Dress-up contest: a dark side of fiscal decentralization

Ruixin Wang () and Wendun Wang ()
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Ruixin Wang: CentER, Tilburg University
Wendun Wang: Erasmus University Rotterdam

No 2013/30, Working Papers from Institut d'Economia de Barcelona (IEB)

Abstract: A `dress-up contest' is a competition for the best public image, and fiscal decentralisation can lead to such contests between local governments. In this paper we model the dress-up contest and investigate how it a effects social welfare. We show that yardstick competition (due to fiscal decentralisation) forces local governments to allocate more resources to more visible public goods (such as cash assistance) than less visible goods (such as vendor payments) and thus starts dress-up contests. The resulting distortion of resource allocation causes a structural bias in public expenditure and further hurts social welfare. To empirically verify our theoretical model, we employ U.S. state-level data from 1992 to 2008, and we estimate the panel data model using various econometric approaches. The empirical results provide strong evidence that fiscal decentralisation can lead to distortion in public expenditure arising from dress-up contests. We also find that this distortion increases the regional poverty rate.

Keywords: Fiscal decentralization; yardstick competition; dress-up contest; functional coefficient model (search for similar items in EconPapers)
JEL-codes: D72 H75 H77 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2013
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