Decentralization: A World-Wide Phenomenon

1. Challenges of Budget Management in DecentralizationBudget Management and Financial Accountability CourseDana WeistLead Public Sector Specialist, PRMPSdweist@worldbank.org2 March 2004

2. Decentralization: A World-Wide Phenomenon • Underway in over 85 countries • Political and economic rationales • Varieties • Deconcentration • Delegation • Devolution

3. Decentralization Trends Source: International Monetary Fund. Government Finance Statistics Year Book , various years, Country Tables

4. Differences Across Regions Subnational Share of Expenditures Subnational Share of Revenues Note: Simple average of most recent observations in available countries. Numbers in parenthesis indicate number of countries represented. Source: International Monetary Fund. Government Finance Statistics Year Book 1998, Country Tables.

5. Positive or Negative Outcomes? • If designed well, decentralization can • Move decision making closer to people (subsidiarity principle) • Enhance efficiency and responsiveness of service delivery • Improve economic growth • Potentially alleviate poverty • But, design is complicated, since it spans political, fiscal, and administrative policies and institutions

6. Key PE Questions • Who is doing what? • How is it being financed?

7. Macroeconomic Stability • Key factor is “hard budget constraint” • Creates incentives for subnational fiscal discipline • Limits risk of central government • Can be “softened” through several channels (intergovernmental fiscal system, financial system, SOEs, borrowing, etc.)

8. Equity • Extent of fiscal equalization • Ways and means for targeting poor places and poor people

9. Four Pillars of Intergovernmental Fiscal System • Expenditures • Revenues • Intergovernmental transfers • Subnational borrowing/debt

10. Expenditure Issues • Objective: significant and clear expenditure responsibility and autonomy • Subsidiarity principle: provide services at lowest level of government compatible with "benefit area" associated with those services • Distinction between production and provision • Do local services respond to local needs? • Do citizens have meaningful opportunities for voice? • Do officials face incentives to respond? • Assign expenditures first, then assign revenues that match expenditure needs

11. Local Revenue Issues • Own resources typically inadequate to carry out assigned functions • Revenues not adequately responsive to changing needs • Striking variations in size and capacity – one size doesn’t fit all • Local revenue mobilization strengthens accountability -- link taxes with benefits derived from local government services • Simplest and most effective form of tax autonomy: discretion to set tax rates

12. Rationales for Intergovernmental Transfers • Vertical imbalances • Horizontal imbalances • Inter-jurisdictional spillovers (externalities) • Enhancing national objectives at the subnational level • Paying for national programs implemented by subnational governments

13. A “Good” Transfer System • Transfers should be transparent and predictable (formula-based) • Equalization transfers should include • A measure of “need” • A measure of “capacity” • Adequate sub-national revenue autonomy • Stable but flexible financing • Avoid a proliferation of conditional grants

14. Local Borrowing • Benefits • Finance long-lived assets efficiently and equitably • Overcome liquidity problems of lumpy investments • “Pay-as-you-use” financing • Improve selection of investments • Risks • “Soft” budget constraint • Macro-instability

15. Borrowing Risks Can Be Managed • Strengthen intergovernmental fiscal system • Apply administrative controls • Implement rule-based framework • Establish market-based system • Impose other controls

16. Decentralization Challenges • Balance responsibilities with resources, capacity and accountability • Subsidiarity • Finance follows function • Responsibility with capacity (learn by doing) • Accountability through political channels, own source revenues, participation and transparency • Create incentives for implementation to match formal arrangements

17. Operational Implications of Decentralization • Many more potential clients • Weaker client capacity • Limited knowledge of Bank processes and requirements • Weak capacity in project preparation and procurement • Local accountability may be weak and potential for local corruption may be high • Shorter time frame for local officials • Need for • Improved data • Streamlined Bank processes? • Experimentation and new solutions?

18. Public Expenditure Management Lens • Clarity in expenditure assignment? • Adequacy of resources? • Formula-based transfer system? • Hard budget constraint? • Budgeting and reporting systems • Uniformity vs. flexibility • Carrots vs. sticks