The Effect of Fiscal Transfers on Local Economic Development

Abstract

Many countries rely on a system of fiscal transfers to support local governments. We examine the effect of such transfers on local budgets and economic development by exploiting a 1991 decentralization reform in the Philippines that resulted in newly created cities getting a large and permanent increase in fiscal transfers from the national government. Comparing outcomes over time in pre-existing cities to cities created after the 1991 reform, we find strong evidence of spending increases in the new cities, followed by increased economic activity – new cities exhibit an increased nighttime light intensity of about 10 percent. Our estimates are robust to controlling for regional shocks, town-specific time trends, and population changes over time.