Does Competition for Capital Discipline Governments? Decentralization, Globalization, and Public Policy

Abstract

Competition among countries—or regions within them—to attract mobile capital is often thought to discipline their governments, motivating them to invest more in infrastructure, reduce waste and corruption, and spend less on non-productive public goods. The result should be convergence on business-friendly policies. We argue that this requires an assumption—units start out very similar—that is often unrealistic. If units are heterogeneous (in natural resources, geographical location, inherited human capital or infrastructure), capital mobility often weakens discipline on the poorly- endowed units. This may help explain disappointing results of liberalizing capital flows within Russia and sub-Saharan Africa. (JEL F36, H73, H87)