Dress-Up Contest: A Dark Side of Fiscal Decentralization

IEB Working Paper N. 2013/030

37 Pages Posted: 16 Oct 2013

See all articles by Ruixin Wang

Ruixin Wang

Tilburg University - Center for Economic Research (CentER)

Wendun Wang

Erasmus University Rotterdam (EUR)

Date Written: June 13, 2013

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

JEL Classification: D72, H75, H77

Suggested Citation

Wang, Ruixin and Wang, Wendun, Dress-Up Contest: A Dark Side of Fiscal Decentralization (June 13, 2013). IEB Working Paper N. 2013/030. Available at SSRN: https://ssrn.com/abstract=2340417 or http://dx.doi.org/10.2139/ssrn.2340417

Ruixin Wang (Contact Author)

Tilburg University - Center for Economic Research (CentER) ( email )

Wendun Wang

Erasmus University Rotterdam (EUR) ( email )

Burgemeester Oudlaan 50
3000 DR Rotterdam, Zuid-Holland 3062PA
Netherlands

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