Decentralization and Macroeconomic Management

Abstract

The literature on fiscal federalism has amply discussed both the potential efficiency and welfare gains from decentralization and the potential trade-offs between decentralization and income redistribution. By contrast, it has generally put less emphasis on the effects of decentralization on macroeconomic management, although policymakers worldwide increasingly have to grapple with these effects. This paper examines the constraints that a high degree of decentralization can place on the ability of the central government to carry out its traditional macroeconomic management functions and explores various ways to minimize these constraints.

Local Government Revenue Mobilisation in Anglophone Africa

“…Substantial devolution of revenue and spending responsibilities to subnational jurisdictions can affect the central government's ability to carry out stabilisation and macroeconomic adjustment through the budget. The destabilising potential of subnational governments is greatest when they face no hard budget constraints (Bird 2010;World Bank 2000;Ter-Minassian 1999). Expectation of a bail-out when in financial trouble weakens the incentive to economise on costs, and may generate resource waste and rigidity within local authorities.…”

“…This contributes to diluting the capacity of local governments in general (Martinez-Vázques and Smoke 2010b: 340). However, a major challenge in many anglophone African countries is the implementation of a stable and transparent system of transfers, geared to filling gaps between the assigned spending and revenue-raising responsibilities of lower-level governments (Boadway and Shah 2009;Ter-Minassian 1999). The definition of such a system is far from easy, especially given the need to preserve adequate incentives for tax effort and cost effectiveness by the subnational governments.…”

Revisiting the link between growth and federalism: A Bayesian model averaging approach

“…On the other hand decentralized political decisions create inter-jurisdictional spillovers (Musgrave, 1959, Oates, 1972 which negatively affect growth by distorting local tax and fiscal incentives. Less conventional arguments that could go in both directions range from economies of scale (Prud'homme, 1995, Rodriguez-Pose andEzcurra, 2010) and macroeconomic stability (Ter-Minassian, 1997, Fukasaku and de Mello, 1999, Martinez-Vazquez and McNab, 2006 to government accountability (Martinez-Vazquez and McNab, 2003) and institutional quality (Ahmad and Tanzi, 2002).…”

Bailouts in Federations: Is a Hard Budget Constraint Always Best?*

“…In the policy literature, it seems to be widely assumed that, because of this common pool fiscal externality generated by a SBC, a hard budget constraint (HBC) for RGs is always desirable (Ter-Minassian (1997)). Indeed, much of the literature is concerned with the design of institutional mechanisms that will harden the budget constraint.…”