Dress-Up Contest: A Dark Side of Fiscal Decentralization
IEB Working Paper N. 2013/030
37 Pages Posted: 16 Oct 2013
Date Written: June 13, 2013
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
JEL Classification: D72, H75, H77
Suggested Citation: Suggested Citation