The Economic Effects of Federalism: A Comparative Analysis

For a long time, research on federalism has devoted its attention to analyzing decentralized political institutions and their impact for macro-economic and fiscal performance. On the one hand, researchers have argued – mostly on a theoretical basis – that devolved government leads to better democratic governance as well as more economic growth. On the other, based on empirical analysis scholars have frequently pointed out that the decentralization of fiscal powers – notably own taxes for the subnational governments – lead to healthier public finances at lower levels of government, which, in turn, is better for the national budget. In this paper, we are going to re-examine the decentralization hypothesis from a comparative institutionalist perspective. Rather than focusing only on fiscal decentralization, we examine whether and how the ensemble of devolved powers, i.e. fiscal, legislative, and administrative competencies, and the existence of institutional mechanisms such as the participation of subnational governments in national political institutions or intergovernmental councils affect economic growth. Following the comparative politics literature, we pose two competing hypotheses. Firstly, we hypothesize that the effect of devolved political institutions on economic growth increases the more subnational institutions are autonomous from the centre (self-rule). Secondly, we propose a competing hypothesis according to which the economy grows more, the more subnational governments share power with the national level and the other subnational units in a country (shared-rule). To empirically examine these hypotheses, we use a dataset that compares self-rule and shared-rule in 81 countries in the period from 1950-2010. Based on econometric analyses, we are going to analyze how federalism impacts on economic growth, and discuss the implications of our findings for the financing and governability of federal states. The results of our paper will contribute to our understanding of federal institutions’ economic effects and provide important insights for elected officials on how to design and reform multilevel political institutions.