Pitfalls and Roadblocks in Fiscal Decentralization

Dilip Mookherjee

May 8 2007

PITFALL NO. 1: CAPTURE AND CORRUPTION

• Concern of designers of both the US and Indian constitutions: greater scope for elite capture in local governments compared with central governments

• Minorities of low socio-economic status could be more vulnerable in the absence of federal safeguards: blacks in US South, scheduled castes in India

• Argument is based on greater heterogeneity and size of government at the federal level, and greater media attention, which renders special interest capture less likely

PITFALL NO. 1 (contd): CAPTURE

• Functioning of local democracy is crucial to control capture and corruption: requires informed and active civil society, often missing in poor, backward regions

• Expect that institutions of local democracy will vary widely across regions, hence decentralization will have uneven impact across regions, may increase inter-regional inequality

• Argentinian experience with school decentralization: schools in poor, backward regions fell further behind, while those in better-off regions improved

PITFALL NO. 1 (contd): CAPTURE

• Other examples: Ecuador Social Funds projects in building latrines were less successful in communities with high inequality

• Poorer intra-village targeting of Food for Education program in Bangladesh in villages with greater land inequality; similar patterns with respect to credit and employment programs in West Bengal, India

PITFALL NO. 2: CAPACITY

• Second major concern: lack of administrative and financial capacity in local government

• Related to low utilization of scale economies• Quality of personnel; ability to raise funds;

spending on capital projects requiring technical expertise; insufficient exploitation of learning and accumulation of experience

PITFALL NO. 3: COORDINATION

• Numerous interjurisdictional externalities that local governments do not internalize

• Divide responsibility for health, transport, education across different local governments, and central govt

• `Race to the Bottom’: reason for concentrating tax collection at the central level, creates need for intergovernmental fiscal grants

PITFALL NO. 3 (contd): COORDINATION/FREE-RIDING

• Hunger at local level for fiscal transfers from the central government: inherent free-rider problem, overstate local need

• `Soft Budget Constraint’ problem: lack of self-sufficiency; fiscal dependence; macroeconomic problems from tendency to overspend: e.g., Argentina

• Low incentives to enforce regulations in the national interest (e.g., environmental) and collect taxes that are shared with other regions: problems in post-Communist Russia

PITFALL NO. 4: CASH (UNFUNDED MANDATES)

• Converse to the soft budget constraint: strong central governments harden budgets of local governments, limiting flexibility of spending to variations in local needs

• Probably the more common problem: e.g., Brazil, Pakistan, China, India, S Africa

• Decentralization often used by central governments to limit spending on social sectors: devolve responsibilities without corresponding devolution of finances and personnel

PITFALL NO. 5: CALLOUSNESS (POLITICALLY MOTIVATED

TRANSFERS)• Transfers of resources across regions

often politically motivated

• Higher level governments try to retain discretion over inter-regional allocations, use them as instruments for political patronage and electoral advantage

PITFALL NO. 6: CONSISTENCY (DE JURE vs DE FACTO DECENTRALIZATION)

• Frequent contrast between rhetoric and reality

• Local governments may lack independent constitutional authority and can be dismissed by higher levels (e.g., Pakistan, China)

PITFALL NO. 6 (contd): DE JURE DECENTRALIZATION

• De jure decentralization often not backed up by substantive devolution of `funds, functions and functionaries’ (e.g., education, health functions not devolved, low fiscal transfers in most of India)

• May not allow local governments to be popularly elected; do not allow political parties to contest elections (e.g., Pakistan, China, Uganda)

• Create confusion by failing to delineate responsibilities clearly between different levels of government (e.g., Ugandan health programs)

PITFALL NO. 6 (contd): DE JURE DECENTRALIZATION

• Delays and failures in implementing statutory provisions, e.g., appointment of state Finance Commissions, Election Commissions in many Indian states, lackadaisical implementation of recommendations

• Insufficient effort to provide training and capacity-building for local government officials

PITFALL NO. 6 (contd): DE JURE DECENTRALIZATION

• Do not clarify respective roles and authorities of elected members of local government and bureaucrats (e.g., problem in many central Indian states such as Uttar Pradesh)

• Do not provide local governments with authority to hire and fire bureaucrats, or design their personnel policies (with few exceptions, e.g., S Africa)

PITFALL NO. 7: COMPREHENSION

• Some publicly provided goods are credence goods: e.g., health

• Difficult for poorly informed citizens to evaluate medical treatments or to value preventive services esp. for children

• Increased reliance on local popular will may result in reduced expenditures on immunizations (e.g., Uganda), drinking water quality (e.g., Indonesia)

PRINCIPAL ROADBLOCK: POLITICAL WILL

• Many decentralizations are poorly designed and implemented, and this is not due to ignorance or lack of experience!

• Key political problem: higher levels of government are inherently unwilling to devolve power or finances

PRINCIPAL ROADBLOCK: POLITICAL WILL

• Raise primary question: why does the higher level government want to devolve in the first place?

• Only in rare instances is there a genuine political will to implement decentralization that is meant to succeed: transition to democracy from authoritarian regimes (Indonesia, S Africa); election of governments committed ideologically to democratic decentralization (Workers Party, Brazil)

ROADBLOCKS (contd): POLITICAL WILL

• Motive for decentralization in most other contexts: challenge to authority of central governments from regional governments and powers

• Decentralization a strategic tool in competition for legitimacy and power between central and regional governments

ROADBLOCKS (contd): POLITICAL WILL

• Attempt to cultivate channels of political patronage at local levels

• Indian story: central government wanted to bypass state governments and create direct channels of resource transfer to local governments, and undermine authority of state governments

• Early bills blocked by state governments, later passed on condition that state governments would be free to implement devolution to local governments

ROADBLOCKS (contd): POLITICAL WILL

• Many state governments inherently unwilling to devolve powers and funds to local governments

• So there is a big gap between de jure and de facto decentralization

• Implementation varies widely across different Indian states

ROADBLOCKS (contd): POLITICAL WILL

• Decentralization sometimes used by autocracies to consolidate their power and pre-empt competition from regional powers

• In such contexts (e.g., Pakistan, Uganda, China), decentralization used to subvert democracy at the national level

• Tendency to rely on administrative devolution rather than decentralization of political power

SUMMARY

• More often than not, decentralizations are poorly designed and implemented (callousness, consistency)

• Even if they were properly designed and implemented, there are other potential pitfalls: capture, capacity, coordination, cash, and comprehension

• Decentralization likely to be accompanied by widening inter-regional disparities: owing to regional dispersion in both pitfalls and roadblocks

PROBLEMS FOR INTER-REGIONAL INEQUALITY

• Problems of local capture, corruption, capacity and more severe in poorer, backward, less equal regions

• Free-rider problem in inter-governmental grants limits inter-regional equalization and reaction to unverifiable local shocks

• Prosperous regions less willing to contribute to subsidize less prosperous regions

NECESSARY SAFEGUARDS

• Essential to accompany any decentralization with safeguards and monitors

• Evaluate de facto devolution and service delivery based on community and household surveys implemented by independent agencies

• Need to design indices of devolution and service delivery

NECESSARY SAFEGUARDS (contd)

• Necessary for central governments to intervene in instances where devolution or service performance falls below minimum standards, particularly in poor, backward areas

• Combine with measures to curb local capture and corruption:

• Close monitoring of elections, prevent manipulation of voting process, allow political parties, encourage competition from new entrants to incumbents

• Consider reserving positions for minorities in local government (India)

NECESSARY SAFEGUARDS (contd)

• Audits from above (Indonesia experiment), random checks by independent external auditors, penalties for malfeasance, advertise results before elections (e.g. Brazil)

• Constraints on delivery of services to minorities; explicit formulae for inter-regional allocations based on measures of need

NECESSARY SAFEGUARDS (contd)

• Create rules for intra-regional targeting based on surveys of socio-economic status of households (e.g., PROGRESA in Mexico)

• Build local civil society: mandatory village meetings, encourage minorities to form active social groups (e.g., DPEP in India), participatory budgeting (e.g., Brazil), citizen oversight committees (e.g., Bolivia)

NECESSARY SAFEGUARDS (contd)

• Transparency in flow of funds : e.g., local governments should know what resources and powers they are entitled to (e.g., Uganda); clear delineation of responsibilities between levels of government; assignment of powers to elected local officials over personnel working with or under them

• Citizen empowerment via clear legal rights and entitlements; ease of using legal system to demand information from local governments (e.g., Right to Information, Employment Acts in India)