Abstract:
Fiscal decentralization is adopted by many developed and developing economies to
enhance the provision of public goods and services in accordance with the preferences of
citizens. Fiscal decentralization is the devolution of responsibilities from central government to
provincial governments comprising of expenditure assignments and revenue generation. This
study intends to empirically examine the causal relationship between fiscal decentralization and
economic growth and then find the impact of fiscal decentralization on economic growth in
Pakistan by employing annual data for the period 1980 to 2018. The analysis is carried out in
two parts. In the first part the causal relationship between fiscal decentralization and economic
growth is examined by employing Vector Error Correction model (ECM). The results show that
fiscal decentralization i.e. expenditure decentralization and revenue decentralization causes
economic growth in the long run. In the second part, the impact of fiscal decentralization on the
economic growth is analyzed and for that purpose Johansen cointegration and error correction
model is employed. The results show that expenditure decentralization has a negative impact on
the economic growth while revenue decentralization has a positive impact on the economic
growth in the long run and both are statistically significant. Moreover, the ECM model
estimation indicates the role of private investment, a key macroeconomic variable that is found
negatively affecting economic growth. The results also indicate the role of social indicators like
education, health and law and order have a positive and significant impact on the growth. The
negative impact of expenditure decentralization highlights the administrative incapacity of
provincial governments in designing optimal policies and development planning.
