Decentralization and Development. Fiscal federalism in theory and practice

Seminar Paper , 2019 , 8 Pages

Economics - Finance

This seminar paper deals with a critical discussion of the economic insight from chapter 8: Decentralization and development of the Handbook on Fiscal Federalism. Decentralization is generally defined as the transfer of certain administrative and fiscal functions or powers of a central authority to several local authorities. The main advantage of local decentralization is that local governments are more efficient at providing certain public services compared to the higher levels of government Oates (1972).

The chapter focuses on the type of decentralization in developing and transition economies, on the transfer of political decision-making power to subnational levels of government and cases where local community organizations formally participate in the implementation of funded and centrally directed projects. It’s important to mention that the chapter distinguishes decentralization in the sense of decentralization of political decision-making power from administrative delegation of functions of the central government to the local one. However, the effects of a policy of decentralization may differ sustainably. Like the common case when the central government delegates responsibility for social sector expenditure to local authorities in the form of unfunded mandates, which results in a closure of the social programmes.

Decentralization can be used to serve the political power of the central government to dispel some authority, when the central control might be threatened by regional interest. During the apartheid regime in South Africa, decentralization was used as an instrument of central control and racial division. But on the other hand, it also has positive effects where decentralization is the result of the recent transition from authoritarianism to democracy, as in countries such as Brazil or Indonesia.

Table of Contents

1. INTRODUCTION

2. DEPARTURES FROM THE FISCAL FEDERALISM LITERATURE

3. ADAPTATION OF DECENTRALIZATION FOR DEVELOPING COUNTRIES

4. EMPIRICAL EVALUATION OF DECENTRALIZED DELIVERY OF PUBLIC SERVICES

5. DECENTRALIZATION AND BUSINESS DEVELOPMENT

6. CONCLUSION

7. LIST OF REFERENCES

1. Introduction

This seminar paper deals with a critical discussion of the economic insight from chapter 8: Decentralization and development of the Handbook on Fiscal Federalism. Decentralization is generally defined as the transfer of certain administrative and fiscal functions or powers of a central authority to several local authorities. The main advantage of local decentralization is that local governments are more efficient at providing certain public services compared to the higher levels of government Oates (1972). The chapter focuses on the type of decentralization in developing and transition economies, on the transfer of political decision-making power to subnational levels of government and cases where local community organizations formally participate in the implementation of funded and centrally directed projects. It's important to mention that the chapter distinguishes decentralization in the sense of decentralization of political decision-making power from administrative delegation of functions of the central government to the local one. However, the effects of a policy of decentralization may differ sustainably. Like the common case when the central government delegates responsibility for social sector expenditure to local authorities in the form of unfunded mandates, which results in a closure of the social programmes. Decentralization can be used to serve the political power of the central government to dispel some authority, when the central control might be threatened by regional interest. During the apartheid regime in South Africa, decentralization was used as an instrument of central control and racial division. But on the other hand, it also has positive effects where decentralization is the result of the recent transition from authoritarianism to democracy, as in countries such as Brazil or Indonesia. These different territorial domains and contexts clearly affects the functioning and impact of a devolution of political power. The discussion begins with a description of why decentralization raises several different questions in the institutional context of developing and transition countries. This is mainly because the institutional context differs qualitatively in some respects from the US case. Therefore, the classical US case must be abandoned in order to relate decentralization to the developing countries. Then assess the impact of decentralization on the delivery of public services and ends local business development with ongoing empirical work.

2. Departures from the fiscal federalism literature

Much of the fiscal federalism literature focuses on the economic efficiency of intergovernmental competition, which starts with the Tiebout (1936) model. The Tiebout model assumes that different local governments offer different public tax-expenditure bundles and mobile individuals should assign themselves according to their preferences, but these assumptions don't apply for poor countries. Like the assumption of population mobility that enables governments to overcome the well-known problem of revealing preferences for public goods doesn't work in poor countries. The standard literature on decentralization and fiscal federalism focuses on the allocation of funds and assumes that funds are automatically allocated, reach their intended beneficiaries. In developing countries this doesn't met, due to bureaucratic corruption, instruments and incentives must be created to review and evaluate the effectiveness of the allocation. Moreover, the information systems, accounting systems and mechanisms of monitoring public officials are much weaker in low-income countries. In relative few democratic development countries the institutions of local democracy and mechanisms of political accountability are often weak. Therefore, any question about delivery of public services has its concerns with state capture by elite groups. In addition, the traditional literature on decentralization focuses on efficiency in public provision, not on issues of distribution. But if a main objective of decentralization in development countries is to reach out to the poor than targeting success in poverty alleviation programs is a more important performance criterion, which is missing in the decentralization literature. The fiscal federalism literature typically assumes that lower levels of government both levy taxes and spend funds, so localities can be classified as low or high performer, but this link between local income and expenditure are rather meagre. In most countries, a large part of the more elastic and progressive sources of tax revenues are levied by the central government, and there is a built-in tendency towards a vertical fiscal imbalance. Notwithstanding, is income often geographically concentrated and therefore certain local territories will find it much easier to generate significant tax revenue than others, but there are limits to interregional tax competition. In many low-income countries, the decentralization issues discussed there are primarily about transferring centrally levied tax revenue to lower levels of government. The focus lies on public expenditure assignment, which are not accompanied by significant financial decentralization, such as empower lower-level governments to levy taxes. Another assumption of the literature on decentralization, which doesn't hold, is that that different levels of government have similar levels of technical and administrative capacity. In the recruitment of qualified workers, in most countries central bureaucracies attract better than local ones. But the problem is particularly severe with many developing countries, where the quality of staff in local bureaucracies such as accounting is very small. Even its more professional and technical staff suffer from the disadvantages of isolation, poor education and little interaction with other professionals in local branches.

3. Adaptation of decentralization for developing

countries

Most of the fiscal federalism literature, like Oates (1972) is pointing out that, when preferences are heterogenous and there are no spill overs across jurisdictions decentralization is in favour of centralization. However, decentralization would lead to under provision of local public goods in the event of spill overs, since local decision makers do not consider benefits going to other local branches. This is relevant when the public good is less local like highway transportation, public research and controlling pollution and epidemics. Vice versa it is less relevant when the public goods are more local, as for example local roads. In the case of spill overs and no heterogeneity a central government providing a common level of public goods and services for all localities is more efficient. Moreover, the fiscal federalism is extended to political economic environment setting, where political agency and intergovernmental problems between the ruler and ruled are considered. Bearing that in mind the traditional literature is arguing that the local government has an information advantage over the upper-tier governments. The main reason is because of political accountability. In democratic countries the incentive to use local information rather than national is stronger. Since the local information's are more answerable to the local people while the other information is going through constituencies might get diluted. But how can the public monitor and affect elected officials at different levels of government.

The problem of political accountability is being discussed by Seabright (1996) in terms of allocation of control rights in the context of incomplete contracts with a model of central and local elected officials. In his model political accountability is always greater at the local level. Even though centralization allows benefits from policy coordination, which is especially important if there are spill overs across jurisdictions, it has costs of diminishing accountability, since the welfare of a locality have reduced probability to determine the re-election of the government. In other means, centralization has an effect of diminishing accountability, and therefore other institutional devices, like non-governmental organizations or devices like "yardstick competition", where legal systems are compared with each other; may be used to strengthen local accountability. Especially when poor results occur, bureaucrats' efforts can't be directly observed by citizen. But a yardstick competition can serve as indicator of relative effort of agents, if a wedge between effort and outcomes are correlated between jurisdictions. However, the combination of decentralization and yardstick competition have been successful in China, during the early years of china's market reforms, decentralization with jurisdictional competition allowed some coastal areas to experiment with institutional reforms. Other literature like Tommasi and Weinschelbaum (1999), which is posing the political agency problem in terms of the number of citizens relative to their elected agents in comparing centralization and decentralization. They conclude that decentralization is the preferable way, if the problem of intergovernmental externality is less important than the coordination effect.

However, developing economies may be more vulnerable to capture and corruption by local elites and therefore the political accountability may be stronger affected by the possibility of corruption, because local governments have better local information and accountability pressure. On the other hand, the central government exposed to corruption have wider negative impacts like inefficiently low service delivery, cost-padding or targeting failures. In addition to these aspects an analytical framework being developed by Bardhan and Mookherjee (2000a) which try to formalize the trade-off between centralized and decentralized delivery systems. By shifting control rights from the central to a local government, the service delivery tends to be expanded, but with capture of the local authorities, there is a tendency that the service delivery to be excessively provided to the local elite at the expense of the non­elites. This will depend on the extent of local capture and on the degree of fiscal autonomy of the local government. There are three different financing mechanisms for local governments to consider: local taxes, user fees and central grants. Local tax financing entails the risk that the captured local government may resort to a regressive financing pattern whereby the non­elite bear the tax burden of providing services to the elite. Limitations on the ability of local governments to levy taxes may then be desirable, even at the expense of reducing flexibility of service delivery to local needs. User charges can be a useful trade-off between the need to adapt provision to local needs and avoid a heavy burden on the local poor. Since no user is forced to use the service, the extent of cross-subsidisation for the poor is limited. Thus, with user-fee financing, decentralization clearly dominates centralization and local tax-funded decentralization regardless of the extent of local coverage. Central grant funding can encourage local governments to assert higher local needs or costs, leading to a reduction in service delivery. The welfare impact is unclear, depending on several relevant policy and financial parameters. However, user charges cannot be used to finance poverty alleviation programmes such as targeted public distribution of food, that are inherently targeted at groups that are unable to pay for the service.

A critical determinant of the welfare impact of decentralization is the extent of capture of local government relative to the central government. When local governments are less vulnerable to capture than the central government, decentralization is then likely to improve both efficiency and equity. However, the opposite may be the case where the capture is much greater at local level than at central level. The extent of capture of local governments by local elites depends on levels of social and economic inequality within communities, traditions of political participation and other variables, these vary widely across communities and countries. Depending on the potential for capture of local governments, decentralization programs must focus on strengthening local accountability mechanisms. The positive spill over effects in terms of strengthening the institutions of local democracy are often not considered in policy debates, even though the results might be significantly strong. The 1996 National Election Survey data in India finds that where political awareness is more active, local democracy and institutions of decentralization are more effective. It also has been observed like in Kerala and West Bengal that if regular local elections take place, theft and corruption are stronger resisted. In order to gain a better understanding of the importance of decentralization in developing economics, its necessary to deal with political economy and accountability issues, rather than focusing on the trade-off between decentralization and centralization. A general political economy problem which occurs recently in all developing countries, is that the rich no longer use some of the public services, which results in lacking the necessary political support by the rich to face anti-poverty programs.

4. Empirical evaluation of decentralized delivery of public services

In this section, attempts are pointed out, that have been made to empirically assess the impact of decentralization on the provision of social services in developing countries. Hard quantitative evidence is rather scare, and many econometric problems arise during the empirical evaluation, such as the question that some of the data used in the assessment of local community participation and project performance may be subjective, or the problem of simultaneity that better project performance improves beneficiary participation or that higher beneficiary participation encourages better project performance. Furthermore, the problem of endogeneity has a not undermining effect, which arises because decentralization may be resulted from economic or political changes and effect the outcomes of devolution of power as well. Besides those econometric issues its important to mention that decentralization also depend on the context where its being implemented, which might impact the political accountability and the way it's being designed. But there are a few studies available in the literature, which try to show the impact of decentralization in development countries. Like there are two successful cases of decentralization in Latin America been reported, where a before- after comparison of service delivery outcomes is possible. One of them is the case of participatory budgeting municipal government in the city of Porto Alegre in Brazil, where assembly meetings of local citizens discuss investment priorities, review accounts and elect representatives to a citywide council that allocates available resources. Significant results been found between 1989 and 1996 access to basic water and sewage sanitation as well as school enrolment nearly doubled, while increasing revenue collection by 48 per cent. Although it is difficult from this study to isolate the effects of participatory budgeting reforms from those of other ongoing changes, it seems likely that there has been a significant impact on the pattern of resource allocation between locations, particularly on poor locations, compared to the past and to other areas in Brazil. The other case is the decentralization initiative in Bolivia in 1994. But without household level data on access to public services, these crucial aspects of the impact of decentralization cannot be properly assessed. In the literature, there is hardly any household level analysis of the comparative impact of centralized versus decentralized delivery. However, there is a study on the targeted performance improvement of Galasso and Ravaillon (2005) using data from a 1995-1996 household expenditure survey to examine a decentralized food-for-education program in Bangladesh. In this program, in which two million children participated, they found that the program was slight having a positive effect for the poor. Speaking of a larger proportion that the poor received benefits than the non-poor. Another convincing report pro decentralization is the 1994 World Development Report on Infrastructure, which identifies several cases of quality improvement and cost savings in infrastructure projects after local communities were given responsibility. As a result, all studies presented in the chapter show positive effects of decentralization, but are rather descriptive than analytical due to the fact that most are not based on household survey data and therefore lack of hard quantitative data, making the comparative impact of centralized versus decentralized programs on different socioeconomic groups of households difficult to assess.

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• College: Johannes Gutenberg University Mainz
• Author: Samuel Mäurer (Author)
• Publication Year: 2019
• Pages: 8
• Catalog Number: V1176440
• ISBN (PDF): 9783346612663
• Language: English
• Tags: decentralization, development, fiscal