Issue Paper 7: Decentralisation in Developing Countries
Table of Contents
Issue Paper 7: Decentralisation in Developing Countries 1
A. Introduction 2
Box 1: Enthusiasm for Decentralisation 2
B. The Landscape of Decentralisation 4
Types and Dimensions 4
Theoretical Justifications 4
Design Issues 6
Developing Country Contexts 6
Driving Forces 7
C. Some Practical Guidelines 8
The Limits of Generalisation 8
Expenditure Assignment 8
Box 2: Principles for Expenditure Assignments 9
Revenue Assignment 10
Box 3: Ideal Characteristics of a Local Tax 10
Box 4: Revenue Instruments for Fiscal Decentralisation 12
Comments 12
Revenue Assignment, Revenue Sharing and Grant Design 12
Box 5: Sources of Finance for Sub-national Governments 13
Box 6: Criteria for the Design of Intergovernmental Finance Arrangements 16
Macroeconomic Control 17
Box 7: Decentralisation and Macroeconomic Management 18
Issues in Decentralised Expenditure Management 18
Accountability 18
Box 8: Accountability Mechanisms 20
Budget Formulation and Implementation 20
Management Information 21
D. Aid and Decentralisation 23
Donor Influences on Decentralisation 23
Fungibility and Conditions 23
Decentralisation and Poverty Alleviation 24
Capacity 25
Sector Wide Approaches 27
E. Issues in Practice 28
Introduction 28
Ethiopia 28
Box 9: Decentralisation in Ethiopia 29
Kyrgyzstan 30
Annex I: Kyrgyzstan Country Profile 32
F. Concluding Remarks 35
REFERENCES 36
Table of Contents 1
Decentralisation in Developing Countries
Decentralisation is regarded in developing countries as a critical mechanism for aligning public expenditures to local priorities, for improving management incentives, and for improving accountability to users close to the point of service delivery. Yet many Developing Country administrations have been reluctant to decentralise in large part because they fear that for various reasons (weak systems, poor information, unlimited needs, weak capacity, administrative diseconomies) decentralised budget responsibilities would lead to loss of expenditure control. How can decentralisation in its various forms be achieved without compromising expenditure control or accountability for achieving performance?
A. Introduction
Decentralisation these days is generally regarded as a good thing. The terms of reference for this paper assume so, and it is easy to find other more or less exuberant quotes that convey the same message (see Box 1). We share a bias towards decentralisation, but we hope this paper will convey some of the complexities of the subject and encourage a measured view of the practical issues involved.
Box 1: Enthusiasm for Decentralisation
| |
|Both the following quotes are from Robert Chambers, 1997, Whose Reality Counts?: |
|..the emergent paradigm for human living on and with the Earth brings together decentralization, democracy and diversity. What is |
|local and what is different is valued. The trends towards centralization, authoritarianism and homogenization are reversed. |
|Reductionism, linear thinking and standard solutions give way to an inclusive holism, open-systems thinking and diverse options and|
|actions. (p189) |
|[In the context of chaos and complexity theory] The analogy to be explored for human society is that not centralization and many |
|complex rules, but decentralization and a few simple tendencies or rules, are the conditions for complex and harmonized local |
|behaviour. (p195) |
Chambers (the dictionary) gives a basic definition:
decentralize or decentralise verb transitive to withdraw from the centre; to transform by transferring functions from a central government, organization, authority or head to smaller local centres.
This definition does not confine decentralisation to the relationship between different tiers of government but also covers any management arrangements that relocate responsibilities away from the centre.
We approach the topic as follows:
• Section B is a concise tour of the landscape of decentralisation: we review the terminology of decentralisation, its theoretical justifications, the design issues that arise, and the driving forces behind it.
• In Section C we summarises some standard guidelines for the design and evaluation of decentralisation.
• Section D discusses some decentralisation issues that are especially relevant for aid agencies.
• Section E, drawing on the authors' experiences in Kyrgyzstan and Ethiopia, illustrates the major issues with country examples.
• Section F gives some overall conclusions.
B. The Landscape of Decentralisation
Types and Dimensions
There are three or four standard types of decentralisation :
• Deconcentration means the dispersion of responsibilities within a central government, e.g. to a regional branch office.
• Delegation goes a step further: local governments or agencies act as agents for the central government, executing certain functions on its behalf.
• Under devolution, not only implementation but also the authority to decide what is done is shifted to the lower body.
• Privatisation or deregulation involves a transfer of responsibility to non government organisations or the private sector.
The fourth type – privatisation – is not always included, but is an important reminder that the scope for decentralisation does not stop at the boundary between public and private sectors. In reality most situations involve a mixture of the different types – in an array of public services, a mix of solutions from deconcentration to managed competition/privatisation is likely to coexist.
Economists are likely to focus on the fiscal dimensions of decentralisation, but its institutional and political dimensions are equally important. Institutional dimensions include the legal framework, mechanisms for accountability, the societal context, and the capacity to fulfil the roles assigned. Decentralisation always has a political aspect. It implies that a central authority is letting go of something. One should consider, inter alia, the motives for such a move, the possibly conflicting political interests of the different parties, and the relationships between the political and the bureaucratic institutions involved. Moreover, the effects of decentralisation may depend less on the formal rules that are established than on how they are interpreted in practice.
Theoretical Justifications
Economic justifications for decentralisation are of two kinds. Welfare economics supports the proposition that total welfare can be increased by adapting to local preferences instead of applying a 'one size fits all' approach. More recently, institutional economics has drawn attention to efficiency issues, which apply to all levels of government as well as to relations between them. The principal/agent problem within the government hierarchy has been described as follows:
Information asymmetries and incentive incompatibilities can impede the efficient delivery of public services by line agencies and their civil servants. Because of their closeness to the clients and their involvement in day-to-day operations in a specific sector or subsector, line ministries and their agencies possess superior information about how best to implement programmes to achieve the intended results. It thus becomes imperative for the government to grant the line ministries sufficient degree of managerial autonomy over the specific allocations and the responsibility to implement their respective budgets.[1]
The arguments from choice and efficiency are supplemented with the view that people are more willing to pay taxes if they receive services that they value, so that decentralisation may be accompanied by an increase in tax effort and less resistance to user charges. Another (dynamic) argument is that decentralisation can allow experimentation and innovation which may disseminate better practices.
Non-economic arguments for decentralisation, in general or in particular circumstances, may be even more influential. Decentralisation may be a political imperative, and there may be ideological and/or instrumental values attached to such concepts as democracy, or participation associated with decentralisation. From some political and moral standpoints, the virtues of decentralisation reside in the inherent process rather than its contingent effects.
Bird and Vaillancourt highlight the contrast between top-down and bottom-up perspectives:
The approach to fiscal decentralization from the bottom up generally stresses political values – improved governance in the sense of local responsiveness and political participation, for example – as well as allocative efficiency in terms of improving welfare.. ...some have seen decentralization to be intrinsically valuable. ...The results of a good process must themselves be good.
From the top down (the central government) the rationale for decentralization may be, for example, to make the life of the central government easier by shifting deficits (or at least some of the political pressures resulting from deficits) downward. Or it may be a desire on the part of the central government to achieve its allocative goals more efficiently by delegating or decentralising authority to local governments.. Whatever the rationale, this top-down approach suggests that the main criterion for evaluating fiscal decentralization should be how well it serves the presumed national objectives.
The choice of perspective is thus essential in approaching issues of fiscal decentralisation…. (Bird and Vaillancourt, pp3-4).
Others have drawn similar distinctions between client and citizen perspectives[2] or between decentralised administration and decentralised governance.[3]
There is not a great deal of empirical evidence as to whether decentralisation lives up to the expectations of its various proponents. This is partly because decentralisation is hard to define or quantify, and partly because it is complex and circumstances are so varied. It is still the case that:
The arguments in favour of decentralization are usually a priori rationalisations based on plausibility.[4]
Design Issues
The basic issues to be resolved in establishing the configuration of decentralisation are:
• What should government do? Underlying the decentralisation debate is one about the role of government and the boundaries and interaction between government and the private sector. What services should government provide, and how (e.g. purchase or provide, directly or via agency)?
• Which services should be provided by which level of government? (The expenditure assignment.)
• How to match revenues with responsibilities at each level? Invariably, the preferred distributions of expenditure and revenue responsibilities leave a gap to be bridged in the financing of lower tiers of government. The core issue in fiscal decentralisation is how to resolve vertical and horizontal imbalances between expenditure and revenue assignments. (Vertical imbalance is the gap between the revenue-raising capacity of sub-national governments and their expenditure responsibilities. Horizontal imbalance – an equity concern – arises from the varying fiscal capacities of different subnational governments.)
• How to strike a balance between autonomy and control? Again this applies as much to deconcentration or delegation within any tier of government as to the relations between tiers. A specific problem is to reconcile macroeconomic control and stabilisation with decentralisation.
It is important to pay as much attention to implementation and institutional issues as to the basic design.
Developing Country Contexts
A lot of decentralisation is going on:
Out of 75 developing and transitional countries with populations greater than 5 million, all but 12 claim to be embarked on some form of transfer of power to local units of government [1994].[5]
Also, the principles of 'New Public Management' are spreading – privatisation, civil service reforms, etc. There is increased appreciation, not least by aid agencies, of the links between effective governance, growth and development.
At the same time there are important differences between developing/transition and developed countries (though there is a lot of variation in both groups). Bahl summarises empirical findings as follows:
• Measured by expenditure share, industrialised countries are about twice as decentralised as developing countries.
• Decentralisation is directly related to the level of economic development.
• Countries that are larger and more heterogeneous in their populations are more decentralised.
• Countries at war, or threatened by war, are more centralised.[6]
A particular issue is whether poorer countries have the administrative capacity to cope with decentralisation. We take up the capacity issue in Section D below. Transition countries have a distinctive inheritance: in Section E we describe the characteristic decentralisation issues faced by one of them.
Driving Forces
What motivates trends towards decentralisation? There are a number of static factors that influence the choice of more or less decentralised political and administrative arrangements: a country's size, diversity and history are all important. But there are also more recent trends that have given impetus to decentralisation. These include:
• The trend towards more democratically elected governments.
• The trend towards market economics, and the re-thinking of government roles. Much administrative decentralisation is an attempt to involve or to simulate the market. There is increasing recognition of complementary roles that can be played by private (profit and non-profit) organisations.
• Urbanisation, education and economic development are all increasing both the demand for local services and the capacity to administer them locally.
• Technology has reduced the importance of economies of scale, and increased the possibilities of diverse provision in infrastructure and other sectors. Information technology facilitates the 'de-layering' of organisations and makes traditional bureaucratic hierarchies less compelling.
For aid agencies, interest in decentralisation often reflects their exposure to public sector management reforms at home, as well as the increasing concern with governance already mentioned. Many are decentralising their own organisations in various ways. For some of them decentralised aid delivery may be seen as a means of bypassing unsatisfactory central governments in the recipient country.[7]
C. Some Practical Guidelines
The Limits of Generalisation
Decentralisation, in its various forms, is a vast topic. It is also a topic where generalisation is perilous:
generalities ..largely miss the mark. The essence of decentralization is that it does not occur in general but rather in a particular country – in a country with its own history and traditions and its own specific institutional, political and economic context. (Bird and Vaillancourt, p2.)
The case for decentralisation also varies by sector[8], and what is necessary and practical will not be the same in rural as in urban areas.
At the same time, we are dealing with a system in which all of the pieces must fit together. We can highlight standard rules of thumb for different elements of decentralisation, (and we do so in the rest of this Section) but the different elements interact in complex ways: in the end the system has to be judged as a whole.
Expenditure Assignment
Two basic rules are:
• First fix the expenditure assignment, then ensure revenues to match.
• Apply the principle of subsidiarity: responsibility for expenditure should take place at the lowest level of government consistent with efficient performance of that service
Traditional public finance theory suggests that an efficient assignment of expenditure between levels of government should be based on geographic proximity to beneficiaries; in other words, each locality should provide and pay for services whose benefits accrue within its boundaries. Economies of scale and scope are also important considerations. Central government would continue to provide national public goods, such as defence, where the free-rider problem would lead to an inadequate level of provision locally. Similarly, central government provision would also be appropriate in cases where substantial inter-regional externalities exist and require coordination. Box 2 sets out broad principles for expenditure assignment.
Box 2: Principles for Expenditure Assignments
|Category of Service |Definition |Funding |
|Central government functions |Such functions generally provide benefits beyond any one region. |Central Government |
| |Typical services include: the courts; enforcement of national | |
| |laws; defence; foreign affairs and diplomacy; civil aviation; | |
| |finance, treasury and tax collection; and the setting of national| |
| |policies, standards, regulations and legislation. | |
|Shared functions |These are generally “needs services” provided in the national |Grants from central government |
| |interest to the entire population regardless of means. The |to local governments to support |
| |services serve local communities and so are most effectively |financing to minimum standards. |
| |organised at the local level. The central government sets |Local administrations able to |
| |minimum standards and monitors and enforces compliance. Examples|supplement from other sources. |
| |include social protection, health and hospitals, primary and | |
| |secondary education. | |
|Local functions subject to central |This category includes those services which benefit the local |Level of financing left to the |
|regulation |communities but which follow national guidelines and regulations |local administrations to |
| |so that minimum standards for safety and health are maintained. |determine provided minimum |
| |Examples may include the fire protection service, water supply, |regulated standards met. Can |
| |sewage treatment, enforcement of environmental standards. |use tax sharing, equalisation |
| | |and own source revenues. |
|Purely local functions |Where the provision of services is aimed at benefiting local |Funding purely at the discretion|
| |communities, with local decision makers best placed to decide on |of the local administrations. |
| |what services are to be provided, to whom and to what quality and|Can use tax sharing, |
| |quantity. General urban facilities such as the provision of |equalisation and own source |
| |parks, refuse collection, recreation halls and markets are |revenues. |
| |examples. | |
Source: Mokoro Ltd, “Improving Budgetary Procedures and Inter-Governmental Finance”, Kyrgyz Republic, November 1996. Adapted from the World Bank’s Aide Memoire, Public Sector Resource Management Adjustment Credit Preparation Mission, Kyrgyzstan, Annex 2.1, 1996.
Revenue Assignment
A distinct set of principles applies to the question of who should have the responsibility for raising revenues. Although major expenditure responsibilities are increasingly being decentralised so as to improve service delivery (e.g. health and education), there are few high-revenue sources that can be assigned to sub-national governments without creating national distortions. Important considerations include administrative costs, the need to reduce the risk of tax avoidance, and to avoid distortions and the creation of internal barriers. Unfortunately, the potential yields from taxes which meet the criteria of a good local tax (see Box 3) invariably fall short of what is required to finance appropriate expenditure assignments. This is despite the argument that local governments can expand the tax base (e.g. by setting lower thresholds, based on local knowledge), and the belief that local taxation may increase willingness to pay. The increasing importance of VAT has made the gulf between revenue and expenditure assignments even more unbridgeable.
Box 3: Ideal Characteristics of a Local Tax
| |
|Among the characteristics that might be sought in an "ideal" subnational tax are: |
|the tax base should be relatively immobile, to allow local authorities some leeway in varying the rates without losing most |
|of their tax base; |
|the tax yield should be adequate to meet local needs and sufficiently buoyant over time (that is, it should expand at least as fast|
|as expenditures); |
|the tax yield should be relatively stable and predictable over time; |
|it should not be possible to export much, if any, of the tax burden to non-residents; |
|the tax base should be visible, to ensure accountability; |
|the tax should be perceived to be reasonably fair by taxpayers; |
|the tax should be relatively easily to administer efficiently and effectively. |
| |
|Source: Bird and Vaillancourt, p11. |
This raises a problem of accountability, since local authorities will be spending more than they raise themselves. However, the key criterion is that expenditure and revenue decisions should be related at the margin. At least in principle, it is possible to reconcile the gap between expenditure and revenue assignments, so long as local authorities can set some tax rates. A corollary is that tax instruments intended to further specific policy objectives should be assigned to the level of government with responsibility for the related service. (Accountability is discussed further in ¶39ff below.)
Of course, user charges can (but do not necessarily) establish links between revenue and expenditure and between payment made and service received. Charges for locally provided services are efficient and they are relatively easily administered. However, as Bahl (¶1.67–1.68) notes:
The problem with user charges in transition and developing countries is that essential services – where user charge potential is greatest – are often provided at subsidised rates.. In China and Russia, public transit, utilities and housing are not self-sustaining and are part of national wage policy.. The same is true in most developing countries, where the low income population is substantial and where affordability (and politics) are major problems.
Box 4 gives an overview of the appropriate assignment of different types of revenue instrument
Box 4: Revenue Instruments for Fiscal Decentralisation
|Revenue Type |Appropriate Government Level for |Comments |
| |Revenue Assignment | |
|Value Added Tax (VAT) |Central |Complex administration makes it unsuitable for use by |
| | |subnational governments |
|Taxes on international trade |Central |Unsuitable for subnational governments |
|Corporate income tax |Central or shared |Can be distortionary if shared on a derivation basis. |
|Individual income tax |Central or shared |Income distribution is a central government responsibility.|
| | |There is often a regional mismatch between origin of tax |
| | |and receipt of services, reducing its appropriateness as a |
| | |local tax. |
|Taxes on exciseable goods |Shared or local |Should be applied at point of import or manufacture; this |
| | |is derivation basis. |
|Retail sales tax |Shared or local |Good local tax. However, administration can be difficult |
| | |in transitional economies. |
|Taxes on motor vehicles |Shared or local |Useful source of revenue for highly urbanised areas. |
|Property and land tax |Local |Non-distortionary when tax is applied on value of land. |
| | |Difficult administration in cases where ownership of |
| | |property is unclear. |
|User charges |Local |Purely local tax. Its usefulness as a revenue source is |
| | |often undermined by government subsidisation of user |
| | |charges. |
| | | |
|Source: Summarised from Bahl, “Fiscal Decentralisation” in EDI Seminar Series, World Bank, 1998. |
Revenue Assignment, Revenue Sharing and Grant Design
Subnational governments may be financed by the assignment of certain revenue instruments, by the systematic sharing of such instruments between central and sub-national levels, by grants from the centre, or by some combination of these alternatives (see Box 5).
The advantages of assigning revenues to local governments are that:
• the system is more decentralising than one of tax sharing;
• vertical balance is more easily achieved – areas with greater revenue raising capacity are areas where more services can be provided (and is usually where more people are located and thus more services are required); and
• the link between local service provision and local revenues is clearer.
The main disadvantage of a system of revenue assignment, particularly as applied to transitional economies, is that it often works against achieving horizontal balance, or the equalisation of revenue capacities across regions.
Tax sharing is often more appropriate for transitional economies with limited and variable local revenue raising capacities. If stable tax sharing rates are used, tax sharing has the advantage of enabling local administrations to plan their expenditures through giving them a medium-term view of a large portion of their income. However, a system whereby revenues are collected by local representatives of a centralised tax administration for use locally gives rise to the risk of dual subordination: pressure from local governments to put more effort into collecting taxes which accrue to local administrations at the expense of national revenues. A provision that local governments are permitted to keep a percentage of any additional national revenues collected over a certain targeted amount can reduce such pressure and thereby reduce distortions of the tax system. While tax sharing can work towards achieving vertical balance, it does not of itself equalise revenue capacity between regions, nor does it necessarily ensure efficient and equal provision of services of national priority or for services which provide benefits or cost spillovers to other areas.
Box 5: Sources of Finance for Sub-national Governments
|Own source revenues: taxes, charges and fees collected wholly by the subnational government rather than by the centralised tax |
|administration. The amounts collected are usually small and do not make up the majority of subnational revenues. |
|Assigned revenues: revenues (such as sales, income or property taxes) which are designated specifically for subnational |
|governments. These revenues are usually collected by local representatives of the centralised tax administration but are kept by |
|the collecting subnational administration. The appropriate types of revenues to be shared are those which can be related to |
|services provided locally (e.g. sales tax relates to the provision of services where people shop) but which do not have significant|
|administrative costs if collected locally, such as VAT. |
|Shared taxes: taxes and other revenue instruments collected by local representatives of the centralised tax administration into a |
|centralised revenue pool and subsequently shared with subnational governments. Normally, a proportion of one or more particular |
|taxes (e.g. profit tax) is shared with local governments, based on the origin of collection. To reduce revenue distortion, the |
|proportion shared should be known and stable over time and should be the same across all regions. |
|Intergovernmental grants: provide additional revenue from central government’s general revenue pool to meet certain local |
|expenditure needs (e.g. the need to provide a national minimum standard of education service in areas without sufficient local |
|revenue-raising capacity). |
As has been argued, efficient revenue collection and service delivery rarely match, and intergovernmental finance grants serve the purpose of bridging the gap. Grants allow a country to rely on more efficient centralised tax collection agencies whilst enabling expenditure decisions to be decentralised. The following types of grants are used:
• Non-matching grants – grants which do not require local governments to provide any top-up funding. These may be either conditional (selective) or unconditional (general).
➢ conditional – a set amount of funds without local matching funds, providing that the funds are used for a particular purpose; this is used to ensure a certain level of spending on priority expenditure items;
➢ unconditional – grants which attach no constraints on how the grants are spent and, unlike conditional grants, no minimum expenditure is expected; since the grant can be spent on any combination of public goods and services or to provide tax relief to residents, they do not modify relative prices;
• Matching grants – conditional transfers that require that funds be spent for specific purposes and that the recipient match the funds to some extent. Matching grants have an income effect, whereby the subsidy gives the recipient region more resources, some of which may go to acquire more of the assisted service; and a price substitution effect, as the subsidy reduces the relative price of the assisted service, allowing the recipient region to acquire more for a given budget
Grants may be also closed-ended (available up to a pre-determined limit) or open-ended (with no fixed ceiling).
In designing an inter-governmental finance system, the overall amount of the transfer should first be determined, followed by a decision on how it will be allocated across regions. The overall amount of grants to local levels may be determined on an ad hoc basis or, preferably, set according to some clear and agreed criteria – often a formula is used to provide budgetary certainty as part of the medium term budgeting process. This formula will typically: (i) estimate minimum subnational expenditure “needs” (based on assigned expenditures and often related to population, per capita income, social indicators or the actual cost of delivering services); and (ii) assess the extent of local government revenues (own source, assigned or share) available to finance these needs. In designing the transfer, central governments are often concerned that local government’s “revenue effort” will decline if they become too dependent on transfers. Depending on how much inter-regional equalisation of expenditures is desired, transfers will fill all or part of the expenditure/revenue gap.
Thereafter, the allocation of this total amount amongst regions should be determined by a transparent formula, which is normally positively correlated with regional population and inversely proportional to per capita regional income. Box 6 summarises criteria for intergovernmental fiscal arrangements.
A key issue, and one that parallels aid debates, is the extent to which the central government can and should, through the grant system, influence the expenditure patterns of lower tiers. Fungibility implies that, even when grants are provided for specific purposes, central governments have less real than apparent influence over the pattern of expenditures by lower tiers.[9] At the same time, grants are not the only, nor necessarily the most important, way, in which central government influences the behaviour of lower levels. Other mechanisms (which may operate formally or informally) include:
• legal framework and policy guidelines;
• specifying services to be provided (remaining discretion for the service provider will depend on how detailed the specifications are);
• determining costs (e.g. by specifying services, but also national salary scales etc);
• setting personnel standards and/or deploying staff;
collaboration in budget formulation, and/or review and approval of proposed budgets.
Box 6:
Criteria for the Design of Intergovernmental Finance Arrangements
| |
|The criteria specified below may conflict with each other, and policy makers may have to assign priorities to various factors in |
|comparing policy alternatives. |
|Autonomy. Subnational governments should have complete independence and flexibility in setting priorities and should not be |
|constrained by the categorical structure of programs or uncertainty associated with decision-making at the centre. Tax base |
|sharing – allowing subnational governments to introduce their own tax rates on central bases, formula-based revenue sharing, or |
|block grants – is consistent with this objective. |
|Revenue adequacy. Subnational governments should have adequate revenues to discharge designated responsibilities. |
|Equity. Allocated funds should vary directly with fiscal need and inversely with the taxable capacity of each province. |
|Predictability. The grant mechanism should ensure predictability of subnational governments’ shares by publishing three- to |
|five-year projections of funding availability. |
|Efficiency. The grant design should be neutral with respect to subnational government choices of resource allocation to |
|different sectors or different types of activity. |
|Simplicity. The subnational government’s allocation should be based on objective factors over which individual units have little|
|control. The formula should be easy to comprehend so that “grantmanship” is not rewarded. |
|Incentive. The proposed design should provide incentives for sound fiscal management and discourage inefficient practices. |
|There should be no specific transfers to finance the deficits of subnational governments. |
|Safeguarding central government’s objectives. The grant design should ensure that certain well-defined objectives of central |
|government are adhered to by subnational grant recipients. This is accomplished by proper monitoring, joint progress reviews, |
|and technical assistance or by the use of a selective matching transfer programme. |
| |
|Source: Based on Shah, A. 1994. “The Reform of Intergovernmental Fiscal Relations in Developing and Emerging Market Economies,” |
|World Bank Policy and Research Series 23. |
The incentives provided by an intergovernmental transfer system need to be seen in the context of all these factors. It is always worth asking whether the complexity and transaction costs introduced by detailed conditions on financial transfers are justified by the difference they make to the outcome.
A high level of intergovernmental transfers can be either centralising or decentralising, depending on how they are structured.[10] A more decentralised transfer system will have the following characteristics:
• There is some certainty and predictability about the amount of transfers received.
• Transfers are adequate in amount to give local governments some influence over the quantity and quality of services delivered.
• Transfers are structured to give local governments some discretion over the use of the money.
Macroeconomic Control
There are potential conflicts between decentralisation and the maintenance of fiscal stability. This should influence the assignment of responsibilities between national and subnational governments and the extent to which subnational governments are allowed to borrow. The orthodox position is summarised in Box 7. A counter argument on subnational borrowing is that subnational governments may have legitimate demands for borrowing (short term to smooth out cash flow, long term only for investment), but that it is the worst of both worlds to allow them borrow while, explicitly or implicitly, providing guarantees to their creditors.
Box 7: Decentralisation and Macroeconomic Management
| |
|Decentralizing spending can have significant implications for macroeconomic management. Even if the overall level of expenditure |
|of subnational governments is constrained by limits on their taxing and borrowing powers, changes in the composition of their |
|expenditures can affect overall demand and the balance of payments in ways that may defeat national stabilization objectives. This |
|may happen, for example, if subnational expenditure shifts towards items that have a relatively large impact on demand, such as |
|transfers to consumers. |
|From a macroeconomic management perspective, therefore, central governments should retain responsibility for expenditures that |
|have a particularly strong impact on demand or are sensitive to changes in the business cycle, such as unemployment benefits. In |
|general, the greater the share of expenditure assigned to subnational levels of government, the greater the need to involve them |
|in the pursuit of any needed fiscal adjustment. |
|Designing a solid system of intergovernmental transfers is crucial not only to redistribute resources within a country but also to |
|ensure that limits on borrowing by subnational governments can be set and enforced effectively. |
|Decentralisation should progress more slowly in countries experiencing acute fiscal or macroeconomic imbalances. In these |
|countries, it is especially important that a hard budget constraint be imposed on the subnational governments, through a design of |
|intergovernmental fiscal relations that ensures for the subnational jurisdictions an adequate ex ante balance between expenditure |
|responsibilities and their own revenues plus clearly designed transfers from the centre, and bars them from borrowing. |
| |
|Source: Ter-Minassian, Sept 97. |
Issues in Decentralised Expenditure Management
Accountability
Earlier discussion in this section has mainly concerned tiers of government (as opposed to deconcentration and delegation within tiers). Most of the accountability and expenditure management concerns discussed next are equally relevant in both contexts. In both contexts, it is believed that allowing decisions about ends or means to be made at lower levels will result in better outcomes (services more efficiently delivered and/or more in line with what relevant stakeholders want). To allow this result, those at lower levels must have significant discretion. To ensure that this discretion is used appropriately, they must be held accountable.
Accountability has political, administrative and economic dimensions:[11]
• Political accountability requires leaders to be responsive to constituents.
• Administrative accountability requires both a legal and a bureaucratic framework that makers clear who is responsible for what.
• Economic accountability requires that beneficiaries (local residents) are responsible for paying for services, at least at the margin.
A key question is accountability to whom. From a top down perspective it is natural to think in terms of accountability to the upper levels of a hierarchy (vertical accountability), but important to remember also accountability to clients or voters (horizontal accountability). This may be seen as a matter of principle (if the perspective is that clients or voters know best) or as a pragmatic means of decentralised control – using clients/voters closer to service delivery as a means of discipline (ensuring incentive compatibility). Thus horizontal accountability mechanisms may be relevant, even in a context where a central government (or organisational headquarters) wants to exert strong vertical control. Box 8 suggests various mechanisms for accountability, for line agencies in general and for local governments in particular.
Recognising the diversity of activities that may be decentralised, it is important to think about accountability for particular services, and not only the accountability of local administrations in general. Sector and facility specific accountability mechanisms may be available (user fees, school governors, hospital boards) that are an effective supplement to the broad accountability of a local administration to voters (if there are elections) and to the upper tiers of government.
A vital element for accountability in any type of decentralisation is a hard budget constraint. This relates not only to a local government's responsibility to raise taxes at the margin, but also to self-accounting facilities' dependence on own revenues/cost recovery. More generally, even when an activity is wholly dependent on external subvention, it is important that its management has to operate within defined resource limits.
Box 8: Accountability Mechanisms
|For line agencies in general: |
|An appropriate balance between autonomy and accountability of the line agencies has to be struck. Accountability will depend on: |
|publication of financial accounts and with what lags |
|publication of financial audits and with what lags |
|the extent of oversight of financial accounts and audits by groups in civil society |
|clarity of outputs of organisational units |
|contestability in the delivery of outputs |
|tenure of agency heads |
|explicit or implicit performance contracts for agency heads and their employees |
|extent of performance audits and their publication |
|the use of client surveys. |
|The publication and general dissemination of their results, i.e. making them transparent, will contribute further to the |
|effectiveness of these arrangements. (Source: Campos and Pradhan, p10.) |
| |
|For local governments in particular: |
|In order for the benefits of decentralisation to be captured, the following conditions should be in place: |
|elected local government |
|chief local officers who are appointed by the local government |
|local governments must have some taxing powers |
|local governments must have some significant expenditure responsibility |
|local governments must have some autonomy in determining service levels |
|local governments must have adequate tax administration capacity to collect those revenues assigned to it. (Source: Bahl, 1998) |
| |
|Obviously, since most of these conditions are open-ended, and it is most unlikely that all would apply in a particular case, |
|accountability must be a matter of degree. |
Budget Formulation and Implementation
More often than not, developing country administrations are still working within an inherited tradition of top-down line-item annual budgets, in which the governing concern is a desire for fiduciary control rather than active resource management. Decentralisation (in the sense of deconcentration or delegation) without modifying the approach to budgeting is of very doubtful value. Line item budgeting limits the discretion of budget-holders, and there is now likely to be a longer chain of information and approvals, both for the budget itself and to authorise in-year variations in it. Decentralisation should therefore be accompanied by a shift from line item budgeting for inputs towards cost-centre budgeting for results.[12]
The characteristic stumbling block for the preparation of bottom-up budgets is that budget preparation at lower levels takes place in the absence of firm guidelines on resource availability. Budget requests are prepared which exceed the eventual funds available, and, under time pressure, submissions are cut back by the more senior levels. The resulting allocations are inefficient because those cutting do not have the detailed knowledge that would enable them to optimise allocations within a given limit. It is therefore particularly important in a decentralised system that the decentralised units be given reliable guidelines at an early stage. In turn, this strengthens the case for medium-term expenditure planning. Planning only one year's expenditure at a time does not allow strategic reorientation of expenditures or the most efficient use of resources, and – particularly with the longer information chain that decentralisation entails – it is practically impossible to complete a satisfactory cycle of budget preparation based on reliable ceilings within a 12 month period.
During budget implementation too, decentralisation may accentuate the standard problems of delay and unpredictability in the release of budgeted funds. Problems of timely disbursement and adequate cash flow may be exacerbated if decentralisation has been implemented in such a way as simply to lengthen the administrative chains involved.
Management Information
Decentralised budgeting requires a shift along the spectrum from low trust approaches with ex ante controls, towards high trust approaches that rely more on ex post review of performance. This in turn means that information management is a crucial aspect of decentralisation. This point applies whether decentralisation is conceived as a top-down or bottom-up exercise. Local governments, and local service delivery agencies, can only be held accountable to their voters and clients if they have adequate information. Making sure that communities know what resources are supposed to be reaching them may be a relatively simple but effective form of decentralised discipline. Equally:
an important accompaniment to any top-down decentralisation is an improvement in national evaluation capacity.[13]
Directly assessing the incidence and effectiveness of government services can be an important adjunct to more traditional (largely financial) reporting.[14]
Information should not only be transmitted up the hierarchy but also used at each management level. Any well-functioning public expenditure management system should:
• Provide good and reasonably detailed information on planned and actual distribution of expenditures, and it should be possible to link expenditure information to information on service levels and outcomes (i.e. expenditure data need to be both sufficiently disaggregated and classified by objective).[15]
• It should provide information that allows expenditure allocation to be more discriminating (e.g. in targeting regional and social groups), that makes trade-offs between alternative expenditures more transparent, and that facilitates analysis of the incidence and effectiveness of public services. (At present even basic information on unit costs is often lacking.)
Decentralisation makes the availability of such information even more critical. Additionally, comparative information between regions and agencies can play an important role in identifying more effective practices, as well feeding into consideration of horizontal imbalances.
D. Aid and Decentralisation
Donor Influences on Decentralisation
Decentralisation is an appropriate interest for aid agencies:
• Donors need to consider how to adapt to decentralisation that occurs in recipient countries. Interventions need to be designed to fit in with existing (or emergent) institutional patterns, even if decentralisation per se is not a dominant consideration..
• More actively, donors may be active proponents of decentralisation, as a means to more efficient administration or more effective governance.
• Déjà vu: many issues in the relationship between donor and recipient reappear in the consideration of relations between central and decentralised organisations in general – fungibility and conditionality, for example.
Donors have unwitting as well as deliberate effects on decentralisation in their partner countries:
.. Unfortunately, aid has sometimes been part of the problem. Past aid has gone almost exclusively to (or through) central governments and has affected how public services are delivered. Even though some local governments can provide services more effectively, developing countries tend to have unnecessarily centralised service provision, to which aid has contributed. The traditional design and management of aid packages have also reduced the participation of local communities in the design and implementation of development projects.[16]
Donor perspectives are shaped by trends towards decentralisation in their own countries, and many (probably most) aid agencies aim to decentralise their own activities more in future. Agencies should reflect on the appropriateness of home country experience to their partners' circumstances, as well as on the interaction between their own decentralisation and their partners'.
We comment on four aspects of aid and decentralisation: fungibility and conditions; decentralisation and poverty alleviation; capacity issues; and sector wide approaches (SWAps).
Fungibility and Conditions
Most aid design – especially of projects – has been based on the principle that what you see is what you get. The idea that aid finances the projects to which it is formally applied is often comforting, but generally fallacious.[17] There seems a greater readiness these days to accept that fact and its implications. An implication for aid agencies is that they should view their projects less in terms of incremental resources to a particular sector (unlikely) and more in terms of the knowledge and qualitative improvements that a project may bring (possible). A second implication, is that donors should indeed be more willing to contemplate budget support and sector wide approaches. There are two reasons for this: first, a focus on separate projects may carry additional transaction costs that cannot be justified once fungibility is admitted; second, dealing with governments at a more general level may be more productive (at least as long as there is an overlap of interests between donors and the government).
An implication for governments everywhere is that they should be think hard before erecting elaborate systems of grants to ensure that subnational governments do what the central government would like them to do. Broadly speaking, as long as subnational governments have significant resources of their own, conditional grants will be largely ineffective unless their objectives coincide with those of the subnational government, in which case they are unnecessary. (And just as donors may be able to influence recipients in less mechanical ways than the tying of funds to projects, so national governments may influence subnational governments in other ways than the earmarking of grants – as illustrated later by the case of Ethiopia.)
Finally, is there a case for applying aid to geographical regions and lower tiers of government, in such a way as to redress a perceived imbalance in national resource distribution? Leaving aside the question whether aid agencies' values should override the government's, the chances of succeeding for long seem slim. Some countries (India, Ethiopia – see the discussion of 'offset' below) have quite explicit mechanisms to ensure that a bias in the direction of aid is cancelled out by adjustments in federal allocations. Even without a formal mechanism, one would expect implicit adjustments to take place. Does this mean that aid programmes focused on particular regions or levels of government are futile? Not necessarily – but the value-added of the aid is likely to consist more in technology transfer, capacity building and innovation that accompanies the finance than in an increase of net resources to the recipient.[18]
Decentralisation and Poverty Alleviation
It is often implied that decentralisation is inherently pro-poor – that taking service provision closer to the people will serve the interests of large numbers of poor people. Certainly there are reasons why poverty-oriented programmes may need to be implemented in a decentralised way: local bodies should be better able to identify the poor, for example. Local provision of services often stands to be an inherently more efficient mode of delivery. But there are also many ways in which decentralisation may operate against the interests of the poor. Unless horizontal inequities are addressed in revenue assignments and compensating grants, decentralisation may widen the gap between regions with different levels of fiscal capacity.[19] Even if horizontal equity among regions is achieved, there are often large inequities within administrative regions (not least between urban and rural areas). The local elements best able to take advantage of decentralised authority may be elites whose interests are not closely aligned with poor people's. In a 'participatory' system it is always relevant to ask who is participating and to whose advantage.[20] giving life to local political institutions may increase the opportunity for collusion between locally-based elites and the centre.[21]
Thus, decentralisation does not of itself reduce poverty. What it can potentially do is to improve the local conditions of the population through increasing the extent and efficiency and cost effectiveness of basic services. It can also concentrate Government efforts on devising and implementing regional economic strategies. Specifically, a decentralisation programme can be used as a tool for:
• identifying appropriate recipients for a targeted poverty programme as part of a regional economic strategy
• increasing equity through providing equalisation grants
• establishing better targeted services of use to the local population
• more efficient and cost-effective provision of basic services.
Relevance to poverty reduction resides not in the fact of decentralisation but in the details of its design.
Capacity
'Lack of capacity' at lower levels is regularly cited as a factor inhibiting decentralisation. This may be so, but it is always worth asking why, and what is meant by capacity. On the latter, Parker (p36)offers a practical interpretation:
As we are primarily concerned with the delivery of goods and services, it is possible to adopt a specific interpretation of institutional capacity that focuses on the degree of resource mobilisation, cost-effectiveness in service provision, and performance with respect to meeting minimum standards of service provision. Based on this interpretation, lack of institutional capacity may be reflected in one or more of the following:
• inadequate funding to meet minimum standards of service and provision;
• inability to mobilise fully all resources available from tax bases, revenue-sharing arrangements and/or matching grant programs;
• failure to deliver goods and services cost-effectively; and
• an inappropriate mix of services in relation to local preferences.
Why does decentralisation require more capacity than the alternative? In principle (looking at the theoretical justifications for decentralisation) it should simplify administrative and managerial requirements. On the other hand, bureaucratic hierarchies are usually structured to place specialist functions at higher levels; there may not be enough accountants, engineers or quantity surveyors to go around a larger number of local administrative units. This is a genuine problem – though we should note that the response could include redefining of skill requirements, sharing of manpower resources etc.
One danger is that decentralisation requires more capacity because it isn't genuinely decentralised. If what is done at the lower levels is minutely checked all the way up the hierarchy (pre or post action) decentralisation is likely to add to the administrative burden, not reduce it. And if local units simply replicate the personnel demands of the organisational levels above them, decentralisation will be more demanding of personnel than it needs to be. If responsibilities are devolved without the resources to meet them, again there may be an apparent 'lack of capacity' that actually reflects either a failure to put resources where they are needed or a general scarcity of resources that may simply have been less visible before. There is some empirical evidence that 'capacity' does not necessarily increase with jurisdictional size.[22]
In this connection, aid agencies should consider carefully the administrative demands that they impose. If project implementation is decentralised to local levels, but donor procedures still require prior reviews at the donor headquarters, it is fairly predictable that the donor will blame faltering implementation on 'lack of capacity'.
A particular issue is the ability of local administrative units to attract and retain adequate staff. Campos and Pradhan (p9) correctly point out that
managerial autonomy and predictability will not produce desirable results unless the civil service in line agencies attracts competent individuals.
Even if individuals are competent, the high turnover that is often found is inconsistent with efficiency and accountability.
External observers and central government officials perhaps have a common bias towards denigrating local capacities. Certainly, capacity problems are genuine, but one has to be careful not to apply a false benchmark that assumes more capacity at the centre than really exists.[23] Equally, as Bird has pointed out, low capacity at local levels is not an exogenous given:
Concern is sometimes expressed about the possible effects of decentralising public sector activities owing to the poor quality of local government administration in many developing countries. To a considerable extent, however, each country gets the local government it wants. .. local government officials, like those anywhere, respond to the incentives with which they are faced. If those incentives discourage initiative and reward inefficiency, then it should come as no surprise to find inefficient local governments. The answer to this problem, if it is one, is to make it possible and attractive for honest, well-trained people to make a career in local government. Similarly, the answer to local governments that make "wrong" decisions is to provide an incentive structure that leads them, in their own interests, to make the "right" decisions, that is, decisions that are both economically efficient and politically acceptable. The fiscal arrangements needed to achieve this result will promote accountability and provide incentives for the cost-effective provision of public services. (Bird, Vietnam p40)
Sector Wide Approaches
Sector Wide Approaches are an attempt to address obvious weaknesses that are associated with fragmented, project-focused donor interventions that have tended to bypass (and in so doing exacerbate) the perceived weaknesses of governments' administrative structures. Often the strategies embraced by SWAps emphasise the decentralised provision of services. We see a danger, however, that the expressed intention of supporting decentralisation may be undermined by the nature of the relationship between donors and central government. It is good to pursue better coordination among donors, and better alignment of donor interventions with national sector strategies. But a centralising bias may be introduced at two levels. The collaboration between donors and central government may operate to exclude both lower levels of government and non-government stakeholders.[24] And donor procedural demands may run counter to the principles of decentralisation (the situation posed in ¶62 is not imaginary).
Once again, the underlying lesson is that the issues associated with decentralisation are seldom as simple as they may seem – a point that is borne out in the two country examples we review next.
E. Issues in Practice
Introduction
This section uses Ethiopia and Kyrgyzstan to give practical illustrations of some of the points we have made in this paper. It does not pretend to do justice to the complexity of either case.
Ethiopia
Box 9 gives the highlights of Ethiopia's distinctive federal system. It would be hard to find a better demonstration that issues concerning decentralisation are complex, country-specific and often counter-intuitive.
Thus, for example:
a) There are important differences between ostensible formal arrangements and how things work in practice. Despite Regions' having the right to secede, in practice there is a high degree of policy leadership, coordination and fiscal discipline from the centre.
b) The system of block grants calculated within an expenditure ceiling has considerable virtues. It is simple and consistent with macroeconomic discipline. As long as regional and federal governments have similar views on priorities, a complex system of specific-purpose grants is not needed to ensure consistency of regional behaviour with central priorities. One problem of vertical imbalance – the theoretical incentive for Regions to expand expenditure irresponsibly – is obviated. However, it has been argued that it would be wise to put a more sophisticated grant system in place before "cooperative federalism" breaks down, while matters are still relatively uncontentious.
c) Formulas are treacherous, and rarely as 'objective' as they seem. Thus it can be demonstrated that the current formula, in the aggregate, penalises additional revenue collection by regions, despite having a term to encourage regional revenue effort. The formula has been continually tinkered with, partly to ensure that the results are politically acceptable (e.g. in not reducing any region's budget envelope from one year to the next). Some regions have adapted the federal formula to distribute resources among their zones: they too have had to make pragmatic adjustments (e.g. to accommodate the larger personnel budgets of some zones where experienced staff are concentrated).
d) Even though the Federal government ostensibly funds the regions through unconditional block grants, it has very considerable influence over regional expenditures. All of the mechanisms listed in ¶35 above are relevant. (One consequence is that, despite the ostensible autonomy of the Regions, is has been possible to prepare sector development programmes for health and education that set credible policy and expenditure targets for all the Regions simultaneously.)
e) Stability and the time horizons of actors in the system are important. Unless people expect consistency and stability in grant arrangements, there is not much incentive, or time, to adapt to their nuances. Thus, the grant formula's unintended bias against revenue generation has probably had no significant effect, partly because there hasn't been time for the disincentive to register. Conversely, the unpredictability of annual revenues to the regions is a disadvantage. (Budget ceilings, consistent with the aggregate expenditure envelope are usually issued vary late, and there is – so far – no forward indication of expenditure expectations for later years. This has repercussions down the line, since the lateness of the annual Federal ceilings makes it impossible for decentralised budgeting to be based on known resource limits.)
f) Old habits die hard. There is no reason to doubt the government's commitment to decentralisation. Nevertheless there is an instinctive tendency to impose uniform solutions from the centre. Thus, for example, the education and health sector development programmes prescribe a quite rigid pattern for provision of primary facilities across the country which may inhibit local initiatives and adaptation to local circumstances.
g) There is a similar danger that some donors, despite modifying their procedures to support sector-wide approaches, are reinforcing centralising tendencies in sector programme implementation arrangements.
h) The 'offset' system is rationale in principle, but, as presently operated, has the perverse effect of reducing national uptake of aid, since regions perceive aid as an inferior substitute for the government funds it displaces.
i) It is dangerous to assume that capacity increases uniformly up the hierarchy. The education and health sector programmes are threatened more by the weakness of the two central ministries than by capacity constraints in their regional counterparts.
j) The system is still evolving and developing: generalisations that apply now may not do so in future.
Box 9: Decentralisation in Ethiopia
|Ethiopia has a large (50m plus) and diverse population. Following the overthrow of the strongly centralist derg regime in 1991, |
|and the secession of Eritrea, a decentralised federal system was established. This has a number of striking features: |
|Regions (and also the lower tiers of zones and woredas) are explicitly based on ethnicity. As a result the 11 constituent regions |
|and city administrations vary enormously in population (from nearly 20 million to less than 200 thousand). |
|The constitution provides for self-determination by ethnic groups: there is a defined procedure for leaving the Federation if they |
|choose. |
|Constitutional arrangements envisage woredas as the key units, but this is an aspiration for the future rather than a description |
|of the present. 'Dual accountability' means that sub-national governments are accountable to the national administration as well |
|as to their constituents. Further decentralisation of budgeting and expenditure responsibilities to zones and woredas is |
|proceeding at different rates in different regions. |
|Regions are responsible for the bulk of public expenditures (including most health and education services). But the Federal |
|government collects most revenues, with the result that vertical imbalance is very high by international standards. The Federal |
|government collects about 80% of all revenues; the regions, on average, fund only 30% of their expenditures from their own revenue |
|sources. |
|The basis of revenue assignments is unusual, in that a number of instruments are allocated to region or federal level according to |
|taxpayer category rather than type of tax. |
|Vertical imbalance is bridged by (ostensibly) unconditional block grants (called 'subsidy'). Allocation is based on a formula |
|which also addresses large horizontal imbalances (Addis Ababa is nearly self-sufficient, while the weakest region depends on the |
|'subsidy' for 90% of its budget.) The formula has three main elements: population, an index of development indicators, and a term |
|intended to reward regional revenue collection efforts. |
|Each year's 'subsidy' is based on an assessment of total permissible (federal plus regional) expenditure. The system thus supports|
|a high level of fiscal discipline but leaves regions little choice over their levels of expenditure. |
|The Federal government 'offsets' aid to the Regions. Each year's subvention to a region is adjusted by the amount of aid the |
|Region is expected to receive, |
| |
|Regions have their own civil services, but pay and conditions are aligned with those of the federal government. Unlike many SSA |
|countries, Ethiopia does not have an overstaffed public service. |
|Many aspects of the system (which has been characterised as '"cooperative federalism") are still working themselves out. In |
|practice, regions mostly accept the policy guidance of the Federal government and replicate its administrative structure and |
|procedures, but it is not clear that they are bound to do so in future. |
|For extended analysis see the World Bank's 1999 Ethiopia: Regionalization Study and Lister, 1998, Implementing Sector Development |
|Programmes in Ethiopia. |
Kyrgyzstan
The system of decentralisation in Kyrgyzstan (for details see Annex I) is fairly typical of transitional economies. Politically and administratively, it operates in a deconcentrated manner: three (national, regional and district) of the five levels of government (national, regional, district, city and village) are accountable to central agencies and have heads appointed directly by the President. Fiscally, the inter-governmental finance system operates a conventional combination of tax sharing and grants from central governments to equalise revenue capacity and ensure appropriate incentives for local tax collection. The system comprises:
• stable tax sharing, providing basic local revenue capacity through vertical transfers;
• a system of categorical grants calculated to fund minimum levels of service on basic priority health and education services;
• a system of equalisation grants to compensate for horizontal inequities between resources and needs;
• local own source revenues for funding local service provision; and
• fixed expenditure assignments to clearly define expenditure responsibilities between different levels of government.
Although there are 5 levels of government (the same number of levels as in China but containing less than 1% of the population), in practice more than three quarters of funding for local government services comes from central government through the categorical and equalisation grants. Consequently, local parliaments have relatively little discretion over the services provided in their localities and little control of the level of financing.
While local governments are primarily responsible for providing primary and secondary health and education, the structure of the inter-governmental finance system actually inhibits the decentralisation of decision-making and provision of services. At present, there is no stipulation in the Republican budget over which line item grants from the Republican budget should be allocated – the Annual Budget Law states simply that these must be used for “priority expenditure directions in the sphere of social sphere”. In practice, however, because salaries and Social Fund deductions are statutory expenditures, there is not much choice. Because the overall amount for categorical grants is calculated to be the same as salaries and Social Fund deductions, funding for other line items in local budgets must come from their other sources. However, this is limited. In short, there is little explicit Central Government control over health and education expenditures at the local level (only to ensure statutory expenditures are met). However, the lack of adequate financing means that they exercise control implicitly.
Insufficient financing and continued centralised control over expenditure decisions inhibits reforms in expenditure management necessary to improve the cost-effectiveness of service provision. Kyrgyzstan, like other countries in transition, inherited health and education systems that, while providing wide access to good-quality provision, suffered from key structural problems. Decision-making, administrative responsibilities, and financing were all centralised, and performance measures were generally based on inputs such as hospital space per person and the number of doctors and teachers. The way that budgets are made up (from physical norms and line item allocations) inhibits any managerial/financial discretion at the local or central levels. Any reduction in physical capacity reduces the amount of budgetary expenditure given. Thus, the normative basis of budgeting actually penalises authorities which reduce their nominal physical capacity in order to deliver more effective services with the resources available (because budgetary resources are provided on the basis of physical resources). This leads to weak incentives to seek cost-saving alternatives. The effect of these weaknesses is that the system is chronically underfunded and unsustainable with the current level of resources. Salaries and pension contributions have become treated as fixed costs, with all other items acting as a residual.
A number of key changes to the inter-governmental finance are required to strengthen incentives for local administrations to improve the cost-effectiveness of service provision. Firstly, there is a need to move away from making up budgets on the basis of norms and line budgeting towards identifying and prioritising expenditure requirements and concentrating scarce resources accordingly. This will facilitate greater management responsibility by local administrations and enable rationalisation of health and educational facilities. Secondly, the basis of grant allocations should be reorientated to facilitate the targetting of resources to priority expenditure areas. Grants should be allocated to individual programme areas rather than to specific line items. Finally, expenditure and revenue assignments should be clarified for each level of government. Local government officials indicated that they are not clear on how much discretion they are allowed, particularly with respect to the divestiture of social assets. At the same time, there is confusion amongst village governments as to what revenues they are allowed to collect and what services they are responsible for providing.
Annex I summarises the key aspects of the decentralisation system in Kyrgyzstan.
Annex I: Kyrgyzstan Country Profile
|COUNTRY PROFILE: KYRGYZSTAN |
|Country background |
|Small landlocked former Soviet Republic in Central Asia. Population of approximately 4.5 million; 700,000 live in the capital, |
|Bishkek. GDP per capita of around $700. Ethnic mix of Kyrgyz (60%), Russian (20%), Uzbeks and Kazakhs (15%), other (5%). 60% of |
|population lives in rural areas. Unitary government. Economy based on agriculture, gold, and aid. Reasonably active economic |
|restructuring programme, though has stagnated recently. Total 1999 central Budget of $440 million. Local expenditures represent |
|around one-third of total state Government expenditure. Government undertaking major budget reform programme, including introducing a|
|medium-term fiscal framework (MTFF). |
| | |
|Description of fiscal decentralisation system | |
|5 levels – central, oblasts (provinces), rayons (districts), |Incentive system for local governments to collect above their |
|municipalities, and villages |targeted amount – they can keep percentage of some additional taxes |
|At lowest level, there are more than 450 entities |collected |
|Subnational governments are funded by a system of own source |Local administrations formulate their own (annual) budgets which are |
|revenues, shared taxes and grants from central government |approved by local parliaments |
|Public expenditures are financed largely from the central |Central tax collection – taxes are collected at the local level by |
|(Republican) budget, either directly or through grants to local |representatives of local government and are then sent upwards to |
|levels |central level, before being shared with local governments on a |
|Grants consist of unmatched categorical (conditional) grants for |derivation basis |
|health and education and unmatched general (equalisation) grants |Central government sets all tax rates (excluding local charges and |
|Type of decentralisation is deconcentration, with local |fines) and the tax sharing rate |
|departments being branches of central government |Main shared taxes are profit tax, excise tax and sales tax |
|Vertical imbalance is achieved mainly through categorical grant |Main central tax is VAT |
|Horizontal imbalance is achieved mainly through equalisation |Main local tax is land tax |
|grant |Local governments are responsible mainly for providing primary and |
| |secondary health and education, agricultural advisory services, |
| |maintenance of local infrastructure and local administration |
|Assessment of System |
|Positive: |Negative: |
|Tax sharing rates are stable (for minimum 3 years) and the same |Unclear guidance on expenditure assignment, particularly at lowest |
|across all regions (set at 35% shared with local level) |levels of government |
|Transparent formulae for categorical grants from central to |Too many levels of government for efficient administration (same |
|oblast level, based on weighted population and numbers of pupils |level as for China) – result of political decentralisation occurring |
|Transparency as a principle for grant calculations established |first |
|For first time, with 1999 Budget, allocation of categorical grant|System designed and implemented too quickly, particularly with |
|to priority programmes (not economic items) specified in draft |introduction of village level – political imperative |
|Annual Budget Law |Split in expenditure responsibility between capital and recurrent |
|Draft Government order for determining equalisation grant |spending for health and education between different levels of |
|allocations prepared, with provision for ensuring a gradual |government |
|transitional to the new allocations |Lack of capacity at local level to implement system (particularly at |
|Dialogue begun with oblasts and with key ministries (health and |village level, where they are unclear of their roles) |
|education) on criteria for allocating categorical grants |Dual subordination at local level – leads to negative incentives for |
| |local governments to collect shared taxes |
| |Richer areas fare better than poor areas with grant receipts |
| |Equalisation grant is effectively deficit financing, although a |
| |transparent formula based on regional income has been worked out |
| |The setting of the level of the total grant pool insufficiently |
| |discussed by Government Budget Commission |
|Lessons/Next steps | |
|Significant training required for local government staff in the |Build grant calculations into the MTFF and develop medium term |
|principles and practices of the inter-governmental finance system|budgeting practices at local level to ensure income predictability |
|Re-examine expenditure assignment and issue clear guidelines on |Address the question of dual subordination to improve incentives for |
|responsibilities for lowest level of government – address |efficient revenue collection |
|particularly the split between capital and recurrent spending |Improve discussion and criteria for determining the overall grant |
|currently assigned to different levels of government |pool – one way would be to identify priority services (by programme) |
|Eliminate the practice of giving equalisation grants on the basis|in education and health |
|of regional deficit financing |Develop transparent formulae for determining allocations from oblasts|
|Instead, establish and implement a transparent formula (based on |to other levels of government |
|regional income) for equalising disparities between regional |There is a need to involve more fully the Ministry of Education and |
|revenue potential |Ministry of Health in the devising of future categorical grant |
| |formulae |
F. Concluding Remarks
Decentralisation can facilitate better provision and management of services, and trends towards decentralisation are likely to continue. But decentralisation is not a panacea. There are often differences between its surface and reality. Systems may have multiple tiers without being meaningfully decentralised. In assessing existing or proposed institutions it is important to consider systems as a whole and to understand the various (possibly conflicting) motives for decentralisation that may be at work. Donors, in particular, should beware of over-simplifying the issues. There are costs as well as benefits. The smaller the country, and the more levels that are included in the decentralised structure, the higher the costs will be. Moreover, the incidence of benefits is not necessarily equitable.
Decentralised provision and financing does not guarantee improvements in quality or distribution of services. Local performance depends on the incentives facing decision makers, which in turn depend on the financial, institutional and political environments in which decentralisation occurs.
As regards intergovernmental fiscal relations, the main lessons are:
• IGF relations form a system and all pieces must fit together (e.g. revenue and expenditure assignment, structure of IGF transfers; autonomy of local officials to set local tax rates, tax bases and budgets; degree of local governments’ borrowing ability)
• Assign expenditures first, then assign revenues in amount that will correspond to expenditure needs: order is important; otherwise, the vertical dimension of revenue sharing is never properly addressed.
• Begin fiscal decentralisation with a strong central ability to lead and monitor to preserve accountability and appropriate macroeconomic balance during the process.
• Do not ignore the need for the system to work towards horizontal balance, particularly given often wide disparities between urban and rural areas.
• Aim for a simple and stable system of grants and shared taxes to whose design central government adheres.
• The system should not ignore intra-regional fiscal relations – the design of the system should be inclusive.
• Impose a hard budget constraint on local governments – central government should resist the temptation to bail out local governments in fiscal difficulties.
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Bahl, “Fiscal Decentralisation” in EDI Seminar Series, World Bank, 1998.
Bird R, and Vaillancourt F (eds), Fiscal Decentralisation of Developing Countries, CUP, 1998.
Bird R, and Vaillancourt F, “Fiscal decentralisation in developing countries: An Overview” in Bird R, and Vaillancourt F (eds), Fiscal Decentralisation of Developing Countries, CUP, 1998.
Bird R., Ebel R, and Wallich C. (eds), Decentralisation of the Socialist State, World Bank, 1996.
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[1] Campos and Pradhan, p9.
[2] Goldman, p39.
[3] Parker, p19, citing Ruttan.
[4] Rondinelli et al, 1984.
[5] Parker p19, citing Dillinger.
[6] Bahl, 1998, ¶1.31.
[7] For an extended treatment on these lines see the study by Douxchamps et al prepared for the European Commission.
[8] Goldman, for example, considers sector-wise scope for decentralisation in the light of the following factors: economies of scale; technical system; complexity of environment; diversity of client, livelihood systems etc; unit size, span of control; crossing area boundaries; stability; political issues; fiscal issues; institutional issues.
[9] There is, however, a well-established 'flypaper' effect: money passed from higher to lower tiers of government tends to result in more expenditure and less tax relief than perfect fungibility would imply. (Dollar and Pritchett, p64, discuss the similar flypaper effect for international aid.)
[10] Bahl, pp10, 24.
[11] Bird and Vaillancourt, p13.
[12] As one aspect of this, there should be much greater readiness to allow decentralised agencies to retain and use revenues from cost recovery.
[13] Bird and Vaillancourt, p13. Bahl makes the same point:
Most developing and transition countries, no matter how vigorous their local government reform programs, will be very centralised for a long time to come. Macroeconomic considerations alone guarantee this result. the strengthening of local government finance will need to be led and regulated by a strong central government. Paradoxically, the first step in effective central decentralisation may be to develop a strong central ability to lead and monitor fiscal decentralisation. ("Rule #3")
[14] See, for example, Cockcroft, 1996.
[15] A fully-fledged programme budgeting system is not necessarily required, but there does need to be a practical ability to relate both allocations and subsequent expenditures to their objectives.
[16] Dollar and Pritchett, p22. They also cite the problem that donor loans to decentralised bodies tend to require central government guarantees, which runs counter to good local government revenue practice and tends to mean that devolved projects are centrally planned.. (ibid. p86).
[17] Dollar and Pritchett find (p19) : although most aid is targeted to finance investment costs, estimates suggest that the net effect of a dollar of aid is to increase public investment by only 29 cents – exactly the amount by which any dollar of government revenue would have raised investment.
[18] See Lister, 1998: Irish Aid and Capacity Building in Sidama. (Of course resources to the recipient region will still be somewhat higher on account of the aggregate of aid to the country.)
[19] Bear in mind that costs may higher, capacity lower, requirements different in disadvantaged regions.
[20] Crook and Manor's study (cited by Parker, p26) found that although poor people or women did participate more under decentralised systems, there was no evidence that either poverty or gender issues received a higher priority in the development process.
[21] Parker, p26. Pakistan and Bangladesh are often cited as examples.
[22] Parker p36, cites a 1995 World Bank study of Colombian municipalities, which finds that capacity does not necessarily increase with jurisdictional size..
[23] Thus one conclusion from the Uganda study by Ablo and Reinnikka is that central government capacity to channel resources to health and education had been seriously over-estimated.
[24] See Gould, 1999 for an extended argument along these lines.
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