint to attract capital, investment, talents and innovate in
the same way as their richer counterparts, thereby distorting the allocation of
9 Calamai (2009) is an exception. He concludes saying that in Italy devolution has not
certainly stimulated the widening of regional disparities. However drawbacks of this study are
the different measures used in the analysis to indicate the decentralization process in Italy in
the last decades.
1 0 This literature mainly deals with regional disparities and ethnic inequalities.
9
resources and perpetuating and even exacerbating pre-existing patterns of disparities in the provision of goods and services, income, and wealth.11 From a
political perspective, decentralization may imply a reduction of the influence of
poorer regions (Devarajan, Khemani, and Shah (2007)). Therefore an increase
in inequality can be due to competitiveness for national resources and transfers
as richer regions could have greater influence in the allocation of financial resources and transfers. The redistributive power of the central government would
therefore be weakened and poor regions would be more vulnerable under a territorially regressive financial system. Summing up, therefore, the rich regions,
with a better socioeconomic environment would benefit more from decentralization to subnational governments.Tanzi (1996) stresses that decentralization in
developing countries might cause coordination problems and a poor quality of
local bureaucrats. Moreover from an efficiency perspective, persistent interregional inequalities are inefficient at the national level since the bad performance
of poor regions, that are left behind, lowers overall national wealth.
Federalism and lower territorial disparities
On the other hand, in the vein of the efficiency gains predicted by the decentralization theorem, there exist a number of studies that predict that decentralization reduces territorial inequalities (Weingast (1995); Qian and Weingast (1997); Ezcurra and Pascual (2008); McKinnon (1997); Shankar and Shah
(2003); Gil, Pascual and Rapún (2004); and Calamai (2009)). Decentralization implies a transfer of authority and of responsibility that may imply greater
transparency and put both local governments and the central government under
pressure in order to deliver more efficient goods everywhere that tends to contribute to equalize regional standards of living and wealth. If in fact the margin
of improvement in efficiency is greater in poor areas, and therefore decentralization may be a catalyst for economic convergence. Furthermore in democratic
systems, subnational governments of poor territories have strong incentives to
achieve levels of development similar to those of the most developed regions in
order to be re-elected.
The empirical literature
The empirical evidence (that can be grouped by single-country case studies
and cross-country studies) on the link between decentralization and regional disparities is mixed and reaches far too contradictory results for any clear pattern
to emerge. Let us mention the single country studies by Kanbur and Zhang
(2005) for China and by Hakai and Hosio (2009) for the United Stated. The
former finds an increasing effect of decentralization on regional inequality, the
latter finds a decreasing effect. Also cross-country studies reach as well mixed
results. An increasing effect is in Rodriguez-Pose and Gill (2004) whereas a
decreasing effect is in Lessmann (2009) and Ezcurra and Pascual (2008). A
more recent empirical evidence is more likely to identify higher regional disparities associated to decentralization in developing countries while rich countries
seem to achieve more equal regional income distributions. These results are in
1 1 Effects in this direction are in Mauro (1995); Enikolopov and Zhuravskaya (2007); Granik
and Saraceno (2010). Leesmann and Markwardt (2009) find that decentralization counteracts
corruption in countries with high degree of press freedom.
10
Rodriguez-Pose and Ezcurra (2010) and Lessmann (2011)
2.2.2
Federalism and interpersonal disparities
The analysis of the effects of federalism on interpersonal inequality has been
almost neglected and unexplored. Neyapti (2006), Morelli and Seaman (2007),
Sepúlveda and Martínez-Vázquez (2011), and Tselios et al. (2011) represent the
only empirical exceptions. These studies obtain contradictory results. Morelli
and Seaman (2007) highlight that, in the case of the UK, decentralization has
been harmful for interpersonal inequality. Neyapti (2006) also shows that decentralization has increased inequality, although the impact has been less damaging
in countries with good governance levels. Similarly Sacchi and Salotti (2012b)
find that a higher degree of tax decentralization is associated with higher household income inequality within a country. By contrast, Tselios et al. (2011) show
that greater fiscal decentralization is associated with lower interpersonal income
inequality especially in less developed regions/countries. Similarly, Sepúlveda
and Martínez-Vazquez (2011) conclude that decentralization seems to reduce income inequalities in those cases where the national government still represents a
significant share of the economy. There is thus little that can be extracted from
the existing empirical literature. Theoretical studies about decentralization provide no further insights. Although interregional and interpersonal inequalities
are not unrelated (Kanbur and Venables (2005)), a very little interest has been
devoted to the study of the implications of decentralization at the individual
level and on interpersonal inequality. Overall it can stated that the link between
decentralization and interpersonal inequality strictly depends on the quality of
governance of a country (Neyapti (2006); Kyriacou and Roca-Sagalés (2011)).
Let us better analyze this statement.
Federalism and lower interpersonal inequality
Theoretically, the rationale beyond the link between decentralization and
lower interpersonal inequality is threefold: (i) local governments may be better
able to match different preferences across and within jurisdictions. Therefore,
if local interpersonal inequalities are perceived to be an important issue, then
they can be more efficiently tackled at a local/regional scale; (ii) the transfer of
responsibility to a subnational level of governance, closer to the people, creates
opportunities for voice and participation of all citizens, including the poor, and
the local marginal groups. Such empowerment may to lead local governments to
undertake policies more sensitive to the presence of poverty and interpersonal
inequalities (Le Galès (2002); Brenner (2004)); (iii) greater transparency and
a better accountability, generated by decentralization, limit the opportunities
for corruption, reducing the risk of a small elites, capturing the returns of public policies and contributing to a reduction of inequality within a jurisdiction
(Weingast (2009)).
Federalism and higher interpersonal inequality
But there are also theoretical reasons that may justify the link between decentralization and higher interpersonal inequality. First, there may exist a resource constraint. In fact it could be the case that local governments, especially
11
in the poorer regions of less developed countries, do not have the resources and
capacity to tackle income inequalities as well as the central government. Second, there may exist an ability constraint. Subnational governments attract
less skilled and capable officials and decision-makers (Prud’homme (1995)) and
therefore local governments, especially in the poorest and more unequal regions,
may lack both the capacity and resources to tackle inequality as effectively as
a more centralized government. Finally, if, as it happens in less developed and
less equal territories, there is a bad local accountability, decentralization could
increase social fragmentation and inequality (Blanchard and Shleifer (2001);
Bardhan and Mookherjee (2006); Neyapti (2006)).
Summing up therefore the effects of decentralization on interpersonal inequality are strictly related to the quality of governance of a country, which in
turns depends on the level of development achieved by a country.12
3
The model
Reviewing the literature on the link between federalism and growth and between
federalism and inequality, we have emphasized that the profession is still far from
finding clear-cut results both in terms of the sign of those effects and in terms of
the mechanisms at work beyond those links. In this section we make an effort in
this direction, and we sketch a two-period model with overlapping generations of
heterogeneous agents and an education-related public good, in order to interpret
most of the stylized facts described above. We depict many different scenarios
that can account for the mixed results of the empirical research both in terms of
the effects of federalism on efficiency (human capital accumulation) and in terms
of federalism and inequality (namely interpersonal disparities and territorial
disparities).
3.1
The institutional set-up and the transitional dynamics
to the steady state
We rely on Cerniglia and Longaretti (2012), slightly modifying it in order to
have steady states. This allows us also to better explore the inequality issue,
dealing with stationary distributions of human capital and, in turn, of income.
We consider a small and open economy with perfect mobility of capital. In
the economy there are overlapping generations (OLG) of a continuum of twoperiod lived agents with mass equal to 1 and there is no population growth.
There exists a unique non-perishable output good (Y ) that, at any time t, can
be consumed (X), or purchased by the Government. The Government then
uses these purchases to provide public goods (or services) (Z) to individuals.
There exists a unique input good, human capital (H), which is heterogeneously
distributed across individuals. Ht indicates aggregate human capital at time t.
Hereafter individual variables (lowercase letters) are indexed by a time subscript
(like the aggregate ones), by an individual (i) subscript and by a superscript,
1 2 For
an overview of this literature, see Acemoglu and Robinson (2011).
12
that indicates the agent’s generation or date of birth. Therefore htit indicates the
human capital of agent i, of generation t, at time t. Human capital heterogeneity
implies htit = htjt ∀i = j.
We also assume a genetic transmission mechanism, that is:
t
ht+1
it+1 = hit
(1)
This genetic mechanism allows us to have a steady state and a stationary
distribution of human capital. Such assumption is consistent with the empirical
literature that shows that more skilled individuals, who have higher education,
also have more skilled children 13 .
We assume a CRS production function with a constant marginal product
that is equal to the wage rate (w) . The public good (z) is education-related and
enhances the human capital of young individuals. In order to obtain a clear-cut
result, we assume an explicit functional form:
htit+1 = 1 + (zt )1/2 htit
(2)
As for preferences, they are captured by the following lifetime utility function: Ui = ln xtit + R1 ln xtit+1 , where R is the exogenous gross interest rate,
1
t
t
R is the discount factor, xit is consumption while young and xit+1 is consumption while old of the i-th agent of generation t. When young, agents
consume, pay the cost of the public good in order to get educated, and work.
Since preferences do not depend on leisure, agents supply their entire endowment of human capital. We assume that the per-capita cost of one unit of
public good is equal to c, with the cost recovered via a head tax (czt ) . A
young agent’s disposable income is therefore whtit − czt . Furthermore, given
the constant exogenous interest rate, agent i at time t has unlimited access to
the intertemporal
budget constraint (IBC) becredit (lit ). Under this set-up
1/2
1 t
1
t
t
t
comes: R xit+1 + xit = R w 1 + (zt )
hit +(whit − czt ), whose interpretation
is straightforward: the present value of lifetime consumption equals the present
value of lifetime disposable income.
The maximization problem becomes: tM ax
Ui subject to the IBC, which
t
xit ,xit+1
yields the following solution14 :
1 xt∗
w 1 + (zt )1/2 htit + Rwhtit − Rczt
(3)
i =
1+R
The efficient provision of the public good would maximize individual consumption (eq. 3). The first order condition for a maximum shows that the
provision of public good is optimal when the per-capita marginal cost (c) of
1 3 Many studies show that also nature and genetics play an important role in determining
the outcomes of children in terms of their education attainment (see for example Behrman
and Wolfe, 1987).
1 4 In this setting, the credit market allows individuals to smooth consumption throughout
t∗
their lifetimes, therefore xt∗
it = xit+1 .
13
education equals the marginal return from education
−1/2
1 wzit
R
2
htit
discounted
at time t. Therefore the efficient provision of the public good perfectly fulfils
individual demands. It follows:
2
1 whtit
∗
=
(4)
zit
2 Rc
Notice that individual demands for the education-related public good are
increasing and convex in the individual level of human capital.15 Therefore, if
the provision of the public good was the efficient one, increasing returns to scale
would be at work in the human capital technology (see Cerniglia and Longaretti
(2012)). As it will be clear below, these increasing returns are the rationale that
explains all the results we get both in terms of efficiency (higher level of steady
states) and in terms of inequality.
In order to model our institutional set-up, assumptions are as follows.
We firstly assume that the entire population belongs to a unique political
jurisdiction. Let us say that this situation is a unitary country where political
power to provide the public good belongs exclusively to the central government.
Obviously in such institutional set-up, geographical regions do exist indeed, but
without any political power.
As for a second institutional set-up, we assume that the geographical regions do have political power to locally provide the public good. In this case
geographical regions coincide with political jurisdictions (J) and for the sake
of simplicity we assume they are only two. Let label this situation as a federal
country.
We consider now the provision of the public good in each institutional set-up.
In the unitary country a uniform level of public good is provided regardless
of the heterogeneity across agents, therefore zit = zt for any i. As elucidated
in section 2, this assumption relies on Oates (1972) and in the context of the
present paper it can be also a reasonable approximation to the aim of our
analysis. The level of zt is chosen averaging individual demands.16 Therefore,
∗
taking the mean of all zit
(eq. 4), we get
w 2 t t 2
U
zt =
V ar hit + ht
(5)
2Rc
where the superscript U stands for "unitary".
Substituting eq. 5 into eq. 2, we get the individual law of motion of human
capital in a unitary country:
w t ) + h 2 ht
htU
=
1
+
V
ar
(h
(6)
t
it+1
it
it
2Rc
1 5 Indeed this result comes from the law of human capital accumulation (eq. (2), but it
would have hold even with a more general function htit+1 = (1 + (zt )α ) htit with 0 < α < 1.
Notice, furthermore that this explicit functional form comes from Bruckner (2006), since it
satisfies all the properties of the law of accumulation of human capital assumed therein.
1 6 See Cerniglia-Longaretti (2012).
14
In period t + 1 each i-th family is composed by an old individual and a
t+1J
young individual, whose human capital is hit+1
= htJ
it (recall eq. 1). Therefore
aggregating the all families, we obtain the accumulation of human capital in the
unitary country:
tU
w 2 t
U
t+1
t
ht+1 = ht+1 + ht+1 /2 = ht +
V ar (htit ) + ht ht
(7)
4Rc
U
and the transitional rate of growth γ from period t to period t + 1 in the
unitary country:
γU ≡
U
2
ht+1 − ht w =
V ar (htit ) + ht
4Rc
ht
(8)
The hypothesis of a genetic transmission of human capital generates dynamics only from period t to period t + 1.17
Let us pass now to the federal country. Through this set up we can deeply
investigate the heterogeneity issue at a twofold level: between jurisdictions and
within each jurisdiction, that means respectively at territorial and interpersonal
level. For analytical tractability, we assume that agents do not move across
jurisdictions’ borders; nevertheless it is worthy to note that the twofold heterogeneity emerges regardless mobility.18
In each political
jurisdiction J at any time t a uniform public good level
is provided ztJ by the local government averaging the demands of the agents
who live in that political jurisdiction. Therefore taking the mean of eq. 4 as far
as each political jurisdiction is concerned, we get
w 2 t J 2
J
J
zt =
V ar hit + ht
(9)
2Rc
Notice that the heterogeneity within a jurisdiction is proxied by V arJ (htit ) .
For each jurisdiction, we obtain the following individual law of the human
capital accumulation:
w J 2
V arJ (htit ) + ht
(10)
htJ
htit
it+1 = 1 +
2Rc
1 7 In fact eq. (5) shows that the level of public good wich is provided by a central government
increasingly depends on the mean and on the variance of the distribution of human capital.
In turn the level of public good affects the accumulation of human capital. Therefore, in
this setting, the dynamics depends on the change in the variance and in the mean of the
distribution of human capital. At each time, from period t + 1 onwards, the distribution
of human capital is the same. The economy, in fact, is composed of a young generation
identical to the previous young generation (recall eq. (1)), and of an old generation, that
has accumulated human capital identically to the previous old generation (recall eq. (2)).
Therefore, whereas at the individual level agents keep on accumulating human capital from
young to old, this framework exhibits dynamics at the aggregate and at the average level only
from period t to period t + 1.
1 8 This is because we consider a finite number of jurisdictions, and a continuum of completely
heterogeneous individuals.
15
Averaging in each jurisdiction, we obtain the dynamics of average human
J 2 J
w J
J
capital in a jurisdiction J: ht+1 = ht + 4Rc
V arJ (htit ) + ht ht and the
transitional rate of growth γ J from period t to period t + 1 for the jurisdiction
J:
J
J
w J 2
ht+1 − ht
J
J (ht ) + h
=
V
ar
(11)
γ ≡
t
it
J
4Rc
h
t
We now compare the transitional rate of growth under the two different
institutional settings. Inspection of eq. (11) and eq. (8) reveals that each
political jurisdiction J accumulates more human capital and grows at a faster
rate from period t to period t + 1 being in the federal country than being a
geographical region in the unitary country as long as the following equation
holds
J 2
2
V arJ htit + ht
> V ar htit + ht
(12)
As long as eq. (12) holds, federalism is an efficiency enhancing and growth
generating process. This result holds regardless of any assumption on mobility
of individuals. In particular, in order to benefit from federalism, a region should
exhibit either a sufficiently high mean or a sufficiently high variance in the local
distribution of human capital. This means that the heterogeneity argument in
favour of federalism strongly applies in this context, and especially when heterogeneity is within-jurisdictional. In the Appendix we demonstrate that, if a
federal system comprises two jurisdictions, and eq. (12) holds for one jurisdiction, it cannot hold for the other. This means that it cannot be the case where
both the jurisdictions benefit from federalism.
The same equation and a similar intuition hold when we compare political jurisdiction J1 and political jurisdiction J2 , in terms of performance under
federalism. If equation
J1 2
J2 2
> V arJ2 htit + ht
(13)
V arJ1 htit + ht
holds, then J1 accumulates more human capital than J2 . This means that, if a
political jurisdiction is poor but sufficiently heterogeneous in terms of the local
distribution of human capital, it could experience an higher rate of growth,
compared with another political jurisdiction which is richer but not sufficiently
heterogeneous.
The crucial point in interpreting these results relies on the fact that the local
government provides a uniform level of the education-related public good averaging individual demands at the local level, which are increasing and convex
in the individual level of human capital. This convexity implies that, the more
dispersed is the human capital in a jurisdiction, the higher the provision of the
education-related public good and, by this token, the higher the accumulation
of human capital from time t to time t + 1. Even a poor jurisdiction therefore may benefit from decentralization, accumulating more human capital, if its
heterogeneity offsets its low average human capital (income).
16
Summing up, the mechanism at work here in explaining the link between
federalism and human capital accumulation relies on the fact that fiscal decentralization implies an increase in the efficiency of the public sector, since
local governments can provide an amount of the education-related public good
that better suits local preferences. In fact local preferences are averaged in the
provision of the public good within each jurisdiction. As a consequence, the
distribution of human capital within each jurisdiction (its mean and variance)
determines both the sign and the size of the effects of federalism on human capital accumulation. Many scenarios therefore may arise in line with the mixed
results of the empirical literature. On one hand it is more likely that a rich
jurisdiction benefits (in terms of higher accumulation of human capital) from
decentralization, even though it could also be the case that it does not, if it is
highly homogeneous. On the other hand it is more likely that a poor jurisdiction
does not benefit from decentralization, even though it could be the case that it
does, if it is highly heterogeneous.
3.2
Inequality
Macroeconomics and distribution are an oxymoron in a representative agent
hypothesis. On the contrary, distribution becomes an issue of macroeconomics
when agents are heterogeneous. In our settings we have already emphasized
that the dynamics of the distribution of human capital generates transitional
growth, that in turns affects the distribution of human capital, and by this token
the distribution of income. We have also demonstrated that federalism may be
an efficiency enhancing and growth generating process.
Let us now focus on the results of our model in terms of inequality. As
already emphasized, our framework allows us to study inequality at a twofold
level: (i) among agents within a geographical region, and within a political jurisdiction; (ii) between geographical regions, and between political jurisdictions.
In order to do that, we use the variance of the distribution of human capital
(and, by this token, of income) as a proxy of inequality among agents. As for the
analysis of inequality between jurisdictions, we will simply compare the average
performance in terms of human capital accumulation in each jurisdiction.
In order to develop the analysis in terms of inequality, we consider a country
consisting of two different areas, which we call Γ and Ω. The two areas are two
different political jurisdictions under a federal country setting, whereas they are
two geographical regions under a unitary country setting. The two areas differ
from each other in terms of the mean of the distribution of human capital. This
means that one jurisdiction is richer than the other one. In our example the
rich jurisdiction is Ω.
3.2.1
Interpersonal disparities: inequality among agents within a
geographical region, and within a political jurisdiction
We start by analyzing whether decentralization affects inequality among agents
within a geographical region, and within a political jurisdiction.
17
Let us firstly focus the attention on a situation in which the poor region is
worse off and the rich one is better off with decentralization in terms of human
capital accumulation. From the analysis above, this means that the poor region
is not sufficiently heterogeneous in order to offset its low average human capital
(income).19
For the poor region, decentralization induces a lower accumulation of human
capital from period t to period t + 1, but inequality among individuals would be
lower compared to the situation that would emerge under a centralized provision
of the public good. Therefore it emerges a trade-off for the poor region between
efficiency and equality.
In fact, the variance of the distribution of human capital in jurisdiction Γ
would be
w tΓ 2 2
ΓF
V ar (hit+1 ) = 1 +
V arΓ (htit ) + ht
V arΓ (hit )
(14)
2Rc
in a decentralized economy20 and
w t 2 2
ΓU
t
V ar (hit+1 ) = 1 +
V ar (hit ) + ht
V arΓ (hit )
2Rc
in a centralized economy.21 If the poor region is worse off (in terms of human capital accumulation) with decentralization, from eq. (12) it follows that,
tΓ 2 2
t 2 2
w w
1 + 2Rc
V arΓ (htit ) + ht
< 1 + 2Rc
V ar (htit ) + ht
. Therefore, given the distribution of human capital at time t in jurisdiction Γ, the poor
region would accumulate less human capital but would be less heterogeneous in
a decentralized economy, than in a centralized economy, that is
V arΓF (hit+1 ) < V arΓU (hit+1 )
(15)
Symmetrically, the same trade-off emerges for the rich region, but in the
opposite direction: human capital accumulation increases but equality decreases
among agents. That is:
V arΩF (hit+1 ) > V arΩU (hit+1 )
(16)
Overall as long as a country is composed of two regions, a poor one and a
rich one, and the poor one is worse off with decentralization and the rich one
is better off, federalism would increase inequality among individuals in the rich
region, and instead would reduce it in the poor region.
Let us now turn our attention to a situation in which the poor jurisdiction’s
heterogeneity offsets its low average human capital and, as a consequence, the
19 A
situation in which the two regions are equally heterogeneous can be a good example.
superscript F stands for "federal".
2 1 The superscript U stands for "unitary".
2 0 The
18
poor region accumulates more human capital in a federal country setting than
in a unitary country setting. Results tell us that the trade-off still holds: decentralization increases human capital accumulation and inequality among agents
in the poor region whereas decreases accumulation and inequality in the rich
region:
V arΓF (hit+1 ) > V arΓU (hit+1 )
(17)
V arΩF (hit+1 ) < V arΩU (hit+1 )
(18)
and
Summing up, this analysis seems quite interesting since it shows that there
exist a trade-off between efficiency and equality within a region: a region that
gains (looses) from decentralization in terms of accumulation of human capital,
is worse-off (better-off) in terms of equality, that is the variance of the distribution of human capital is higher (lower) in a federal country setting than in a
unitary country setting. In fact, given the law of human capital accumulation
(eq. (2)), the higher the education-related public good at time t, the more dispersed the distribution of human capital at t + 1. This implies that, if a local
government provides a level of the education-related public good, higher (lower)
than the level that a central government would provide, the jurisdiction would
end up with a higher (lower) average and more (less) dispersed human capital.
It is worth noting that there exists an important link between the distribution of
human capital ex-ante and ex-post the provision of the education-related public
good. In fact the provision of the public good within a jurisdiction depends on
the ex-ante local distribution of human capital and the level of public good provided affects the ex-post local distribution of human capital. Concluding, it is
more likely that a rich and sufficiently heterogeneous region would end up being
richer and more heterogeneous in a federal country setting. Symmetrically, it
is more likely a poor and not sufficiently heterogeneous region becomes poorer
and more homogeneous with decentralization.
3.2.2
Territorial disparities: inequality between geographical regions,
and between political jurisdictions
When the poor region does not gain from decentralization, and the rich one
gains from it, quite obviously territorial disparities increase.
Nevertheless it could be the case that the poor region is sufficiently heterogeneous in order to gain from decentralization more that the rich one in terms
of accumulation of human capital. In the Appendix, we demonstrate that, in
a federation consisting of two jurisdictions, the fact that the poor jurisdiction
benefits from decentralization, implies a catching up phenomenon. As we have
shown throughout the paper, the rationale of this result is that, in the context of increasing returns, more dispersed human capital implies higher growth
rate. This beneficial outcome of intra-jurisdiction heterogeneity would imply a
reduction of inter regional disparities, or, in other words a catching-up phenomenon. Comparing the two areas, i.e. a poor region/jurisdiction Γ and a rich
19
region/jurisdiction Ω, from eq. (13), the condition in order to have catching-up
becomes:
tΓ 2
tΩ 2
V arΓ htit + ht
> V ar htΩ
(19)
it + ht
So, if a federation comprises two jurisdictions, a poor and a rich one, and
the poor gains from decentralization, regional disparities decrease. Under this
point of view there is no trade-off between efficiency and equality: federalism
increases efficiency and reduces territorial disparities.
These results may suggest the policy implication that, in a country, there
may be conditions that make federalism a driving force in order to reduce inter
regional disparities. This occurs when there exists a political jurisdiction, which
is poor but sufficiently heterogeneous in terms of the local distribution of human
capital. In this case it could experience a higher rate of growth, compared with
another political jurisdiction which is richer but not sufficiently heterogeneous.
Once again, the mechanism at work here in explaining the link between
federalism and regional disparities relies on the fact that local preferences are
averaged in the provision of the education-related public good within each jurisdiction and the provision of the public good affects the performance of a jurisdiction. As a consequence the ex-ante distribution of human capital (among
individuals within a jurisdiction) determines the ex-post distribution of human
capital between jurisdictions. Many scenarios therefore may arise. On one hand
it could be the case that federalism helps the rich to get richer, leaving the
poor behind and therefore increasing regional disparities (as stated in the previous paragraph). On the other hand it could also be the case that a poor and
sufficiently heterogeneous jurisdiction even catches up with a richer one.
4
Conclusions
Reviewing the literature, we have underlined how the profession is still far from
clear-cut results on the link between decentralization and growth and on decentralization and inequality. In order to interpret theoretically the mixed results
of the literature, we have developed a two-period model, with overlapping generations of two-period lived agents, who are heterogeneous in the level of human
capital and, by this token, in income. This heterogeneity allowed us to study
both interpersonal inequality and territorial inequality. Furthermore, in the
economy there exists a publicly provided good which is education-related and
increases each individual level of human capital. The local government provides
a uniform level of the public good averaging individual demands at the local
level (which are increasing and convex in the individual level of human capital).
Therefore the mechanism at work in explaining the link between federalism and
human capital accumulation relies on the fact that fiscal decentralization implies an increase in the efficiency of the public sector, since local governments
can provide an amount of the education-related public good that better suits
local needs. As a consequence, the distribution of human capital within each
jurisdiction (its mean and variance) determines both the sign and the size of the
20
effects of federalism on human capital accumulation. Many scenarios therefore
may arise in line with the mixed results of the empirical literature. On one hand
it is more likely that a rich jurisdiction accumulates more human capital in a
federal country setting (even though it could also be the case that it does not,
if it is highly homogeneous). On the other hand it is more likely that a poor
jurisdiction accumulates more human capital in a unitary country setting (even
though it could be the case that it does not, if it is highly heterogeneous).
Furthermore we have demonstrated that there exists a trade-off between
equality and efficiency: a region that gains (looses) from decentralization in
terms of accumulation of human capital, is worse-off (better-off) in terms of
equality, that is the variance of the distribution of human capital is higher
(lower) in a federal country setting than in a unitary country setting. This
emphasizes the link between the distribution of human capital ex-ante and expost the provision of the education-related public good. In fact the provision
of the public good within a jurisdiction depends on its ex-ante distribution of
human capital and the level of public good provided affects its ex-post distribution of human capital. Concluding, it is more likely that a rich and sufficiently
heterogeneous region would end up being richer and more heterogeneous in a
federal country setting. Symmetrically, it is more likely that a poor and not
sufficiently heterogeneous region becomes poorer and more homogeneous with
decentralization.
Since the provision of the public good within a jurisdiction, and by this
token the performance of the jurisdiction itself, depends on the ex-ante local
distribution of human capital, it follows that the ex-ante local distribution of
human capital affects also territorial disparities. In fact we have demonstrated
that, in a country there may be conditions that make federalism a driving force
in order to reduce regional disparities. This occurs when there exists a political
jurisdiction, which is poor but sufficiently heterogeneous in terms of the local
distribution of human capital. In this case, in fact, it could experience a higher
rate of growth, compared with another political jurisdiction which is richer but
not sufficiently heterogeneous. On the other hand it could also be the case
that federalism helps the rich to get richer, leaving the poor behind, increasing
regional disparities.
However, we are aware that these results derive from the specifications of a
model which is a reduced-form sketch of a much more complex phenomenon. In
other words, federalism might affect economic performance through many different channels, and in such a simple setting, we have dismissed: i) institutional
details22 ; ii) any possibility of transfers by the central government; iii) the possibility of distorted allocation of expenditure in case of corruption (Granik and
Saraceno (2010)) and tax evasion (Brueckner (2000)); iv) the empirical findings
(reviewed in section 2.1 and 2.2) that the "quality" of local institutions may
2 2 As we all know, fiscal decentralization in a system of cooperative federalism works differently than in a system of competitive federalism; other institutional aspects that may be
considered are: the strengh of national party system (Riker, 1964) and, more generally, the
type of political and economic incentives of local public officials .In this paper, political economy considerations are left out from the analysis.
21
determine the size and the sign of the effects of federalism on both growth and
inequality. As already said, in many developing countries, or very poor regions,
for example, corruption and tax evasion may limit the benefits from fiscal decentralization that can evolve into a state-corroding federalism (Hongbin and
Treisman (2004)). Corruption and tax evasion may be thought of as increased
costs of providing the public good or, symmetrically, a waste of public resources
and therefore they may cancel some of the gains from better demand fulfillment.
Therefore it would be very interesting, and left to further research, to investigate how things would change if we incorporate in the model the factors listed
above.
Finally, an obvious question is about the actual sign, for example in Italy,
of the condition established in eq. (12). In order to try to roughly answer
this question, we have given a quick look to the data of the CNEL (Consiglio
Nazionale di Economia e Lavoro, an Italian Welfare Institution)23 , that report
the distribution of the population by education both at the aggregate level (Italy
as a whole) and at regional level. From a very preliminary descriptive analysis,
using the official disaggregation of Italy into four geographical areas (namely
North —West, North-East, Centre, and South), it comes out, for example, that
the sign of the condition above is “>” for the North-Eastern and Central regions.
The sign is “<” for the Southern regions and slightly “<” for the North-Western
regions.24 This analysis, of course, deserves further investigation, but this preliminary scattered evidence, based on this data source, seems to suggest that
heterogeneity in the distribution of human capital matters among regions and
within regions. Considering the Italian case again, this could imply that decentralization of education in Italy may improve human capital accumulation in the
North-Eastern and Central regions, but the condition in order to have catching up do not hold and therefore educational decentralization could exacerbate
regional disparities.
Acknowledgements
We are grateful to Massimo Bordignon, Claudio Borroni, Jan Brueckner, Domenico
Delli Gatti, and Ben Lockwood for their helpful comments.
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29
Appendix. Benefits of federalism in a decentralized world with two jurisdictions.
Focusing the attention on a federation comprised of two jurisdictions, a poor
one (Γ) and a rich one (Ω), in this appendix we want to investigate whether
eq. (12) can hold for both the jurisdictions. Let us start by defining as the
density function of the human capital in the entire economy. It follows that the
mass of population living in Γ is PΓ = f (htit ) dh and the mass of population
Γ
t
t
living in Ω is PΩ =
f (hit ) dhit , where PΓ + PΩ = 1. Moreover, it follows
Ω
that the mean
of the distribution ofhuman capital in the two jurisdictions are:
Γ
Ω
ht = P1Γ htit f (htit ) dhtit , ht = P1Ω htit f (htit ) dhtit , and the mean of the disΓ
Ω
tribution of human capital in the entire economy is: ht =
htit f (htit ) dhtit .
Γ∪Ω
Recalling that we have defined the poor jurisdiction as Γ and the rich jurisΓ
Ω
diction as Ω, it follows that ht < ht < ht . Let us now pass to the variance
of the distribution of human capital. It is easy
verify that V arΓ (htit ) =
to
2
Γ
Ω 2
1
htit − ht f (htit ) dhtit , V arΩ (htit ) = P1Ω
htit − ht
f (htit ) dhtit and
PΓ
Γ
Ω
t
2
V ar (htit ) =
hit − ht f (htit ) dhtit . It is also known that:
Γ
Ω
ht = PΓ ht + PΩ ht
(A1)
and
Γ 2
Ω 2 2
V ar htit = PΓ V arΓ htit +PΩ V arΩ htit +PΓ ht +PΩ ht − ht (A2)
If eq. (12) holds for jurisdiction Γ, it must be true that:
Γ 2
2
ht + V arΓ htit > ht + V ar htit
(A3)
Γ 2
ht + V arΓ (htit )
Ω 2 > 1
V arΩ (htit ) + ht
(A4)
From eq. (A1), and eq. (A2), condition (A3) can be rewritten as:
Eq. (A4) is nothing but eq. (19). It follows that, the fact that the poor jurisdiction benefits from decentralization, implies a catching up phenomenon. This
becomes even more evident, checking if eq. (12) can hold also for jurisdiction
Ω. If this is the case it must be true that:
Ω 2
2
ht
+ V arΩ htit > ht + V ar htit
((A5))
30
From eq. (A1), and eq. (A2), condition (A5) can be rewritten as:
Γ 2
ht + V arΓ (htit )
Ω 2 < 1
V arΩ (htit ) + ht
(A6)
It is evident that eq. (A6) is inconsistent with condition (A4). Therefore eq.
(12) cannot hold for both the jurisdictions: if the poor jurisdiction benefits from
decentralization, the rich jurisdiction is worse off, and this implies catching up.
On the contrary and symmetrically, if the rich jurisdiction benefits from decentralization, the poor jurisdiction is worse off and regional disparities increase.
31