Previous studies imply that a positive regional fiscal shock, such as a resource boom, strengthens the desire for separation. In this paper we present a new and opposite perspective. We construct a model of endogenous fiscal decentralization that builds on two key notions: a trade-off between risk sharing and heterogeneity, and a positive association between resource booms and risk. The model shows that a resource windfall causes the nation to centralize as a mechanism to either share risk and/or prevent local capture, depending on the relative bargaining power of the central and regional governments. We provide cross country empirical evidence for the main hypotheses, finding that resource booms: (i) decrease the level of fiscal decentralization with no U-shaped patterns, (ii) cause the former due to risk sharing incentives primarily when regional governments are relatively strong, and (iii) have no effect on political decentralization.
Bibliographical noteFunding Information:
Fidel Perez-Sebastian thanks the Spanish Ministry of Science and Technology (ECO2015-70540-P), Generalitat Valenciana (PROMETEO/2013/037), and the Instituto Valenciano de Investigaciones Económicas for financial support. We thank seminar participants at the Hebrew University of Jerusalem, University of Oxford, and the 2015 OxCarre-Oslo Workshop, as well as to Robin Boadway, Yaniv Reingewertz, Ragnar Torvik, Rick van der Ploeg, Tony Venables, and Wessel Vermeulen for helpful comments and suggestions.
© 2016 Elsevier B.V.
- Bargaining power
- Natural resources
- Risk sharing