EIB Papers Volume 13. n°1/2008 - European Investment Bank

A common feature for
the new member states
is the significance of
investment in public
goods.
32 Volume13 N°1 2008 EIB PAPERS
Decentralisation thus increases the level of government investment in total, and of the
components it increases investment in infrastructure (INF); hospitals and schools (HS); and
public goods (PG). Decentralisation does not affect the level of redistribution investment. In
terms of shares in total government investment, decentralisation increases the relative share of
investment in hospitals and schools, at the cost of investment in redistribution. Note, however,
that although the relative share of redistribution investment declines with decentralisation, its
absolute level does not.
The result that decentralisation reduces the share of redistribution investment is difficult to
reconcile with the traditional theory of fiscal federalism reviewed earlier. The redistribution
variable is meant to capture consumption-oriented local public goods, such as recreational
facilities, and the traditional view predicted that decentralisation should lead to an increase, not
relative decline, in their provision.
In contrast, the results can be more readily interpreted in view of the newer thinking
emphasising broader fiscal competition among sub-national units. Decentralisation increases
the level of investment in especially infrastructure as well as hospitals and schools, all providing
“public inputs” for private firms. What is more, the increase in investment in hospitals and
schools suppresses the share of investment in redistribution, suggesting that decentralisation
leads to a relative decline in consumption-oriented government investment.
It is noteworthy that decentralisation does not lower the level of any type of government
investment. This being the case, there is no evidence of decentralisation being associated
with tax competition that would have a detrimental impact on the overall level of government
investment.
We now turn to a description of the composition of government investment in the new member
states for which data are available. There are, again, big differences in the composition of government
investment between individual NMS, as shown in Figure 5, which also contrasts the composition of
government investment in NMS to the cohesion countries. At one end of the spectrum, the Czech
Republic invests in government infrastructure even more than the cohesion countries. At the
other end of the spectrum, Latvia and the Slovak Republic invest in government infrastructure no
more or even less than old EU member states. On the other hand, a common feature for almost all
NMS is the significance of investment in public goods, including defence, order and safety, public
administration and the environment. Bar in the Czech Republic, the share of public goods is well in
excess of one-quarter of aggregate government investment in NMS, 5 compared to one-fifth in the
cohesion countries and about one-quarter in other EU-15 countries.
5 In a more detailed breakdown, the shares of defence, order and safety, public administration, and the environment in
investment in public goods are, on average, roughly speaking equal in the eight new member states shown in Figure 5.
The share of public administration is slightly higher than the others, and to the extent that such investment is linked to
the development of institutions necessary for a well-functioning market economy, such investment enhances long-term
growth potential.