“In order for development to be sustainable, it has to be comprehensive–it has to successfully balance economic growth with social and environmental.” (Extract from “Beyond Economic Growth”, student book by World Bank, 2004).

The environmental and social problems which accompany rapid global development of economy and society have become increasingly serious and of much concern. The only solution to solve the environmental, social, and economic growth dilemma is sustainable development. This has led many countries and international organizations to put forward plans or goals for sustainable development ^[1] A notable and most recent international plan in this direction is the United Nation 2030 Agenda for Sustainable Development (UN Agenda 2030), which was unanimously adopted by all 193 member states in September 2015. The agenda is comprised of 17 Sustainable Development Goals (SDGs) and 169 targets, which came into effect on 1 January 2016. It is an ambitious international move towards sustainable development and beyond the GDP or mere economic growth as a measure of welfare. The UN described the agenda as unprecedented in scope and significance, and stated that “it is accepted by all countries and is applicable to all, taking into account different national realities, capacities and levels of development and respecting national policies and priorities.”

Sustainable development is a multidiscipline and multidimensional concept. It originated from ecology but has also become a main subject matter in economics, environmental science, and sociology [2,3]^[2][3]. Although these various disciplines study the concept from different perspectives, the essence and goals are the same for them ^[4]. The main goal of sustainable development is the maximization of intergenerational utility. In other words, the concept of sustainable development requires that economic, social, and environmental development should be coordinated with the objective of balancing intragenerational welfare and maximizing the total welfare of all generations ^[4]. In fact, the Brundtland report, Our Common Future (Brundtland report published in 1987 and named after the former prime minister of Norway, Gro Harlem Brundtland who chaired the World Commission of Environment and Development (set up in 1983)) defines sustainable development as “Development that meets the needs of the present without compromising the ability of the future generations to meet their own needs.” Hence, according to the sustainable development concept, economic growth and social progress should be pursued to ensure the welfare of present generations, while protecting the ecological environment and rationally utilizing natural resources to ensure the welfare of future generations. Pursuing economic growth at the detriment of the environment and natural resource utilization is not sustainable development. Protecting the environment while making the economy stagnate would also not be a sustainable development mode ^[1].

In line with the above-mentioned goal of sustainable development, the UN explained that the Sustainable Development Goals and the associated targets are integrated and indivisible, and the goals and targets balance the three dimensions of sustainable development: economic, social, and environmental. It stated further that the governments and representatives who put forward the UN Agenda 2030 are committed to achieving sustainable development in its three dimensions in a balanced and integrated manner, and that the agenda will be implemented for the full benefit of all, for present generation and for future generations. The Sustainable Development Goals are to be attained through governments’ decision-making processes, including policies, plans, programs, and projects. Moreover, for the actualization of the UN Agenda 2030, the UN calls for the development of broader measures of welfare and progress to complement Gross Domestic Product (GDP), the consultation and inclusion of all relevant stakeholders, and the recognition and exploration of link between sustainable development and other relevant ongoing processes in the economic, social, and environmental fields. To this end, the restudyearch aims to compute the National Sustainable Development Index (NSDI) and its subcomponent indices for the selected sample countries. In addition, the last three decades have witnessed an increase in the fiscal authority of the subnational governments in most countries ^[5]. However, not only is it that there is lack of empirical consensus on the welfare effects of fiscal decentralization, but also, little attention has been given to the impact of fiscal federalism on development beyond GDP.

2. Fiscal Federalism

Based on existing theory, fiscal federalism may be a factor influencing sustainable development. Fiscal federalism aims at deriving principles that can be used to determine the optimal allocation of fiscal functions among the different tiers of government in a federation. However, in recent times, the application and practice of fiscal federalism is not limited to federation, as both federal and unitary countries are now embracing the design of some form of fiscal decentralization between the central and subcentral governments. The framework for what became accepted as the proper role of the state in the economy was provided by Samuelson’s two important papers [6,7]^[6][7] on the theory of public goods, Musgrave’s book ^[8] on public finance, and Arrows discourse ^[9] on the roles of the public and private sectors. Their arguments are based on the public finance trio of allocative efficiency, distributive equity, and stabilization. It was opined that the allocative role is best performed by the subnational governments while the distributive equity and stabilization roles are best performed by the central government. Furthermore, Tiebout ^[10] hypothesizes that in a situation where it is efficient to have multiple jurisdictions providing local public goods, then inter-jurisdictional competition for residents will lead to a near-optimal outcome. Tiebout ^[10] argues that jurisdictions can acquire more residents either by acting as a cartel, imposing singular tax rate on the residents, or by engaging in tax competition. Tiebout ^[10] claims that the end result of both approaches will be the same because the tax rates of the various jurisdictions will converge around an average tax rate, even in the case of inter-jurisdictional tax competition. The implication of Tiebout’s hypothesis is that as a result of competition for residents by subnational governments, fiscal federalism will lead to allocative efficiency, which will in turn lead to sustainable development. Moreover, Kalirajan and Otsuka ^[11] drawing from Oates ^[12] argues that “in an ideal decentralized system, existing resources will be allocated to yield the maximum possible output (locating on the production possibility frontiers) and the competitive environment including inter-governmental competition will be conducive for technological progress (shift in the frontier).” This also implies that fiscal federalism has a positive developmental outcome. This is the view of the so-called “traditional” or “first-generation theory of fiscal federalism.” This approach assumes that the public decision-makers are benevolent agents who choose to maximize the social welfare of the citizens ^[13]. On the other hand, the so-called “second-generation theory of fiscal federalism” assumes that public decision-makers usually have goals which are induced by political institutions that often diverge from maximizing the welfare of the citizens. They therefore argue that fiscal federalism could have varied, and not necessarily a positive developmental outcome [13,14,15,16]^{[13][14][15][16]}. In relation to the empirical literature on sustainable development impact of fiscal federalism, there are two limitations. One is that most of the research on the developmental output of fiscal federalism is based on the impact of fiscal federalism on economic growth, using GDP or GDP growth rate as a measure of welfare, and fiscal federalism has been given little or no consideration in most of the studies on the determinants of sustainable development. The other is that most hitherto used proxies for sustainable development are not as comprehensive as the NSDI employed in this restudyearch. The argument that fiscal federalism foster economic growth and development through allocative efficiency has been the main reason most countries tend towards more fiscally decentralized economy in recent times. This has also been the reason for much empirical research on the fiscal federalism–developmental outcome nexus. Moreover, the measure of developmental outcome has been restricted to economic growth or development measured by GDP per capita or GDP per capita growth rate. However, the serious social and environmental challenges which accompany economic growth give rise to a dilemma in sustainable development, which in its holistic view comprises of the economic development, social development, and environmental development. This is the reason many countries, organizations, and interested parties are clamoring for the need to see development beyond just economic development, but as one that is comprehensive, balanced, and well-coordinated in the three dimensions of sustainable development [17,18]^[17][18]. Furthermore, in its 2020 report, the UN-Habitat estimates that 23 percent of the Sustainable Development Goal indicators have a component which is local or urban, and the OECD economic outlook states that 105 of the 169 sustainable development targets, which underline the 17 Sustainable Development Goals would not be reached without the proper coordination and engagement of the subnational governments ^[19]. Thus, it is imperative to investigate the impact that the recent resurgence of interest in fiscal federalism will have on sustainable development. This argument is not based on political decentralization or political decisions, but on fiscal decentralization, which the Tiebout-sorting hypothesis and other theoretical literature on the link between fiscal federalism and developmental outcome through allocative efficiency deal with. The literature on the relationship between fiscal federalism and economic activities is vast and mixed: some studies found a clear positive relationship, e.g., [20,21,22,23,24,25,26]^{[20][21][22][23][24][25][26]}; some found negative relationships, e.g., [27,28,29,30,31]^{[27][28][29][30][31]}; while several others found no relationship at all, e.g., ^[32]. Traditional literature on fiscal federalism [6,7,8,9,12,33]^{[6][7][8][9][12][33]} posit that fiscal decentralization has a positive effect on economic activities. However, some more recent literature argues that fiscal decentralization can pose a significant risk and worsen macroeconomic problems [34,35,36,37,38,39]^{[34][35][36][37][38][39]}. Blöchliger et al. ^[40] opine that the relationship between fiscal federalism and economic activities could indeed be non-linear, with the positive effects fading out as the level of fiscal decentralization increases. They found evidence of a hump-shaped relationship, which portrays a level of “optimal decentralization” beyond which additional decentralization will inhibit rather than foster economic activities. Their argument on the idea of “optimal decentralization” is based on the fact that negative factors such as diseconomies of scale and scope, internal trade barriers, distorting local tax systems, rent seeking of local vested interests, and other negative implications of decentralized policymaking might overwhelm the positive aspects once decentralization extends beyond a critical level. However, in all of the aforementioned studies, the social and the environmental and resource dimensions of sustainable development were not considered. In addition, the economic dimension was restricted to economic growth only. On the determinants of sustainable development, the potential roles of a number of factors have been considered by a growing body of literature. Non-renewable energy consumption and excessive dependence on natural resources have been found to be inconducive to sustainable development [41,42]^[41][42]. Human capital, higher education, democracy, social fairness, and positive institutional environment have been established to have positive impacts on sustainable development [43,44]^[43][44]. Additionally, Reiter and Steensma ^[45] established the impact on sustainable development of corruption, quality of governance, legal system, violent conflict, and foreign direct investment. Moreover, a number of studies have established the influence of several aspects of fiscal policy on sustainable development [46,47,48]^[46][47][48]. The only notable study that has considered the impact of fiscal federalism on sustainable development is Jin and Martinez-Vasquez ^[1]. Using the National Sustainable Development Index as the measure of sustainable development, and panel data of 52 countries, the study argued that there is a hump-shaped relationship between expenditure decentralization and sustainable development. This restudyearch is motivated and warranted by two main reasons: (i) the call by the UN for the consultation and inclusion of all relevant stakeholders, and the recognition and exploration of link between sustainable development and other relevant ongoing processes in the economic, social, and environmental fields towards the achievement of the UN Agenda 2030, and (ii) the very limited attention that has been given in the literature to the study of the relationship between fiscal federalism and sustainable development, despite the fact that in recent times, there has been an increase in the role of subnational government in most countries. Hence, in line with Jin and Martinez-Vasquez ^[1], this study examines the impact of fiscal federalism on sustainable development using the National Sustainable Development Index (NSDI) as the proxy for sustainable development. However, unlike Jin and Martinez-Vasquez ^[1] which set out with the sole aim of verifying an assumed hump-shaped relationship between expenditure decentralization and sustainable development, this study does not assume an already established relationship between fiscal federalism and sustainable development but seeks to determine if a relationship exists or not and take into consideration both revenue decentralization and expenditure decentralization. Moreover, Jin and Martinez-Vasquez ^[1] uses the two-stage least square estimation technique with the Geographic Fragmentation Index as instrumental variable in their analysis and make use of a five-year average panel data. The Geographic Fragmentation Index is only available for years 1990, 1995, 2000, and 2010, and it is argued that in dealing with endogeneity in a dynamic panel data, the IV approach does not exploit all of the information available in the sample ^[49]. The five- year average is also argued to lead to a loss of degree of freedom, and consequently reduced efficiency of the regression estimates. This study makes use of the difference and system generalized method of moment estimators which is a more robust technique that produces a more efficient estimates of the dynamic panel data model ^[49]. This could be the reason for the difference between the findings of the Jin and Martinez-Vasquez ^[1] and the findings in this study concerning the sustainable development impact of fiscal federalism on the aggregate. The study also investigates the impact of fiscal federalism on each of the three dimensions of sustainable development separately. Furthermore, the study examines if the Kuznets’s hypothesis exists for the relationship between fiscal federalism and sustainable development, and investigates if the sustainable development impact of fiscal federalism varies between federal and non-federal countries. Moreover, as a check of robustness and for comparative purposes, the study explores the impact of fiscal federalism on Human Development Index (HDI) and GDP growth rate. HDI being the most popular measure of sustainable development and GDP growth rate being the most used measure of welfare in most studies on developmental outcome of fiscal federalism.