The Impacts of Fiscal Decentralization on the Quality of Government in China: A Test of Market-Preserving Federalism at the Provincial Level

Abstract

The potential influence of fiscal decentralization on economic growth in China has been extensively studied. This paper examines whether fiscal decentralization has influenced marketization and regional disparity (intra-provincial expenditure inequality) and the tradeoff between them (quality of government, QoG). When local governments have sufficient fiscal autonomy, decentralizing fiscal power to sub-provincial governments is found to have a greater impact on increasing marketization, highlighting the important role of fiscal self-sufficiency in the effect of fiscal decentralization on market efficiency. Measuring the QoG from the marketization versus disparity perspective, we find a reversed U-shape relationship between revenue decentralization and QoG. Comparing the effect of fiscal decentralization on the QoG in different regions, intra-provincial revenue decentralization in the eastern area is above the optimal level, while the fiscal decentralization in the middle and western areas is near the optimal level. This paper combines the perspectives of fiscal decentralization and governance and conducts an empirical test of market-preserving federalism to explain differences among provinces.