This paper examines how a scal equalization system a ects the disciplining e ect of competition for capital among heterogeneous regions in a decentralized economy. I build a model in which regions that are heterogeneous in initial endowments try to attract capital by competing public input that enhances the productivity of capital; meanwhile, a scal equalization system is imposed by the central government to reduce regional disparities in scal capacity. The key prediction, borne out in data from the German equalization system, is that while competition for capital strengthens discipline in the well-endowed regions, it weakens discipline in the poorly-endowed regions. However, a conventional equalization transfer scheme, common to many countries, can be e ective in correcting the distortion driven by the heterogeneity of initial endowments across competing regions.
Liu, Yongzheng, "Does Competition for Capital Discipline Governments? The Role of Fiscal Equalization" (2014). International Center for Public Policy Working Paper Series. 19.