(percentage local government involvement in road service delivery); b) decentralization of construction (percentage share of local government in construction activities); c) decentralization of maintenance (percentage share of local government in maintenance); and d) decentralization of administration, which is a proxy for deconcentration<sup>1 7</sup> .

An important econometric issue arises in estimating the equations (11) and (12). The terms **(.t** and **s)** represent random effects deriving from the unmeasured levels of effort expended by each country at a given period of time. I Using panel data, the omitted variable problem arises when we have country specific and time-invariant portions of our error term ( **Iijt** = Pijt + Vijt )- A possibly important country omitted variable could include differences in various institutional and governmental structures that are difficult, if not, impossible to quantify. This specification treats (v,jj) as a country specific omitted variable (fixed effect) that may be correlated with the included regressors. Country dummies are included to eliminate country specific effects and OLS is applied to the data.<sup>20</sup> To the extent that the country specific omitted variables are correlated with included regressors the paramneter estimates obtained by OLS method without country dummies may be biased and inconsistent.

# **3. Empirical Analysis**

## **_Data_**

The empirical analysis employs three data sets: (a) cross-country panel including observations in 35 countries over 10 years; (b) time series data for the case of Korea from 1968 to 1992; and (c) a panel data set across eight states and their respective districts from 1980 to 1992 in Germany. With these three data sets we investigate the impact of decentralizing road provision at three levels of analysis: jurisdictions are countries and we are looking at the share of local government financing of road works--the cross-country 17 Rondenelli (1983) provides a definition distinguishing between major forms of functional decentralization, mainly devolution, deconcentration, and delegation. Devolution involves the transfer of functions or decision-making authority to legally incorporated local governments, such as states, provinces, or municipalities. Delegation involves the transfer of functions to regional or functional development authorities, parastatal organizations, or special project implementation units that often operate free of central govemment regulations and act as agents of the state in performing prescribed functions with the ultimate responsibility remaining with the central government. Deconcentration involves the transfer of functions within the central government hierarchy through the shifting of workload from the central governmen **t** o field offices, and the shifting of responsibilities to local administrative units that are part of the central government structure. Parker (1995) introduces the "souffle" theory of decentralization that incorporates three main ingredients: political, functional, and fiscal elements. Like a souffle that requires just the right combination of milk, eggs, and heat to rise, he argues that a successful program of decentralization must include just the right combination of these three ingredients.

Is We will revisit this term later when introducing country specific effects.

19 We don't address Pijt since it is assumed iid. Further, if Oates' diversity argument holds, we may expect correlation between the error term p and the level of decentralization (no corrections are made for heteroskedasticity).

20 The dummy coefficients are not reported in the results.

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