Public Finance: Why Do Countries Decentralize?
Posted by Mario Pessoa and Bill Dorotinsky
Decentralization is a popular reform, with implications for public financial management, fiscal policy, as well as governance and political economy. Recent events in Bolivia are an example of the continuation of the trend. Despite all of the rhetoric, how far is decentralization proceeding? And what can we say about the reasons countries pursue decentralization?
In a 2005 article entitled "Public Financing in Developing and Transition Countries" (Public Budgeting & Finance, Silver Anniversary Edition 2005, pages 83-98), Roy Bahl and Sally Wallace, explore the reasons why countries decentralize, including data on the share of subnational public spending.
What share of public spending is from subnational governments?
Bahl and Wallace compare data on the share of total government expenditure and total tax collection for 87 countries from 1970 to 2000. They show that
- in industrialized countries local governments account for more than twice the share of expenditures (around 32%) as in developing countries (13%), and t
- in transition countries it is also assigned more expenditure responsibilities to subnational governments (30%) than in developing countries.
But what is more surprising is that the trend has been almost unchanged in the last 25 years!! The spending data suggests that, despite the discussion of decentralization, it has not been reflecting in actual spending levels.
Why is the share so stable?
According to the authors, the reason for this stability seems to be that political motivation and country-specific factors are far more relevant and influence the extent of decentralization in practice. Political rhetoric in favor of decentralization and theories that supports the idea that decentralization favors economic efficiency and better governance are not strong enough to make a difference in favor of actual fiscal decentralization. They argue that in many cases, particularly in transition and developing economies, decentralization is triggered by very specific and concentrated political or economic events that force a shift, but as soon as the situation stabilizes, the tendency is to keep the decentralization at the same level.
What are the drivers for decentralization?
Examples of motivation for decentralization are
- risk of separatist movements,
- transition from non-democratic to democratic governments, and
- significant economic crisis.
The country-specific factors mentioned by the authors are the
- size of the country (the larger and more populated, the greater the tendency to favor decentralization),
- multiplicity of ethnic groups and languages, and even
- differences in climate and landscape that influence local necessities (people want different things from local governments according to the environment they live)
The authors conclude that to the extent that big political and economic disruptive events tends to be less likely in the next quarter century, the major impetus for enhanced local government finance will be lower. On the other hand, trade liberalization, pressure to maintain budget balance, and international competition tend to favor fiscal centralization, specially in developing countries more vulnerable to external shocks and in which governments need more flexibility to manage fiscal and monetary policies.
However, decentralization will continue to be pursued as a means to get government fiscal decisions closer to the people, support economic development, improve the capacity to collect additional taxes, and deliver better services. In this regard, elements such as a better educated civil service, use of communication and IT technology, more reliable PFM institutions, and better salary conditions for local officials are essential to support the efforts to decentralize.
PFM Blog comments
Spending data is one obvious measure for the degree of decentralization, but the data might mask actual trends in decentralization. For example, a central government program for education might change from direct central government delivery to a grant to subnational governments. The grant may still show up as a central government expense, even thought the subnational government is managing the funds and making the decisions.