Fiscal Decentralization And Economic Growth In China

The relationship between fiscal decentralization (FD) and economic growth has been analysed by a number of economists during the last decades. Given the current drive among developing and transitional countries to decentralize expenditures and revenues to subnational governments, it is important to ask not only whether fiscal decentralization influences economic growth, but also how fiscal decentralization may influence economic growth. Linking economic growth and FD together has mainly three reasons: firstly, growth is seen as an objective of FD and efficiency in the allocation of resources in public sector; secondly, it is an explicit intention of governments to adopt policies that lead to a sustained increase in per capital income and thirdly, per capita growth is easier to measure and to interpret than other economic performance indicators. While theoretical examinations started with the pioneer publications Tiebout (1956), Musgrave (1959) and Oates (1972), empirical analysis regarding the role of economic growth on FD started at the end of 1970s (with Kee 1977 and Pommerehne 1977) and estimations concerning the direct impact of FD on economic growth have only been conducted since the end of the 1990s (starting with Oates 1995 and Davoodi and Zou 1998). But the study of the mechanism between economic growth and fiscal decentralization is not sufficient, leading to come up with ambiguous and differing results. Based on the previous study, this paper analyse this mechanism from two sides in theoretical framework, firstly this paper study the mechanism through which the economic growth would influence the fiscal decentralization level, secondly this paper revel the ways through which the fiscal decentralization level would influence the economic growth.China begins its opening and reform policy at the end of 1970s. Before the reform, the country's economic had been under the central planning model for a period of about 30 years. The original fundamental objective behind China's economic reform was to develop the country's economy on the face of the failure of the socialist planning model. Realizing that development could not be evenly distributed among all regions in the country, the central government attempted to give increasing authorities to local economic growth. Fiscal decentralization was one of the main policies thrusts used in this economic strategy, and its role and impact were very significant. After close to twenty years of reform, the share of central government expenditure in the general public sector budget decreased from 54.26% in 1980 to 27.71% in 2004. This significant drop in the share of central government expenditure raised a lot of questions about the impact of fiscal decentralization on the distribution of public resources and whether the fiscal decentralization have positive effect on china's high economic growth.After reviewing the previous empirical study of the impact of fiscal decentralization on economic growth, especially the study of china's fiscal decentralization on economic growth, this paper analyses the impact of fiscal decentralization on the distribution of public resources, especially the impact of fiscal decentralization on government sector size, vertical fiscal equity between central government and local government and horizontal equity and so on. This paper finds that in general china's fiscal decentralization leads more revenue distributed to central government and more expenditure distributed to local government, decrease the government sector size, and fiscal contract system enlarges regional fiscal inequity, 1994 fiscal tax sharing system decreased regional fiscal inequity, but the effect is not sustainable.This paper investigates the effects of fiscal decentralization on the provincial growth in china with a panel-data set around the 1994 fiscal reform. This paper argues that the 1994 fiscal tax sharing system reform largely has significantly positive effect on china's economic growth. The fiscal decentralization has raised the growth rate of nominal per capita GDP at the province level. To have a positive effect on economic growth, fiscal resources and decision-making powers should be decentralized to the lowest feasible level of the government. Also this paper divides the sample according to the economic development level and geographic location. In addition to standing for the positive effects of the fiscal decentralization, the sub-sample analysis find more positive effect of fiscal decentralization on province level economic growth with relatively lower per capita GDP than with higher per capita GDP from 1994-2004. The provinces in the middle China take larger advantages of fiscal decentralization than the provinces in the east and west China have.