1 Introduction

Over the last three decades, interest in fiscal decentralization has grown worldwide
(World Bank, 2000). Evidence of this interest is to be seen in the large proportion of
developing countries that have embarked on some form of devolution of fiscal
responsibilities from central to regional and local governments (Dillinger, 1994), while
many developed nations are reviving the debate on fiscal decentralization (Oates, 1999).
Thus, for example, Belgium became a federal state in 1993, and Italy is currently
moving in that direction. Likewise, in Spain and Portugal fiscal decentralization is an
ongoing process. Meanwhile, the United States Congress has been contemplating over
the last several years the elimination of numerous federal programmes, replacing them
with block grants to subnational governments, and ending the so-called unfunded
federal mandates (Xie et al, 1999).
This global trend is closely related to the belief that fiscal decentralization contributes
to economic development (Oates, 1993), and, eventually, to the reduction of regional
disparities (Qian and Weingast, 1997). This suggests that the devolution of fiscal power
to subnational governments might generate a more balanced distribution of resources
across space. Before accepting this argument, however, it should be noted that fiscal
decentralization could have spatially regressive effects, as a result of the weakening of
the equalization role of central government (Prud'homme, 1995). In light of these
contrasting theoretical positions, detailed examination of the available empirical evi-
dence on the relationship between fiscal decentralization and regional inequality
becomes indispensable. Despite its potential importance, however, surprisingly little
attention has been paid to this issue in the literature. Indeed, so far only Shankar
and Shah (2003), Gil et al (2004) and Rodr| guez-Pose and Gill (2004) have investigated
this issue with cross-country data.
(1)
The results of these studies are, however, incon-
clusive and present a mixed picture of the effect of fiscal decentralization on regional
disparities.
Fiscal decentralization and regional disparities: evidence
from several European Union countries
Roberto Ezcurra, Pedro Pascual
Department of Economics, Universidad Pu blica de Navarra, Campus de Arrosadia s/n 31006
Pamplona, Spain; e-mail: roberto.ezcurra@unavarra.es, ppascual@unavarra.es
Received 5 June 2006; in revised form 1 September 2006
Environment and Planning A 2008, volume 40, pages 1185 ^ 1201
Abstract. This paper investigates for the first time the relationship between fiscal decentralization and
regional disparities in a set of European Union countries. Our findings reveal that the devolution of
fiscal power to subnational governments is negatively correlated with the level of regional inequality
within the sample countries. Therefore, the processes of fiscal decentralization may contribute to a
more balanced distribution of resources across space, making up for the central government's loss of
redistributive power. In fact, this result is robust to the inclusion of additional explanatory variables
in the analysis, and to the choice of the measure used to quantify the degree of dispersion in the
spatial distribution of per capita income.
doi:10.1068/a39195
(1)
In addition, there are some contributions that use single-country data. In this respect, see
Kanbur and Zhang (2005) and Silva (2005) for studies concerning China and the Philippines,
respectively.
When weighing up the findings of these analyses, moreover, it should be noted that
Shankar and Shah (2003) and Gil et al (2004) complete the information provided by
the calculation of correlation coefficients with estimates based on convergence equa-
tions using cross-sectional data (Barro and Sala-i-Martin, 1991). This means that their
results are affected by the numerous econometric limitations inherent in this kind of
methodology (for further details on this issue see Magrini, 2004). Furthermore, only
Gil et al (2004) include in their empirical model the level of decentralization in the
various countries considered. However, these studies ignore the fact that regional
growth is influenced by variables other than the initial level of development and the
national degree of fiscal decentralization, which may bias their estimates. In addition,
Gil et al (2004) do not consider the substantial institutional, historical, and cultural
differences that exist between the various countries examined. Nevertheless, it may be
difficult to determine the true effect of fiscal decentralization on the spatial distribu-
tion of income unless adjustments are made to the data to account for these differences
(Akai and Sakata, 2002). Rodr| guez-Pose and Gill (2004), meanwhile, present a
descriptive analysis with reference to various case-study countries. In particular, these
authors base their conclusions simply on the visual examination of the trajectory of
two indicators of the evolution of regional disparities and fiscal decentralization in six
countries with very diverse development levels.
Against this background, and in a quest for empirically well-founded, stylized
facts, the aim of this paper is to investigate further the relationship between fiscal
decentralization and regional disparities. It is worth mentioning at this point that our
work distinguishes itself from the previous literature in two respects. To start with,
this is the first time this issue has been examined using a sample of countries belonging
to the European Union (EU). In this respect, it should be noted that the last decade
has seen the publication of many studies on the explanatory factors of territorial
imbalances in the EU (Bilbao-Osorio and Rodr| guez-Pose, 2004; Lo pez-Bazo et al,
2004; Paci, 1997; Quah, 1996; Rodr| guez-Pose and Vilalta-Bufi, 2005). So far, however,
no study has tackled the role played by the processes of fiscal decentralization under-
taken in the various member states when attempting to explain spatial disparities
across regions within each country.
(2)
In addition, we use for the first time panel data
techniques to investigate the nature of the relationship between the devolution of fiscal
power to subnational governments and regional inequality (Baltagi, 1995; Wooldridge,
2002). This approach allows us to overcome some of the methodological limitations
that characterize the scant studies that have previously explored the potential impact of
fiscal decentralization on regional inequality with cross-country data.
The remainder of the paper is organized as follows. Section 2 presents an over-
view of the main theoretical arguments used in the literature to justify the possible
influence of fiscal decentralization on the spatial distribution of income. Section 3
describes the level and evolution of regional disparities in the various countries
included in the analysis. Section 4 explores the relationship between fiscal decentral-
ization and regional inequality in the sample countries using a panel data model.
The robustness of the results is tested in section 5. Finally, the main conclusions of
the paper are summarized in section 6.
(2)
Note that overall inequality across the EU regions can be decomposed into inequality across
countries and inequality across regions within each country. Nevertheless, our study is based
exclusively on within-country inequality. It should be mentioned, however, that regional disparities
within the various countries explain the greater part of overall inequality registered in the EU
(Puga, 2002).
1186 R Ezcurra, P Pascual
2 Fiscal decentralization, economic performance, and regional disparities: theoretical
background
The argument commonly used to justify the processes of fiscal decentralization from
an economic perspective is based on the belief that the devolution of fiscal power to
subnational governments leads to efficiency improvements in the public sphere of action,
and to the promotion of economic development and growth (Oates, 1993). The usual
rationale for this argument may be synthesized as follows (Oates, 1972; Tiebout, 1956).
Fiscal decentralization will increase the degree of efficiency in the allocation of resources
because subnational governments have an information advantage over central govern-
ments when it comes to responding to the need and preferences of local citizens.
These efficiency gains will be further enhanced by the mobility of the population.
Indeed, such a scenario would encourage the various regions to compete with one
another by attracting possible migrants, making more efficient use of their resources,
and promoting economic development and growth.
According to Tanzi (1996), however, the preferences of individuals living in the
same country are likely to be quite similar, and lack of coordination among subna-
tional governments could undermine the degree of efficiency of public intervention.
Likewise, the presence of spatial spillovers might result in an inadequate level of
provision of some public goods (Kelejian and Robinson, 1997).
From the point of view of equity, the literature has traditionally emphasized the
spatially regressive effects of fiscal decentralization (Rodr| guez-Pose and Gill, 2005).
Thus, Prud'homme (1995) argues that a centralized public sector generates a more
balanced spatial distribution of income by channelling resources from richer regions
to poorer ones. Accordingly, fiscal decentralization weakens the capacity of central
government to play an equalization role. This will tend to produce a negative effect
on economic performance in backward regions, by reducing their capacity to converge
with the more advanced areas. Consequently, this argument implies that the devolution
of fiscal power to subnational governments will increase existing territorial imbalances,
at least in the short to medium term.
There are, nevertheless, various reasons to suppose that fiscal decentralization
contributes to a reduction in regional inequality. In the framework of the `second-
generation' models of fiscal federalism, for example, Weingast (1995) and Qian and
Weingast (1997) stress the role played in this context by the incentive effects of regional
competition following fiscal devolution. Their argument rests on the premise that the
behaviour of subnational governments is conditioned by the need to represent citizens
and to preserve markets. In this respect, it should be recalled that the ability of
regional and local governments to stay in power depends decisively on their perfor-
mance in attaining a level of development and economic growth similar to that enjoyed
by the rest of the country (Shankar and Shah, 2003). In this scenario the poorer
regions might reduce their development gaps by offering more flexible labour mar-
kets and/or less generous welfare provisions than richer regions. In fact, McKinnon
(1995; 1997) has highlighted the relevance of fiscal competition when it comes to
explaining the process of regional convergence that took place in the United States
after the Second World War (Ram, 1992). This was also a crucial contributing factor in
the striking economic dynamism displayed by Ireland during the 1990s, which allowed
that country to overcome the disadvantages arising from its peripheral location in the
European context (European Commission, 2004).
It is worth noting also that centralized systems may give rise to a spatially uneven
distribution of resources that is likely to benefit politically and economically stronger
regions (Dillinger, 2002). In addition, an important share of total investment often
tends to be located in the capital regions where political decision making takes place.
Fiscal decentralization and regional disparities 1187
Nevertheless, fiscal decentralization is characterized by a downsized central government
(Jin and Zou, 2002), which has the effect of drawing political power away from the
capital and its surrounding region. This contributes to the spatial spread of economic
activity, thus reducing the existing territorial imbalances (Gil et al, 2004).
As we have been able to check, the above discussion does not provide a definite
conclusion about the final impact of fiscal devolution on regional inequality. This is not
especially surprising, given that the range of arguments presented in this section
focuses on various factors that influence the spatial distribution of income by different
channels and mechanisms. Empirical analysis is therefore necessary to clarify the role
played by fiscal decentralization in explaining the level and evolution of regional
disparities.
3 Regional inequality within the EU member states: cross-country and intertemporal
variations
We begin our empirical analysis by examining the degree of dispersion in the spatial
distribution of per capita income with the EU member states. The data used for this
are drawn from the Cambridge Econometrics European database, and include infor-
mation over the period 1980 ^ 99 on GDP and population of 132 regions in twelve
countries: Austria, Belgium, Finland, France, Greece, Ireland, Italy, the Netherlands,
Portugal, Spain, Sweden, and the United Kingdom.
(3)
We have attempted to capture
the fact that fiscal decentralization takes place at different regional levels across the
EU countries. For this reason, the degree of territorial disaggregation considered in our
study varies in the different countries. Specifically, NUTS-1 regions were used in the case
of Belgium and the United Kingdom, whereas NUTS-2 were employed in the remain-
ing countries. As is known, NUTS regions are widely used in the literature devoted to
the study of territorial imbalances in the EU (Terrasi, 2002). Nevertheless, when inter-
preting the estimated level of regional inequality based on NUTS regions, it should be
taken into consideration that the employment of administratively defined regions has
been criticized for failing to capture the spatial impact of the presence of commuting
patterns in the European context (Cheshire and Carbonaro, 1996).
In order to quantify the importance of regional inequality in each country, we
considered the information provided by the population-weighted coefficient of varia-
tion (CV). This measure of dispersion, which is widely used in the literature devoted
to the study of territorial imbalances (Ezcurra et al, 2005; Petrakos et al, 2005;
Williamson, 1965), can be written as:
CV
ct

1
m
ct
X
n
c
i 1
p
it
x
it
m
ct

2
" #
1=2
, (1)
where x
it
and p
it
stand for the per capita GDP and the population share of region i
in country c during year t, respectively, and
m
ct

X
n
c
i 1
p
it
x
it
.
This inequality measure is independent of scale and population size and satisfies
the Pigou ^ Dalton transfer principle (Cowell, 1995). It should also be stressed that CV
(3)
Lack of regional data meant that Denmark, Germany, Luxembourg, the countries incorporated
into the EU in 2004, and the French overseas departments had to be excluded from the analysis.
Likewise, the Groningen region was also omitted, owing to modifications introduced by the
Netherlands into the national accounting system in the mid-1980s.
1188 R Ezcurra, P Pascual
takes into account the population size differences across the various territorial units
considered. This is not common practice in the literature on economic convergence
that has appeared since the contribution of Barro and Sala-i-Martin (1991), despite the
fact that, as noted by Petrakos et al (2005), their omission may give rise to unrealistic
results. In any event, it is important to note that, by including population shares in the
analysis, we are able to attach a different weighting to each region according to its size,
thus reducing the impact of the level of territorial disaggregation on the results (Gil
et al, 2004; Shankar and Shah, 2003).
Figure 1 presents the population-weighted coefficient of variation for each of the
European countries considered throughout the period 1980 ^ 99. As shown, the degree
of regional inequality varies considerably across the different countries. In average
terms, the highest CV values are found in Belgium, Italy, Portugal, and France. These,
therefore, are the countries with the highest levels of dispersion in the regional distri-
bution of per capita GDP. At the opposite end of the scale we find Ireland, Finland,
the Netherlands, and Sweden, which are characterized by the lowest levels of regional
inequality during the sample period. In order to facilitate comparisons with other
0.5
0.4
0.3
0.2
0.1
0.0
0.5
0.4
0.3
0.2
0.1
0.0
R
e
g
i
o
n
a
l
i
n
e
q
u
a
l
t
y
(
C
V
)
R
e
g
i
o
n
a
l
i
n
e
q
u
a
l
t
y
(
C
V
)
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998
Austria
Belgium
Finland
France
Greece
Ireland
Italy
Netherlands
Portugal
Spain
Sweden
UK
Year
Year
Figure 1. Regional disparities within the EU countries.
Fiscal decentralization and regional disparities 1189
geographical settings, it is interesting to note that the CV values registered by these
four countries between 1980 and 1999 are similar to those of the United States. When it
comes to evaluating the implications to be drawn from figure 1, however, it is worth
considering how far the results might be affected by the different number of regions in
each country. To explore this question, we proceeded by calculating the correlation
coefficient between the average values of CV over the twenty years examined and the
number of regions in each country. The coefficient estimated is 0.133, and it lacks
statistical significance. Therefore, this factor does not appear to influence the level of
regional inequality within the sample countries.
In order to complete these results, we consider a regression model that allows us to
study the presence of country-specific effects in our sample. Specifically, the model
proposed can be expressed as:
I
ct
j
c
N
c
y
c
t
c
e
ct
, (2)
where I is the inequality index used to measure regional disparities in country c in
period t (c 1, 2, . . . , C, and t 1, 2, . . . , T), N
c
1 for country c and 0 otherwise,
and t
c
1, 2, . . . , T. Finally, e denotes an error term with standard properties.
The results of the estimation of model (2) by ordinary least squares (OLS) are
presented in table 1. In order to support our previous impression, we test the following
hypothesis:
H
0
: j
1
j
2
. . . j
C
.
The corresponding F-statistic reveals that this hypothesis is rejected ( F 335:45).
Therefore, this confirms that the degree of dispersion in the regional distribution of
per capita GDP differs significantly across the various EU member states considered.
In addition, the information provided in table 1 indicates that there are only two
countries, Austria and Italy, with a nonsignificant time trend, which shows that the
level of regional inequality did not remain stable in most of the countries between
1980 and 1999. In fact, the estimation carried out reveals significant positive trends
for six countries, Finland, France, Ireland, Spain, Sweden, and the United Kingdom,
Table 1. Regional disparities within the EU member states: cross-country intertemporal variations.
Country Country- Time trend Country Country- Time trend
specific specific
Austria 0.234*** 1 10
4
Italy 0.270*** 2 10
4
(43.936) (0.253) (50.657) (0.415)
Belgium 0.399*** 0.003*** Netherlands 0.149*** 0.001***
(74.897) (5.776) (27.979) (3.223)
Finland 0.090*** 0.004*** Portugal 0.304*** 0.004***
(16.841) (9.109) (57.002) (8.967)
France 0.215*** 0.003*** Spain 0.185*** 0.002***
(40.330) (6.972) (34.676) (3.933)
Greece 0.199*** 0.003*** Sweden 0.097*** 0.004***
(37.418) (6.562) (18.190) (9.896)
Ireland 0.073*** 0.004*** United Kingdom 0.118*** 0.005***
(13.655) (9.843) (22.199) (10.330)
F-test 3591.25***
R
2
0.997
Observations 240
*** Significant at 1%.
Note: t-statistics are given in parentheses.
1190 R Ezcurra, P Pascual
while we find four countries with significant negative trends, Belgium, Greece, the
Netherlands, and Portugal. Specifically, of the ten countries with a significant time
trend, only Belgium and the Netherlands registered an annual change in the level of
regional inequality of less than 1% of the estimated country-specific term in the
regression reported in table 1. Accordingly, although the limited time frame of our
study implies that any conclusion should be considered with some caution, the analysis
carried out suggests that intertemporal changes in regional disparities within the various
member states considered are relatively important when compared with cross-country
differences. This is compatible with the convergence process observed across EU
countries during the last two decades (European Commission, 1999; Puga, 2002).
4 The relationship between regional disparities and fiscal decentralization
The analysis undertaken in the preceding pages revealed significant differences in the
level and evolution of regional inequality within the various countries considered.
In order to explore this issue more deeply, in this section we examine the possible
influence in this context of fiscal decentralization, a factor that has not been consid-
ered so far in any of the numerous works devoted to the study of territorial imbalances
in the EU countries.
In order to achieve this aim, we needed first to quantify the degree of fiscal
decentralization in our sample countries. This is no easy task, however, since the
devolution of fiscal power from central to regional and local governments is a complex
and multidimensional process (Mart| nez-Va zquez and McNab, 2003; Schneider, 2003).
Leaving aside conceptual problems, the scarcity of homogeneous and reliable data is an
additional difficulty in this context. Bearing in mind these considerations, and following
the usual practice in the literature, we approximated the level of fiscal decentralization
of the various countries considered by means of the subnational share in total govern-
ment expenditure (Davoodi and Zou, 1998; Oates, 1985; 1993). It needs to be said that
this measure has been criticized for failing to identify the degree of expenditure autonomy
of subnational governments, differentiate between tax and nontax revenue sources, or
determine what proportion of intergovernmental transfers is discretionary or condi-
tional (Ebel and Yilmaz, 2002; Rodden, 2004; Stegarescu, 2005). Despite this, and due
to the lack of reliable alternatives, Rodr| guez-Pose and Gill (2004) point out that the
subnational share in total government expenditure is probably the best available quanti-
tative indicator to carry out cross-country comparisons. In particular, with the exception
of that of Gil et al (2004), all existing analyses on the relationship between fiscal decentral-
ization and regional disparities employ this measure, which facilitates the comparison of
our results with those obtained by other studies in different geographic settings.
Data on the subnational share in total government expenditure are taken from the
International Monetary Fund's Government and Finance Statistics. It should be noted
that there is no information on this variable for the twelve countries considered for the
entire twenty-year sample period, although for most of the countries the set of time-
series observations is complete. Indeed, the average number of observations for each
country is, from a possible maximum of 20, 16.2. Accordingly, we have an unbalanced
panel dataset formed by 194 observations covering the period 1980 ^ 99.
Our research begins with a graphical analysis of the possible link between regional
disparities and fiscal decentralization. As can be observed in figure 2, an inverse
relationship appears to exist between these two variables for the pooled data during
the study period as a whole. In order to confirm this fact, and following the approach
employed by Shankar and Shah (2003) and Gil et al (2004), we calculated the correla-
tion coefficient between CVand the subnational share in total government expenditure,
obtaining a value of 0:618, which is statistically significant. This result is in line with
Fiscal decentralization and regional disparities 1191
the empirical evidence provided by Shankar and Shah (2003) and Gil et al (2004) in a
different geographic context, and suggests that the level of fiscal decentralization may
be a relevant factor in explaining the degree of dispersion in the spatial distribution of
per capita GDP within the sample countries.
However, there are several reasons to suggest that this finding should be met
with some caution. It should be borne in mind that the nature of the analysis carried
out does not allow a causal link between the degree of devolution of fiscal power to
subnational governments and regional disparities to be established. Likewise, as pointed
out by Rodr| guez-Pose and Gill (2004), the level of regional inequality registered by the
various countries does not depend exclusively on their degree of fiscal decentralization.
This suggests that additional explanatory variables should be included in the anal-
ysis. Finally, it should not be overlooked that figure 2 and the correlation coefficient
calculated are based on pooled data, which prevents any attempt to control for
country-specific factors relating, for example, to institutional or historical features
(Akai and Sakata, 2002). In view of these considerations, we estimate the following
two-way fixed-effects model:
I
ct
a bD
c t l
fX
c t l
l
c
g
t
v
ct
, (3)
where D is the measure of fiscal decentralization, X is a vector of variables that control
for other factors that are assumed to influence regional disparities, l are unobservable
country-specific effects, g are time-specific effects common to all countries, and v is the
corresponding disturbance term. It is worth noting that we specify l-period lagged
values of the independent variables in order to reduce any potential endogeneity
problems (Kanbur and Zhang, 2005).
Before presenting our results, we describe the series of variables that make up the
vector X. In this respect, while the choice of these variables is well grounded theo-
retically, it ultimately depends on the availability of reliable statistical data for the
geographical setting on which our study is focused. Thus, we first considered the role
played by the level of national development. It is worth recalling that in recent
decades the literature has paid increasing attention to the relationship that exists
between the level of economic development in a given geographical area and the
evolution of spatial disparities within that area (Petrakos et al, 2005; Terrasi, 1999).
This interest is closely related to the publication of the seminal work by Williamson
(1965), who adopted the well-known study by Kuznets (1955) to a regional setting.
, ,
0.4
0.3
0.2
0.1
0.0
R
e
g
i
o
n
a
l
i
n
e
q
u
a
l
i
t
y
(
C
V
)
0 10 20 30 40
Fiscal decentralization
Figure 2. Regional disparities and fiscal decentralization (pooled data).
1192 R Ezcurra, P Pascual
According to Williamson (1965), as advances are made in the economic development
process, regional disparities in per capita income tend at first to increase, before
systematically decreasing in the following stages of development. The trend in regional
inequality would therefore follow an inverted U shape. This evolution means that the
advances in the economic development process contribute to the spatial dispersion of
economic activity, due to the increasing relevance of factors such as the emergence
of new locational advantages in peripheral regions, the presence of congestion costs
associated with excessive agglomeration in the initially more developed areas, or the
technological diffusion processes (Davies and Hallet, 2002). All of these arguments
raise the possible existence of a nonlinear relationship between the level of national
development and regional disparities. For this reason, we opt to include in our model
national per capita GDP and the square of national per capita GDP.
It is interesting to observe that, throughout the estimation period, all of the
economies under study increased their volume of foreign trade considerably. This is
hardly surprising if we bear in mind the important advances by the European eco-
nomic process during the last two decades The effects of greater competition and
increasingly integrated markets are unevenly spread across space, thus affecting exist-
ing regional disparities (Petrakos et al, 2005). In this respect, it is reasonable to assume
that the impact will be greater on those regions that depend most heavily on the
evolution of international markets. In view of these considerations, we decided to
control our estimations for the possible impact on the observed regional inequality
levels of the degree of international trade openness measured, following standard
practice, as the ratio between total trade (exports and imports) and GDP.
Additionally, the models of the so-called `new economic geography' have high-
lighted from a theoretical point of view the important role played by agglomeration
economies in explaining regional disparities (for a review of this literature see Krugman,
1998). Agglomeration economies result from market and nonmarket interactions (spa-
tial externalities), and imply that proximity to larger markets favours the accumulation
of economic activity in certain areas (Fujita and Thisse, 2002). The measurement of
agglomeration economies is no easy task, however, due to the difficulty involved in
assessing adequately the size of regional markets. Bearing this in mind, we decided to
approximate its impact by means of the degree of dispersion of regional population
density (Lo pez-Bazo, 2003).
Furthermore, as reported by Paci (1997), variations in productive structures over
time also influence the spatial distribution of per capita income. Accordingly we
checked for the possible impact on regional inequality of existing differences in regional
productive structures. Using a fifteen-sector classification of productive activities as
reference, our first step was to calculate for each region and year in the sample the
following specialization index (Krugman, 1991):
SPE
it

1
2
X
S
s 1
jr
ist
r
ist
j , (4)
with
r
ist

E
ist
X
S
s 1
E
ist
, r
ist

X
n
c
k 6i
E
kst
X
n
c
k 6i
X
S
s 1
E
kst
,
where E
ist
stands for region i's employment share in sector s during year t. SPE
i t
can
be understood as a measure of regional divergence, since it compares the productive
Fiscal decentralization and regional disparities 1193
structure of a given region with that of the rest of the country to which it belongs. In
fact, if r
ist
r
ist
, the value of the index would logically be zero. For a region with a
sectoral structure totally different from that of the rest of the country, however, we
would find that SPE
i t
1. From the information provided by this index, we calculated
the average level of regional specialization over the period 1980 ^ 99 for each of the
countries considered in our study, this being the variable to be used in our estimations.
Finally, the relevance attached to the European integration process to achieving
economic and social cohesion and reducing disparities between the levels of devel-
opment of the various regions should not be overlooked. As a consequence, the
quantitative importance of European regional policy increased considerably after
the 1989 reform of the Structural Funds, to the extent that by 2002 it accounted for
more than one third of the European budget and around 0.37% of European GDP.
Although the effectiveness of European regional policy has been evaluated in numer-
ous studies (European Commission, 2004; Rodr| guez-Pose and Fratesi, 2004), the
results to date remain inconclusive. In any event, we decided to control our estimates
for the potential impact that European regional policy might have had on the evolution
of regional disparities. For this, we use the amount of Structural funds directed at
promoting development in regions where per capita GDP is below 75% of the EU
average (Objective-1 regions), expressed as a percentage of national GDP.
The data on the explanatory variables that make up the vector X are taken from
the Cambridge Econometrics European database. The only exceptions to this are the
degree of trade openness and the Structural Funds data, which are drawn from Ameco,
the database compiled by the Directorate General for Economic and Financial Affairs
of the European Commission, and the annual reports on the implementation of the
reform of the Structural Funds, respectively.
It should be mentioned that efficient estimation of model (3) in the absence of
further assumptions on the individual effects can be carried out by OLS on the data
transformed by the within operator (that is, centred on individual means) (for further
details see Baltagi, 1995). For the within estimator we computed a variance matrix
estimator that is robust to cross-sectional heteroscedasticity and within-panel serial
correlation (Arellano, 1987). Likewise, bearing in mind the potential problem of endo-
geneity (Wooldridge, 2002), we considered in our estimations values of the regressors
lagged for various periods. However, the results obtained are in all cases very similar.
For this reason, and to save space, we present only the estimations corresponding to
l 2.
(4)
In this respect, it is worth noting that Rodr| guez-Pose and Gill (2004) observe
the existence of a lag that varies between one and three years between the changes in
subnational expenditure figures and changes in regional disparities.
Table 2 reports the results obtained when we estimate different versions of model (3).
As shown, our model is capable of explaining in general terms a substantial fraction of
the variation in regional inequality across the EU countries considered. Leaving this
aside, it is important to stress that the value of the coefficient associated with the level
of fiscal decentralization is stable, being in all cases negative and statistically signifi-
cant. Specifically, the estimates carried out reveal that an increase of 1% in the
subnational share in total government expenditure contributes to reducing the value
of the coefficient of variation by 0.002, which represents 0.865% of average inequality in
the sample countries over the study period. Accordingly, fiscal decentralization does
not necessarily contribute to an increase in the degree of dispersion in the regional
distribution of per capita GDP within the countries considered. On the contrary, our
estimates support the hypothesis that regional disparities decrease as the subnational
(4)
The rest of results are available from the authors upon request.
1194 R Ezcurra, P Pascual
share in total government expenditure increases. This result is potentially important,
since it highlights the practical relevance of the theoretical arguments laid out in the
section 2 that pointed out that fiscal decentralization may give rise to a more balanced
distribution of resources across space (Gil et al, 2004; McKinnon, 1997; Qian and
Weingast, 1997), to such an extent that it may even offset the effects of the loss of
redistributive power by the central government (Prud'homme, 1995).
(5)
The information provided by table 2 on the remaining explanatory variables con-
sidered shows the evidence of a bell-shaped relationship between regional disparities
and national development in the EU countries considered. Therefore, as advances are
made in the economic development process, regional inequality in per capita GDP
tends at first to increase, before decreasing in the following stages of development. It is
worth recalling that this evolution is consistent with the hypothesis formulated by
Williamson (1965). Additionally, the results obtained suggest that the level of trade
openness is negatively correlated with regional inequality, which raises the possibility
that the growing economic integration process in Europe may have had a positive
impact in relative terms on the less-favoured areas of those countries where foreign
trade plays a major role. Nevertheless, this conclusion should be viewed with some
caution, given that the coefficient associated with the degree of trade openness is
statistically significant only in the estimation that includes the full set of explanatory
variables considered.
Table 2. The impact of fiscal decentralization on regional disparities.
Dependent variable: coefficient of variation (CV)
Constant 0.089 0.041 0.028 0.231** 0.344
(1.087) (0.368) (0.258) (2.459) (3.191)
Fiscal decentralization 0.002*** 0.002*** 0.002** 0.002*** 0.002***
(3.695) (3.331) (2.860) (3.141) (4.144)
Per capita GDP 0.023** 0.033* 0.033* 0.046*** 0.062***
(2.654) (2.062) (2.015) (3.722) (4.183)
(Per capita GDP)
2
0.001** 0.001** 0.001* 0.001*** 0.002***
(2.794) (2.300) (2.191) (4.295) (4.672)
Trade openness 0.001 0.001 0.001 0.001*
(0.957) (0.936) (1.566) (1.918)
Population density 0.063 0.070 0.058
(0.636) (0.870) (0.914)
Productive specialization 1.244*** 1.129**
(3.458) (2.968)
Structural funds 1.512**
(2.557)
F-test 8.20*** 10.10*** 14.68*** 42.27*** 13.05***
R
2
0.370 0.401 0.406 0.494 0.524
Country-specific effects yes yes yes yes yes
Time-specific effects yes yes yes yes yes
Countries 12 12 12 12 12
Observations 184 18 184 184 184
* Significant at 10%; ** significant at 5%; *** significant at 1%.
Notes: t-statistics are given in parentheses. The standard errors are based on a variance matrix
estimator which is robust to cross-sectional heteroscedasticity and within-panel serial correlation
(Arellano, 1987).
(5)
We also investigated the possible existence of a nonlinear relationship between fiscal devolution
and regional inequality. To this end, we added the square of subnational share in total government
expenditure to the list of regressors in model (3). However, the coefficient corresponding to this
variable was not statistically significant.
Fiscal decentralization and regional disparities 1195
Furthermore, the analysis carried out reveals that the average level of regional
specialization is positively correlated with the dependent variable. This highlights the
key role played by the sectoral composition of economic activity in explaining regional
growth processes in the EU countries considered (European Commission, 1999; Paci,
1997). In turn, our estimates show that the Structural funds devoted to promoting
economic development of the least-favoured regions of the Union contributed to
reducing regional inequality within the sample countries. Care is required, however,
when weighing up the implications of this result, since it is not possible to evaluate
something as complex as the effects of European regional policy simply on the basis
of an analysis of this type (for further details see Rodr| guez-Pose and Fratesi, 2004).
Finally, it is worth noting that the degree of dispersion of regional population density is
not statistically significant in any of the various versions of model (3). This is probably
related to the lack of suitable data for measuring the importance of agglomeration
economies in the EU at this level of territorial disaggregation.
5 Robustness analysis
The aim of this section is to present a somewhat detailed study of the robustness of the
results obtained in the preceding pages. We begin by investigating the extent to which
the relationship between fiscal decentralization and regional disparities may be driven
by a specific country in our sample. Likewise, we consider the possibility of our results
being sensitive to the measure of regional inequality used as dependent variable in our
estimations. For this reason, we repeat the previous analysis using various inequality
indices as an alternative to the population-weighted coefficient of variation employed
thus far.
5.1 Influence of the various countries on the relationship between regional disparities and fiscal
decentralization
When weighing up the findings of the preceding section, it is worth gauging the extent
to which they depend on the inclusion in the analysis of the various countries consid-
ered. In fact, it may occur that the negative correlation detected between regional
inequality and the subnational share in total government expenditure was driven by a
particular country. If this hypothesis is true, elimination of that country from the
sample should cause the level of fiscal decentralization to be nonsignificant.
To show that this is not the case, we carried out different estimations of model (3),
excluding each of the twelve countries considered in turn. The results of this analysis
are presented in table 3. As shown, the coefficient associated with the subnational
share in total government expenditure continues to be negative and statistically sig-
nificant in all cases. In fact, the value of this coefficient does not register any relevant
fluctuations. Therefore, this confirms that our results are not determined by the inclusion
in the sample of any specific country.
It is worth mentioning that the analyses carried out so far in this paper are based
exclusively on the degree of fiscal decentralization of the EU countries considered, thus
ignoring their level of administrative and political decentralization (Schneider, 2003).
This omission may be particularly relevant, since some of the sample countries
register significant differences between these three dimensions of the concept of
decentralization. The main examples in this respect are Finland and Sweden, two
countries characterized by a high degree of fiscal and administrative devolution, and
a low level of political decentralization. For this reason, we repeated our estimations
excluding Finland and Sweden from the analysis. However, as can be checked in
table 3, the negative correlation detected previously between the subnational share
in total expenditure and regional inequality still holds.
1196 R Ezcurra, P Pascual
5.2 Alternative inequality measures
To investigate more deeply the robustness of the negative relationship between regional
disparities and fiscal decentralization observed in the preceding section, we examine
whether the results obtained may depend on the measure used to quantify regional
inequality. Indeed, it is a well-known fact within the literature on personal income
distribution that various inequality measures may actually yield different orderings
of the distributions one wishes to compare, since each index has a different way of
aggregating the information contained in the distribution (Sen, 1973).
For this reason, instead of the population-weighted coefficient of variation employed
so far, we applied the following measures, which are widely used in the literature on
personal income inequality: the two indices proposed by Theil (1967) within the infor-
mation theory context, T(0) and T(1), and the Gini index, G, which can be written as:
T0
ct

X
n
c
i 1
p
it
ln
m
ct
x
it

, (5)
T1
ct

X
n
c
i 1
p
it
x
it
m
ct

ln
x
it
m
ct

, (6)
and
G
ct

1
2m
ct
X
n
c
i 1
X
n
c
j 1
p
it
p
jt
jx
it
x
jt
j . (7)
Additionally, we have considered the information provided by the population-weighted
standard deviation of the logarithm of regional per capita GDP, SDlog. This is the measure
of dispersion that in the nonweighted version has been widely used in the convergence
literature to capture the concept of sigma convergence (Barro and Sala-i-Martin, 1995):
SDlog
ct

X
n
c
i 1
p
it
ln x
it
ln ~ m
ct

2
" #
1=2
, (8)
Table 3. The impact of fiscal decentralization on regional disparities: influence on the results of
the various countries.
Country excluded Fiscal decentralization t-statistic R
2
Observations
Austria 0.002*** 4.359 0.540 166
Belgium 0.001** 2.232 0.577 166
Finland 0.002*** 3.478 0.485 166
France 0.002** 2.673 0.520 166
Greece 0.002*** 4.081 0.524 181
Ireland 0.001** 2.371 0.509 166
Italy 0.002*** 3.904 0.528 176
Netherlands 0.002*** 3.669 0.674 166
Portugal 0.002*** 3.853 0.537 173
Spain 0.002** 2700 0.539 166
Sweden 0.002*** 4.490 0.499 166
United Kingdom 0.002*** 5.142 0.476 166
Finland and Sweden 0.002** 2.855 0.453 148
** Significant at 5%; *** significant at 1%.
Notes: All the regressions include country-specific and time-specific effects, and the following
control variables: national per capita GDP, the square of national per capita GDP, trade
openness, population density, productive specialization, and amount of Structural Funds in
Objective-1 regions. The standard errors are based on a variance matrix estimator which is
robust to cross-sectional heteroscedasticity and within-panel serial correlation (Arellano, 1987).
Fiscal decentralization and regional disparities 1197
where
ln ~ m
ct

X
n
c
i 1
p
it
ln x
it
.
As occurs with CV, all the indices selected are independent of scale and population size
and, except for the standard deviation of the logarithm, they all fulfil the Pigou^ Dalton
transfer principle for the whole definition domain of income (Cowell, 1995).
According to the strategy described above, we again estimated model (3) using as
the dependent variable T(0), T(1), G, and SDlog in turn. The results obtained are
reported in table 4. As can be observed, the degree of devolution of fiscal power to
subnational governments is negatively correlated with each of the inequality measures
considered. Therefore, the relationship detected above does not depend on the indica-
tor used to quantify the degree of dispersion in the regional distribution of per capita
GDP within the different countries included in our study.
6 Conclusions
In this paper we examined for the first time the relationship between fiscal decen-
tralization and regional disparities in twelve EU countries. To achieve this aim, a
two-way fixed-effects panel data model is employed. This approach enables us to
overcome the methodological limitations that characterize the scant studies devoted
so far to exploring the potential impact of fiscal decentralization on regional inequality
with cross-country data.
Our estimates support the hypothesis that the devolution of fiscal power to subna-
tional governments is negatively correlated with the level of regional inequality. This
suggests that the advances in the process of fiscal decentralization contribute to
reduce regional disparities in the sample countries. Therefore, our analysis highlights
the practical relevance of the theoretical arguments laid down in section 2, where it
was suggested that fiscal decentralization may give rise to a more balanced distribu-
tion of resources across space (Gil et al, 2004; McKinnon, 1997; Qian and Weingast,
1997), to such an extent that it may even make up for the consequences of the central
government's loss of redistributive power (Prud'homme, 1995).
This conclusion is robust to the inclusion in the analysis of additional explanatory
variables, such as the level of national development, trade openness, the dispersion of
regional population density, the degree of productive specialization, and the funds
Table 4. The impact of fiscal decentralization on regional disparities according to various
inequality measures.
Dependent variable
T(0) T(1) G SDlog
Fiscal decentralization 2 10
4
** 3 10
4
*** 5 10
4
* 0.001***
(2.787) (3.164) (2.075) (3.956)
F-test 18.10*** 13.09*** 3.26*** 16.99***
R
2
0.478 0.461 0.567 0.563
Observations 184 184 184 184
* Significant at 10%; ** significant at 5%; *** significant at 1%.
Notes: All the regressions include country-specific and time-specific effects, and the following
control variables: national per capita GDP, the square of national per capita GDP, trade
openness, population density, productive specialization, and amount of Structural Funds in
Objective-1 regions. The standard errors are based on a variance matrix estimator which is
robust to cross-sectional heteroscedasticity and within-panel serial correlation (Arellano, 1987).
1198 R Ezcurra, P Pascual
provided by European regional policy. Likewise, we have checked that our results are
not driven by any specific country. Furthermore, the negative relationship detected
between fiscal decentralization and regional disparities still holds when alternative
measures are used to quantify the level of regional inequality.
Additional extensions to our work are not difficult to conceive. Some of them relate
directly to the enlargement of the number of countries considered. In this respect, it
should be noted that our results cannot be generalized to other countries with different
levels of development from those included in our sample. Specifically, our study does
not allow us to dismiss the possibility that fiscal decentralization contributes to an
increase in the degree of spatial dispersion of per capita income in developing coun-
tries or in transition economies. In the future, moreover, it might be interesting to
include different decentralization measures in the analysis in order to capture the
various dimensions of the devolution processes (Schneider, 2003; Stegarescu, 2005).
Acknowledgements. The authors would like to thank Carlos Gil, Manual Rapu n and four anony-
mous referees for their helpful comments and suggestions. In addition, the authors wish to
acknowledge the financial support from Spanish MEC (Projects SEJ2005-08738-C02-01 and 02).
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