Cost-efficiency of Japanese local governments: effects of decentralization and regional integration

Stochastic frontier analysis is used to examine the cost-efficiency of Japanese local governments at a prefectural level, corresponding to states in the United States. The issue of cost-efficiency has two policy concerns for fiscal decentralization: one is whether fiscal transfers from central government to local governments influence cost-efficiency; the other is whether the size of the local population influences cost-efficiency. This study empirically confirms that the fiscal transfers have a negative effect. In contrast, population size has a positive effect. The two findings may suggest that Japanese local governments can improve their cost-efficiencies by both reducing the amount of fiscal transfers via decentralization and increasing a population growth via regional integration.