Stuti Khemani Development Research Group, The World Bank

1. Boiling it down to politics: Evidence from federalism in India (and thoughts on local decentralization across the world) Stuti Khemani Development Research Group, The World Bank Decentralization and Intergovernmental Fiscal Reform Course March 24, 2003

2. Issues • “Common Pool” problem—political bargaining between the center and the states/provinces • Bringing government “closer to the people”—political accountability at local levels

3. 1. The “Common Pool” Problem • Decoupling of tax and spending decisions—a political problem even without decentralization ! -- Higher spending -- Higher debt • Decentralization potentially/partially solves the common pool problem—defines property rights over tax revenues, and makes a central executive accountable for aggregate outcomes, with local governments accountable for local public goods • Commitment problem of central government—if the separation in accountability is not clear, states can hold the center hostage • Political relation between the central and sub-national governments– role of political parties

4. Fiscal Federalism in India • Vertical fiscal imbalance—Indian states undertake between 50-60 percent of total government spending; 30-40 percent of state spending financed by central transfers • 3 instruments of intergovernmental transfers: -- Tax sharing and grants determined by an independent agency with constitutional authority -- General purpose grants and loans supporting state “plans”—determined by a national body with political representation -- Specific purpose transfers/matching grants determined by central ministries • Perverse incentives created by “gap-filling” transfers • Evidence for political bargaining? Test using data from 15 major states, over the period 1972-1995

5. The Evidence… • States that belong to the same party as the national ruling party receive greater transfers, and have higher spending and deficits (financed entirely by additional loans from the center) • Amongst affiliated states, resources targeted to those where the national ruling party has a smaller share in the national legislature • No evidence that intergovernmental grants induce greater state spending and/or higher deficits • Implied politics—opportunistic national executive distributing resources to maximize its party’s representation in the national legislature • Transfers determined by the independent agency restrict the extent to which partisan politics can affect resources available to state govts.

6. Understanding Federal Politics • Indian evidence in direct contrast to experience in Latin America—effect of fiscal institutions in a federation is sensitive to underlying political incentives • Federal politics in India— • Electoral competition between political parties that compete for representation in both national and regional legislatures; • Voters vote along party lines: Good (bad) performance of provincial and national governments leads to positive (negative) spillovers for political parties in every election; • Voters hold state governments accountable for local conditions

7. Institutional Solutions to Political Problems? • Fiscal rules do matter—significant, but small effect of politics on intergovernmental transfers in India • Power of independent agencies with constitutional authority—able to counteract political influence

8. 2. Political Accountability of Local Governments • Political accountability at any level depends upon: • Information amongst voters • Social polarization amongst voters • Credibility of political promises • Whether decentralization delivers greater accountability depends upon whether voters are more informed, less polarized, and whether political promises are more credible at more local levels

9. Evidence…(limited) • India: mixed and uncertain—some evidence that allocations by locally elected governments reflect preferences of poor and disadvantaged; yet, risk of “capture” by rural elite • Bolivia: encouraging results of active participation of diverse groups in local politics, leading to greater reflection of local preferences in resource allocations

10. ….continued • Nigeria: -- Non-payment of salaries to teachers and health workers by local governments -- Lack of information at local levels with regard to responsibilities and capabilities of local governments -- Successful feigning of fiscal powerlessness by local governments, given the nation’s history of centralized control

11. Institutional Solutions? • Information provision to voters -- Role of media? -- Role of Civil Society Organizations? -- Role for institutional intervention? • Little known about type of information and dissemination strategies that could be effective in changing political incentives • Experiment with informational interventions and evaluate impact rigorously

12. Conclusion • It’s all politics! • Institutional rules and interventions can make a difference • Better understanding of political incentives can help in designing the “right” institutions • Need rigorous evaluation of the impact of institutional interventions