Abstract
This study examines the effects of Fiscal Decentralization on Economic Growth in the context of Pakistan. The current structure of fiscal arrangements in Pakistan consists of three tiers, federal, provincial and local. Resources are distributed among these tiers through National Finance Commission (NFC) and Provincial Finance Commission (PFC) awards. Besides, local governments also receive random transfers including special/development grants, discretionary funds of parliamentarians and executives, etc. Empirical theorists postulate that Fiscal Decentralization may have positive effects on economic growth due to its efficiency advantages. However, it may have negative effects on economic growth and brings macroeconomic instability when it is not accompanied by enhancing the skill of local government apparatus and by better political accountability. Following Barro (1990) and Davoodi & Zou (1998) theoretical models of fiscal decentralization, the study in hand has developed a model and within the framework of a simple endogenous growth model, Johansen’s cointegration technique is used to estimate the effects of fiscal decentralization on economic growth in Pakistan for the period from 1972 to 2010. The study uses expenditures and revenues as indicators of fiscal decentralization and a set of control variables in the analysis. However, due to paucity of data at local level, it is assumed that over the time, public spending and revenue generation is done by two tiers of government i.e federal and provincial. Empirical results show that fiscal decentralization has positive effect on economic growth in the long run but it is statistically insignificant in case of Pakistan for short run.