Stimulating Local Economies through Central Transfers: A Natural Experiment from Ecuador

This paper provides causal evidence on the economic impact of central-to-local government transfers in a developing country context. We exploit exogenous variation in municipal transfers generated by a 2018 reform to Ecuador’s intergovernmental allocation formula. Using a design-based instrumental variables strategy, we estimate that a 1% increase in government transfers led to a 0.94% increase in total business sales in 2018 and 1.05% in 2019. The strongest effects are found in non-VAT sales. Mechanism analysis shows that transfers boost local economic activity mainly through increased recurrent and capital spending, particularly wages and procurement, suggesting that well-designed transfers can act as effective local demand stimuli.

Journal of Development Economics, forthcoming