Local Governance: Impacts of Fiscal Decentralization on Government Size and Spending Composition in Vietnam*

• Date: 01 December 2019
• DOI: http://doi.org/10.1111/asej.12189
• Published date: 01 December 2019
• Author: Su D. Thanh,Nguyen P. Canh

Local Governance: Impacts of Fiscal

Decentralization on Government Size and

Spending Composition in Vietnam*

Su D. Thanh and Nguyen P. Canh

Received 30 May 2018; Accepted 15 December 2019

The study provides an understanding of the impacts of fiscal decentralization and

local governance on government size and spending composition. We use a bal-

anced panel data set of 63 provinces of Vietnam over the 2006–2015 period. By

estimating the spatial Durbin model, we find that local public spending and gov-

ernment size grow over time and have spatial spillovers. Fiscal decentralization

significantly reduces public spending and government size, which supports the

Leviathan hypothesis. More interestingly, combining local governance, the mar-

ginal spatial spillover effects of the fiscal decentralization on public spending and

government size are intensified. Our findings imply that local governments should

enhance interregional collaboration in fiscal management to limit duplicate public

spending and promote regional sustainable development.

Keywords: fiscal decentralization, public governance, government size and

spending, spatial spillovers.

JEL classification codes: E62, H11, H72, H75, H83, O43, P35.

doi: 10.1111/asej.12189

I. Introduction

Discussion on the spatial interaction of public spending comprises a large strand

of the literature on fiscal decentralization. The spatial spillovers of public spend-

ing refer to a situation in which the public spending of a region/local may affect

that of neighboring regions/locals. As a result, the spatial spillovers may raise

the free-rider problem, which can negatively impact the provision of public

goods. However, with the presence of the spatial spillovers, the yardstick compe-

tition model argues that following and imitating the efficient public policies of

neighboring local governments, the local government can modify its public poli-

cies to improve the efficiency of public resource allocations. In addition, under

*Thanh (corresponding author): School of Public Finance, University of Economics Ho Chi Minh

City, Vietnam, 59C Nguyen Dinh Chieu, Ward 6, District 3, Ho Chi Minh City 70000, Vietnam.

Email: dinhthanh@ueh.edu.vn. Canh: School of Banking, University of Economics, 59C Nguyen

Dinh Chieu, Ward 6, District 3, Ho Chi Minh City 70000, Vietnam. Email: canhnguyen@ueh.

edu.vn. The author acknowledges receiving funding from the Vietnam Ministry of Education and

Training (Vietnam) and the University of Economics Ho Chi Minh City (Vietnam). The number of

the funding project is B2019-KSA-03.

© 2020 East Asian Economic Association and John Wiley & Sons Australia, Ltd

Asian Economic Journal 2019, Vol.33 No. 4, 311–340 311

the pressure of the political process of a decentralization system, accountability

may be enhanced, thus enhancing the efficiency of local institutions (Revelli,

2006; Phuc Canh, 2018). Nevertheless, this process can drive local governments

to allocate local resources in accordance with their own preferences, which con-

sequently undermines fiscal efficiency. In several empirical studies, attention has

been focused on the impacts of spatial interdependences on resource allocation

and local public goods provision (Que et al., 2018). To date, few empirical stud-

ies have investigated the existence of spatial interdependences in conjunction

with the association between fiscal decentralization and local public governance.

The present study investigates the spatial effect of fiscal decentralization and

public governance on the performance of local governments, using government

size to reflect performance. To answer the question of whether fiscal decentrali-

zation in province imay impact government size in province j, we use spatial

econometric models to test the spillover effect of fiscal decentralization on

regional government size. As indicated by LeSage and Dominguez (2012), spa-

tial regression models are appropriate for use in empirical studies related to pub-

lic choice and public goods provision because public goods’spillovers are

associated with the performance of neighboring regions.

The present study intends to clarify the role of public governance in shaping the

effect of fiscal decentralization on government size from the view of fiscal competi-

tion. Findings on the relationship between fiscal decentralization and government

size have been mixed in the specialized literature. Good public governance is sup-

posed to increase the efficiency of fiscal decentralization, thus reducing govern-

ment size (Oates, 2005). However, Qiao et al.(2019)find that countries with good

institutions could see an increasing effect of fiscal decentralization on government

size. In this study, the provincial competitiveness index (PCI) is used as a proxy of

public governance, in line with studies by Nguyen et al. (2012, 2013). The PCI is

composed of 10 subindicators associated with the performance of local authorities

in the business environment, hence affecting the mobile tax base (for more details,

refer to Appendix). Therefore, given the presence of local public governance, eval-

uating the self-enforcing capacity of local government under the fiscal competition

mechanism is of crucial importance.

The study is implemented with the following strategy. First, fiscal decentrali-

zation is proxied by a self-financing indicator as in Song et al. (2018), which is

calculated as the ratio of total local government decentralized revenues (con-

sisting of 100% retained revenues and shared revenues) to total local govern-

ment budgetary expenditures. Given that fiscal decentralization is high, the

degree of local governments’autonomy is reflected by local budget revenues

collected to finance local expenditures, which allows them to be independent of

fiscal transfers, and local expenditure allocation is reflected by local public

goods provided for residents and improved local governance quality. Second,

the study takes account of public spending and government size at the provincial

level. Specifically, government size is measured by total local public spending to

GDP, whereas local public spending is analyzed with two indicators: (i) capital

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