Intergovernmental Grants and Efficiency: An Empirical Study on Administrative Discretion om German Municipalities

Abstract

How do intergovernmental grants affect the level of efficiency in lower-level governments? The existing literature on this topic provides inconclusive evidence regarding the underlying relations of cause and effect as well as its direction. We shed light on this question by suggesting a more general framework on administrative discretion within local governments. Two hypotheses are developed and tested for a panel of municipalities in the German state of Baden-Wurttemberg. Our dual estimation approach includes parametric Stochastic Frontier Analysis (SFA) and non-parametric Data Envelopment Analysis (DEA). This constitutes a valuable robustness check of the results regarding the choice of the reference technology. The findings confirm the decisive character of local administrative discretion and self-interest lead behaviour, inducing an either positive or negative efficiency effect of grants. Besides providing novel insights for the literature, the conclusions are relevant for the architecture of grant policies since intergovernmental transfers are nowadays among the most important sources of income at the local level.