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Federalism and Economic Performance: Evidence for Swiss Cantons Presentation at the BMF-ZEW-Conference on Fiscal Policy Challenges in Europe, Berlin, March 23, 2007. Prof. Dr. Lars P. Feld University of Heidelberg, University of St. Gallen (SIAW-HSG), ZEW Mannheim, Crema Basel and CESifo Munich.

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  1. Federalism and Economic Performance:Evidence for Swiss CantonsPresentation at the BMF-ZEW-Conference on Fiscal Policy Challenges in Europe, Berlin, March 23, 2007 Prof. Dr. Lars P. FeldUniversity of Heidelberg,University of St. Gallen (SIAW-HSG), ZEW Mannheim, Crema Basel and CESifo Munich Berlin

  2. In a Nutshell • Difference to the Literature • Literature is on fiscal decentralization and economic growth • Here: Instruments of fiscal federalism and economic performance. • ‚Instruments‘ are tax competition, grants, fragmentation. • Message • Tax competition is not harmful to regional performance. • No clear-cut results on grants. • Fragmentation is not harmful to economic performance. Berlin

  3. Federalism and Economic Performance Outline of the Presentation • Introduction • Theoretical Background • Empirical Studies • Swiss Federalism • Results on Federalism and Economic Performance in Switzerland • Conclusion Berlin

  4. Introduction • Political Discussion around the World • Commission on Fiscal Federalism in Germany • Is German federalism harmful for economic development? • Joint Decision Trap • Similar discussions in Austria and Switzerland. • Academic Discussion • What is the impact of vertical separation or division of powers on economic development of countries? • Federations vs. unitary states. • Cooperative vs. competitive federalism. Berlin

  5. Introduction • Advantages and Disadvantages of Federalism • Broad discussion in the literature. • Theory of fiscal federalism and plenty of interjurisdictional externalities. • Political economy arguments. • Specific problems in developing countries. • Corruption. • Contradictory Hypotheses • Necessity to conduct empirical research. • Empirical study on Switzerland is particularly helpful. Berlin

  6. Theoretical Background Berlin

  7. Theoretical Background • Regional Development and Convergence • Competitive federalism • Efficiency gains and political innovation • vs. Brain drain • Fiscal equalization/ grants • Income increase and attraction of new industries • Disincentives for structural change and bail-out problems • National Economic Growth • Competitive federalism: • Efficiency reserves vs. decline of help to change economis structures • Fiscal equalization/ grants • Negative incentives vs. development aid. Berlin

  8. Empirical Studies • Cross Country Studies • Still ambiguous results on fiscal decentralization and economic growth. • Specific problems of LDCs. • Autonomy vs. share of decentralized spending. • China • First glance: Ambiguous results. • Second evaluative view: Fiscal decentralization has a positive impact on economic growth of Chinese provinces. Berlin

  9. Empirical Studies • USA • Xie, Zou and Davoodi (1999): • National level: U.S. are in a decentralization equilibrium, because decentralization has no significant impact on national economic growth. • Akai and Sakata (2002) • State level: Decentralization in the U.S. states has a positive impact on their development. • Local Autonomy measured by the share of own from total revenue does not have a significant impact. • Stansel (2005) • Higher fragmentation is associated with significantly higher growth in (log) real per capita money income at the municipal level. Berlin

  10. Empirical Studies • Germany • Behnisch, Büttner and Stegarescu (1999): • National level: Increasing federal share of total spending has a positive impact on total productivity growth. • Berthold, Drews and Thode (2001) • State level: Horizontal fiscal equalization and vertical supplementary grants have a negative impact on regional development of the German states. • Panel of 16 states from 1991 to 1998: Methodological Problems. • Berthold, Drews and Thode (2007) • Panel of 16 states from 1991 to 1998: Still Methodological Problems due to Invalid Instruments. • General Problems of the Studies • Too strong concentration on decentralization measures. • Autonomy and instruments of federalism. Berlin

  11. Swiss Federalism Berlin

  12. Swiss Federalism II CH:Population 7'261'200 Foreigners 1'457'800 Area: 41‘293 km2 26 Cantons (AI 14'900 Inhabitants) 2903 Communes Berlin

  13. Swiss Federalism III Berlin

  14. Results on Federalism and Economic Performance in Switzerland • Econometric Approach • Exogenous Growth Model • Production function of Mankiw, Romer and Weil (1992) • Organisation of federalism as technological progress. Berlin

  15. Results on Federalism and Economic Performance in Switzerland • Variables • Qit : Real GDP; • Lit: Number of Employees • Hit: Share of People with High School Degree or Cantonal Education Spending per Capita • Kit: Private Investment • Vit: Vector of Controls • 0to4: Parameters • it: Error Term. Berlin

  16. Results on Federalism and Economic Performance in Switzerland • Federalism Variables • Share of Decentralization: Share of local spending (tax revenue) from total local and cantonal spending (tax revenue) • Grants per capita • Lump sum grants • Matching grants • Urbanisation as a proxy for agglomeration economies Berlin

  17. Results on Federalism and Economic Performance in Switzerland • Federalism Variables • Fragmentation of a canton in communities as a proxy for economies of scale in consumption. • Tax competition • Difference between an canton‘s tax rate and the average tax burden of other cantons (weithed by the inverse of distance) in the highest income tax bracket (1 million SFr). • Language dummy • Dummy Basel-City. Berlin

  18. Results on Federalism and Economic Performance in Switzerland • Panel of 26 Cantons from 1980 to 1998 • OLS and TSLS with time dummies • Instruments: • Cantonal Dummies • Lagged grants and federal index of mountainous areas • Proxies for interest group influence • Robust standard errors (Clustering-Method). Berlin

  19. Results on Federalism and Economic Performance in Switzerland Berlin

  20. Results on Federalism and Economic Performance in Switzerland

  21. Conclusion • Impact of Swiss fiscal federalism on cantonal economic performance • Production function approach • Panel of cantons from 1980 - 1998 • Grants, in particular matching grants, is negatively correlated with GDP per employee. • Tax competition is not harmful. • Economies of scale do not have a significant impact. • Robustness Checks • Fixed effects regressions. • Growth regressions. • Interaction of population with tax competition proxy. • Political Controls. Berlin

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