The Impact of Fiscal Decentralization on Urban Agglomeration: Evidence from China

Abstract

In the literature on urban studies, the size distribution of cities has been attributed to a random growth process where transportation externalities, congestion costs, and capital formation all play a crucial role. However, the classic economics models do not fully capture the impact of political institutions, particularly fiscal decentralization, on urban size distribution and fail to explain the political economy of urban agglomeration. As a major transitional economy, China’s economic decentralization, in conjunction with political control, portends a more complex environment for urban agglomeration and offers a new ground to analyze its institutional roots and policy implications. This study employs a panel data analysis of Chinese provinces between 1994 and 2015 and finds a pattern where more decentralized regions (provinces) are associated with stronger dominance of large cities for the whole study period. However, the period between 1994 and 2003 displays a different pattern wherein fiscal decentralization is negatively associated with urban agglomeration. Such phenomena can be attributed to the heated competition among local governments and the absorption of resources by dominant cities under the framework of fiscal decentralization in China, particularly in the recent years. More effective coordination is called upon to mitigate the unintended outcome of fiscal decentralization without proper control in shaping urban hierarchy in China and the findings provide lessons for other developing countries.