Fiscal decentralization and regional economic growth: Evidence from Mexico since the 2000s

This study aims to examine whether decentralization causes regional economic growth for the states of Mexico in the period 1998-2016. We employ Granger causality tests and a Panel data Vector Autoregression model to account for the dynamics of fiscal federalism and endogeneity of federal transfers and economic growth. Impulse responses and variance decomposition are also employed to examine the time path of economic growth after unitary fiscal shocks from transfers. Among the results, we find federal transfers positively affect economic growth. The slim response of growth and its puzzling response to investment shocks possibly signal a soft budget problem. Applications for Practice This study offers evidence on the dynamic link between revenue decentralization and economic growth for a middle-income country. The type and structure of decentralization has an impact on regional economic growth and on the fiscal effort of local governments. The 2003 reform has reinforced dependency on conditional transfers, but has also led to greater local tax revenue and to higher local GDP. The 2008 reform has discouraged conditional transfers while promoting a higher dependency on conditional transfers. The path response of growth to investment shocks suggests a soft budget problem. Applications for Practice This study offers evidence on the dynamic link between revenue decentralization and economic growth for a middle-income country. The type and structure of decentralization has an impact on regional economic growth and on the fiscal effort of local governments. The 2003 reform has reinforced dependency on conditional transfers, but has also led to greater local tax revenue and to higher local GDP. The 2008 reform has discouraged conditional transfers while promoting a higher dependency on conditional transfers. The path response of growth to investment shocks suggests a soft budget problem.