Democratization, Decentralization and the Distribution of Local Public Goods in a Poor Rural Economy

Abstract

In this paper we exploit a unique panel data set describing village governance, public goods allocations, and economic circumstances in India over the past twenty years to examine the consequences of democratization and fiscal decentralization within a model that highlights landownership-based interest groups. We first construct a simple model of two-party representative democracy with probabilistic voting in which local governments must choose to allocate public resources among three different goods representing the principal local public goods in Indian villages: roads, which primarily benefit the poor by raising wages; irrigation facilities, which differentially benefit landowners; and schools which have neutral effects. We embed the voting model in a general-equilibrium model of the rural economy in order to capture the general-equilibrium effects of changes in the landless share on the economic returns to the public goods. The model yields predictions about how the landless share affects allocations of the specific public goods under democracy relative to an alternative regime in which the local elite have a disproportionate effect on outcomes relative to that dictated by democracy. The model also has implications for the effects of ceding revenue-generating authority to the local governing body that permit an assessment of the differential burden of taxation on the rich and poor. Based on specifications consistent with the model, we then find evidence consistent with the two-party model of democracy in which increasing the population weight of the poor induces public resource allocations that increase the welfare of the poor. However, we also find that local taxes, where they are permitted, are regressive - the (landless) poor pay a higher tax rate on consumption than do the rich. Finally, we assess the growth implications of local democratization. Our evidence is consistent with almost-perfect substitution of public and private irrigation investment. Our findings thus suggest that the shift in the portfolio of local public goods associated with local democratization in part represents a transformation of a local welfare program from one that serves the rich to one that increases the welfare of the poor with possibly a net gain in total output.