Fiscal decentralization, regional disparity, and the role of corruption

In this study, we examine how efforts taken by states to combat corruption act as a mediator in the relationship between fiscal decentralization and regional income disparities. Fiscal decentralization may affect regional disparities via access to funding, but corruption could limit the ability to efficiently transfer fiscal resources. India is one of the most decentralized nations of the world and also exhibits high regional disparities. Under this scenario, we estimate whether institutions, in the form of anti-corruption efforts by the states, interact with fiscal decentralization and affect divergence across states of India. We find that fiscal decentralization reduces the disparity across states, and the effect of fiscal decentralization is stronger under efforts to control corruption by state vigilance bodies. The results are robust across different specifications of fiscal decentralization and alternate estimation methods accounting for endogeneity. From the policy perspective, in order to harness the potential benefits of decentralization to reduce regional income disparities, governments should focus on improving the quality of institutions through control on corruption at the sub-national level.