FISCAL DECENTRALIZATION AND SUBNATIONAL EXPENDITURE POLICY
Luiz de Mello,1
International Monetary Fund
I. INTRODUCTION
The need to improve the quality and efficiency of government spending has placed subnational
governments at the forefront of service delivery, particularly in the social sectors. In many
countries, it has been recognized that subnational governments have an important role to play in
the implementation of public policies aimed at fostering social and human development. The
key argument for reliance on subnational governments for service delivery is that they are closer
to the intended beneficiaries of public programs. For this reason, subnational governments are
believed to be better equipped to extract information on local preferences and needs more
effectively than the central government, and to be more accountable to local residents. With
greater voice in the design and implementation of public policies, local residents can also
benefit from greater choice in the goods and services delivered to them by the government.
Reliance on subnational governments, or the private sector, for the delivery of public goods and
services is nevertheless not without pitfalls. Fiscal decentralization may lead to the wasteful
duplication of expenditure functions among the different levels of government and poor
governance, thereby reducing the quality of public services and the overall efficiency of the
government. An open policy question is whether the central government should rely more
2
heavily on subnational governments for the design, rather than simply the implementation, of
public programs in general, and in the social sectors in particular. In this case, rather than acting
as agents of the center, subnational governments would enjoy greater policymaking autonomy.
In most countries, the share of subnational outlays in total government spending has increased
reflecting their more active role in service delivery, and, in some cases, greater policymaking
autonomy in the design and implementation of public policies. Nevertheless, the central
government still has an important role to play, even when subnational governments are key
providers of public goods and services. The central government is often called upon to finance
provision, including in some cases the equalization of expenditure capacity among subnational
jurisdictions; to avoid shortfalls in the financing of critical social services; and to provide
technical assistance to subnational jurisdictions.
In a nutshell, this paper is aimed at, first, reviewing the international experience with the
decentralization of government spending to subnational governments and to the private sector,
with special emphasis on the social sectors, including education, health care, social assistance
and welfare, and housing. A second objective of the paper is to discuss the main challenges
facing subnational governments in the design and implementation of public programs, including
the earmarking of revenues, as well as economies of scale and spillover effects in the provision
of public services.
1
The author is now at the Economics Department of the OECD. Mailing address: Economics
Department, OECD, 2, rue André Pascal, Paris 75775 Cedex 16, France. Tel.: (33-1) 45248752, e-mail: luiz.demello@oecd.org.
3
The paper is organized as follows. Section II reviews the conventional distribution of
expenditure functions among the different levels of government and discusses recent
developments in this area. Section III presents some cross-country data on spending shares
among different levels of government. Section IV focuses on education, health care, housing
and infrastructure, and social assistance and welfare. Section V discusses pending issues and
policy implications.
II. THE FISCAL ROLE OF SUBNATIONAL GOVERNMENTS: THE “OLD” AND THE “NEW”
Public finance theory has traditionally assigned a limited role to subnational governments in the
design of social policies. The key argument is that, based on the Musgravean functions of
government, the fiscal role of subnational governments is limited to allocative efficiency,
whereas the central government should focus on income redistribution and welfare, as well as
on macroeconomic stabilization. Based on the principle of subsidiarity, the public goods and
services that should be provided by subnational governments are those which generate benefits
that can be internalized by those jurisdictions. Accordingly, activities such as waste disposal,
street maintenance, primary education, and urban transportation have been devolved or
decentralized to subnational governments in most countries. Delegation/decentralization is
considered the most effective way to deliver these services because their benefits are mostly
local and there is little scope for economies of scale and interjurisdictional spillover effects in
their provision.
4
The role of subnational governments in the provision of public goods and services has been
affected by a variety of factors. These include demographics, technological changes in
communication and transportation, for instance, and the development of market institutions,
which allows for more active private sector involvement in service delivery (Wildasin, 1998).
Moreover, it is often difficult to clearly define the benefits and beneficiaries of specific
programs. For example, the benefits of public spending on primary education are known to be
local but, from the point of view of poverty alleviation, they are national in scope. Economies of
scale, particularly in administrative functions, may call for a more centralized management of
service delivery even when services are provided locally.
More recently, public finance theory has reassessed the assignment of expenditure functions
among the different levels of government based on principal-agent considerations. What matters
in this case is not allocative efficiency from the point of view of internalizing the benefits of
provision within the jurisdictional boundaries of the provider, but the response of different
layers of government to incentives for efficient, cost-effective service delivery. The
consideration of the principal-agent nature of decentralized service delivery has highlighted a
finer distinction between delegation and decentralization. Delegation is preferred when
subnational governments are best suited as agents of the center and when clear incentives for
efficiency gains can be put in place.
In addition, when expenditure functions can be unbundled, rather than treated as a whole, each
layer of government can perform the role that best reflects its preferences and needs or
comparative advantages. For example, because primary education can be used as a tool of
5
poverty alleviation, as mentioned above, national governments often provide financial support
to ensure a minimum level of provision in all jurisdictions, while day-to-day management
responsibilities are assigned to local governments or school boards. Transportation services may
be provided locally subject to regulations issued by the central government.
In line with their changing role in service delivery and program design, subnational
governments have played a more active role in redistributive policies.2 Traditionally, it had been
argued that the effectiveness of subnational redistributive policies depended on taxpayer
mobility. Factor mobility may prevent subnational governments from using the tax system for
the purpose of redistribution, and locally-funded transfer payments may attract potential
claimants from neighboring jurisdictions, thereby discouraging local funding for these
programs. More recently, the recognition that taxpayer mobility may be more limited than
expected has provided some justification for subnational redistributive policies, particularly in
terms of expenditure, rather than taxation, policies. The central government should nevertheless
remain at the forefront of redistributive policies. In some cases, it may be better to use
intergovernmental grants to address differences in average income levels in various subnational
jurisdictions than to use taxes and transfers to individuals (McLure and Martinez-Vazquez,
2000).
2
The role of subnational governments in macroeconomic stabilization, another classical
function of government according to Musgrave, remains limited. To avoid macroeconomic
disarray due to decentralization, as highlighted in the literature (e.g., Ter-Minassian, 1997; de
Mello, 2000), it has been recognized that the central government plays a crucial role in
imposing hard budget constraints at the subnational levels of government.
6
III. SUBNATIONAL GOVERNMENT SPENDING: AN OVERVIEW
Subnational governments, including middle-tier jurisdictions, such as states and provinces, and
local governments, are important providers of public goods and services. Fiscal decentralization
indicators vary considerably among regions but, in more decentralized countries, such as large
federations, subnational governments account for over 36 percent of total governments spending
on average, or approximately 14 percent of GDP (Table 1). A sizeable share of subnational
spending is financed through local revenue mobilization, but subnational governments also rely
heavily on grants and transfers from higher levels of government, which account for nearly a
third of their revenues on average. Interestingly, subnational governments tend to rely on grants
and transfers regardless of their size, measured in terms of ratios of expenditure to GDP and
total government spending.
An interesting question is how the changing role of subnational governments in service delivery
has affected the composition of government spending among different tiers of government
(Table 2). Internationally comparable information on public expenditure by function for the
different levels of government is limited. In general, education and health care account for a
large share of subnational expenditures, particularly in the case of middle-tier jurisdictions.
Housing also accounts for a large share of local government spending, in addition to education
and health care. Over time, middle-tier governments have devoted a growing share of their total
spending to health care programs. Interestingly, although social security and welfare continues
to weigh more heavily on central government budgets, these programs have accounted for a
7
growing share of local governments spending over time. Local government spending on
housing, already high in relation to local government spending, has increased over time.
Cross-country indicators of fiscal decentralization should be interpreted with caution.
Subnational fiscal data are often less reliable than those of the central government and, more
importantly, the quantitative indicators reported above do not allow for a more in-depth analysis
of the qualitative aspects of intergovernmental expenditure arrangements. For instance, the rise
in local government spending on social security and welfare programs, as noted above, may be
due to the delegation of service delivery functions to these jurisdictions, rather than greater
autonomy in the design and implementation of their own welfare programs. Moreover, based on
the data at hand, it is not possible to ascertain how much of subnational spending is financed
through grants and transfers from higher levels of government, rather than local revenue
mobilization.3 Intergovernmental grants and transfers differ considerably in their nature, and
hence the incentives they create at the local level. For instance, local governments tend to have
greater autonomy in service delivery and in program design when spending is financed through
block, rather than matching or earmarked, grants.
3
The GFS does not provide data on earmarked grants and transfers to, and within, subnational
governments.
8
IV. THE INTERNATIONAL EXPERIENCE
A. Education
International experience varies on the role of subnational governments in the provision of
education services. In many countries, particularly in OECD member countries, the central
government plays a key role in financing and standard setting, rather than service delivery,
including personnel management, budget preparation, procurement activities, and
administration. Centralized financing and standard setting is justified on the grounds that
education programs can be used as a poverty-alleviation instrument and as a means to equalize
expenditure capacity among subnational units. Outlays on education tend to account for a large
share of subnational budgets, particularly at the local level. Decentralization beyond the public
sector is also common in many countries, where partnerships with the private sector have been
encouraged and fully managed by subnational, particularly local, jurisdictions subject to the
parameters set by the central government.4 In the developing world, unlike most industrial
countries, the central government typically plays a more active role in service delivery due
primarily to capacity constraints at the subnational level.5 Also, the decentralization of
4
Among OECD countries, the main education decentralization programs are GrantMaintained-Schools (United Kingdom); Charter Schools (United States, also in New Zealand
and Canada), and Future Schools (Australia). According to the General Accounting Office of
the United States, based on the study of Dade County (Florida), Prince William County
(Virginia), and the Edmonton school district (Alberta, Canada), these decentralization programs
have a positive impact on the adoption of innovative managerial and teaching practices, as well
as the responsiveness to local preferences and needs (Rondeau, 1997).
5
For instance, in Mexico, 65 percent of all schools and 75 percent of those in basic education
(preschool and primary education) were federally funded and controlled until 1992 (Juarez,
1999). Federal involvement in education was unequally distributed across the country, but the
(continued…)
9
education services to subnational jurisdictions has been motivated by the need to take account
of regional diversities, particularly of an ethnic and linguistic nature, in many industrial and
developing countries.
Subnational governments may play an important role in personnel management in the education
sector. The decentralization of education programs typically begins with the delegation of
administrative functions, particularly personnel management, to subnational governments. In
the United Kingdom, the United States, and Canada, among other countries, emphasis has been
placed on school districts, rather than local governments for the decentralization of personnel
management functions. When greater personnel management autonomy is granted to
subnational governments, it is important to avoid the risk of overstaffing and excessive
discretion over pay in the course of decentralization, particularly if governance is poor at the
subnational level. In some countries, unionization and issues related to civil servants’ benefits
and entitlements have created resistance to decentralization efforts (i.e., Venezuela).6 Moreover,
in a labor-intensive sector such as education, subnational budgets become excessively
dependent on the central government’s personnel policy when teacher’s salaries are set by the
center. In many countries in Latin America, this situation created unfunded mandates at the
federal government designed education policies, set the academic calendar, and assigned
textbooks and other activities. After 1992, when a comprehensive decentralization program was
implemented, the states were granted autonomy to control and operate all schools in basic
education, subject to federal funding and regulation.
6
In 1994, Venezuela implemented a decentralization program in the education sector by
unifying the federal, state, and municipal school networks (pre-school, primary and secondary
education) and transferring the respective assets and personnel to the states, which would be
responsible for service delivery. See Tracy (1996), for more information.
10
local level and led to the implementation of special transfer programs to finance subnational
payroll outlays (i.e., Colombia). In Brazil, income differentials among subnational units resulted
in sizeable pay inequality between state and municipal schools and sometimes within the same
state. This problem has nevertheless been mitigated, at least in part, due to the earmarking, since
1998, of 60 percent of primary education spending to teacher’s salaries.7
Financing arrangements vary across countries. In general, education programs are financed by
the center, even when implemented by subnational governments. When subnational cofinancing is required, some countries earmark subnational revenues to avoid financing
shortfalls, in addition to the grants and transfers received from higher levels of government. In
Brazil, for example, 15 percent of state and municipal revenues are earmarked to finance
primary education programs. In other countries, local education budgets may be financed
entirely through grants and transfers from higher levels of government. In many cases, transfers
are formula-based and take expenditure needs into account, particularly when the equalization
of subnational expenditure capacity is pursued. Functions are costed subject to the minimum
standards set by the center.8 Other countries also rely on the decentralization of service delivery
to strengthen cost recovery through the collection of user charges and fees for the provision of
some services (i.e., contingency fees, and (subsidized) school fees, among others) (Litvack and
7
For more information on the decentralized service delivery in Latin America, see ECLAC
(1998), and Burki, Perry and Dillinger (1999).
8
In Brazil, for example, a national minimum spending level per primary school student is set
annually with a federal top-up grant to subnational governments that cannot afford the
minimum spending level set by the center. See de Mello (2001), for more information.
11
Seddon, 1999). Willingness to pay for service delivery is believed to increase when the services
are provided by local governments. Other cost recovery schemes such as community financing
have also emerged as means for the central government to reduce the fiscal burden of education
service provision.9
A critical policy question is whether subnational governments are more efficient than the center
in the provision of education services. Efficiency gains can be assessed when education
attainment indicators (i.e., literacy rates and school enrollment rates, among others) are
improved for the same consolidated spending level as a result of decentralization, or,
alternatively, when the same indicators can be achieved through lower spending. Simple
correlations between education attainment and decentralization indicators are typically weak
and should be interpreted with caution because they do not control for other determinants of
education attainment.10 Neither do these indicators capture the more qualitative nature of
decentralization, which could explain differences in attainment for countries with similar
subnational spending shares. For efficiency to be boosted, it is important to know whether
9
Community financing has been an important aspect of decentralization in countries where
governments have been unable to meet the demand for education services. In this case,
community-funded schools have coexisted with the public school network to offer schooling
with particular religious, ethnic, political, or other orientations. With the exception of Bolivia
and Nicaragua, community financing has been less widespread in Latin America than in Africa
and Asia (Bray, 1996; ECLAC, 1998). See also de Mello (2004), for cross-country evidence on
the association between fiscal decentralization and social capital.
10
See Baldacci, Guin-Siu, and de Mello (2003), for cross-country evidence on the efficiency of
government spending on education and health care.
12
service quality improves through the decentralization of service delivery, access to education
services is facilitated, and spending reaches the target population.11
Anecdotal evidence suggests that the quality of services provided by subnational governments
tends to be lower than those provided by higher-level jurisdictions, particularly in the
developing world, but it is hard to control for all determinants of quality, in addition to
decentralization. In industrial countries, where empirical evidence is more readily available,
pupil performance, measured in standardized test scores, tends to improve through greater local
government autonomy in education policymaking. Unfortunately, data inadequacies often
prevent the use of this more sophisticated methodology in the developing world, where more
ambitious decentralization programs are being, or have been, implemented.
In Brazil, recent research has shown that the states in which public schools are free to manage
their budgets and appoint the headmaster, as well as to implement participatory management
schemes, tend to have lower repetition and dropout rates, and their students tend to have better
test scores.12 There is some empirical evidence that quality can be improved when subnational
11
More sophisticated methods of measuring efficiency gains in the education sector consist of
comparing test scores in a given school district relative to a control group in another district that
has not been affected by decentralization, after controlling for other observable determinants of
school performance, such as class size, and socio-economic indicators.
12
A study of the Curumim Program (Paes de Barros, Mendonça and Soares, 1998),
implemented in the state of Minas Gerais, Brazil, suggests that test scores, enrollment and
repetition rates, as well as age-grade gap indicators have improved in a sample of pupils in
primary schools that participated in the program, after controlling for other determinants of
school performance, such as parents’ educational background and occupation, and number of
books at home, among others.
13
governments, particularly at the local level, enjoy greater autonomy in program design and
implementation with increased use of demand-driven, result-oriented, participatory
administration in public schools.13 In Latin America, this trend has been referred to as the
municipalization of the education sector, as has been particularly noteworthy in Brazil and Chile
(de Mello, 2001).14 Overall, it has been suggested that improvements in school systems depend
heavily on empowering local authorities to adapt programs to local conditions (Dalin, 1994).
Information on access and the incidence of public spending is scarce, particularly at the
subnational level. A key determinant of efficiency in the provision of education services is
targeting, or whether public outlays on a given program actually reach the intended
beneficiaries. Benefit incidence studies indicate that that the poor reap a disproportionately
small share of the benefits of public spending on education, further underscoring the need to
target these outlays more accurately. Information on incidence rates by government level is
even scarcer, and the correlation between decentralization parameters and incidence rates tends
to be weak. The information reported in Table 3 shows that, for instance, in the case of primary
education, for the same level of expenditure decentralization—measured as the ratio of
13
The most common participatory administration schemes in Brazil are the School Council,
available in 1997 in over 37 percent of the nearly 42,000 schools funded by state governments,
and the Parents and Teachers Association, available in nearly one-third of states schools. See
Parente and Lück (1999), for more information.
14
Chile is an example of increased private-sector involvement in the education sector in the
developing world, where subsidized private schools now account for over one-third of total
school enrollment. Competition among schools to attract students has increased because funding
is based on grade-adjusted school attendance. However, there is evidence that decentralization
has not by itself removed inequalities between jurisdictions of different incomes (Parry, 1997).
14
subnational spending to central government spending—the share of public spending accruing to
the lowest income quintile is almost twice as high in Argentina as it is in Pakistan. In the case of
public spending on secondary education, which tends to be less pro-poor than spending on
primary education, both countries have similar incidence rates. This suggests that the design of
education programs is more important than intergovernmental spending levels per se, and that
other factors, such as the share of private spending on education and school improvement
programs, also play an important role in determining incidence rates across countries.
B. Health Care
As in the case of education, decentralization in the health care sector may enhance the
efficiency of public spending through improved service quality and coverage. Decentralization
of health care tends to be more complex than in other sectors because diseconomies of scale
tend to discourage subnational provision of costly curative health care services and spillover
effects tend to discourage the provision of preventive health care, particularly immunization and
epidemiological control, by subnational governments.15
15
In Brazil, for instance, municipal joint ventures have been developed in recent years to
generate economies of scale in administrative activities, including hiring new staff, licensing
private health care providers, and procurement. More recently, efforts have been made to
strengthen the institutional framework within which these ventures are created (Ribeiro and
Costa, 1999). According to the Brazilian Ministry of Health, as of July 1999, there are 143
intermunicipal ventures in Brazil, covering a total of 1,740 municipalities.
15
The objectives of decentralization in the health care sector also vary significantly between
developing and developed countries. Few developing countries have long-term experience with
health sector decentralization and reform packages have seldom been evaluated. The focus of
decentralization in the developing world tends to be on increasing the coverage of the public
health care system, particularly in rural areas and in less developed regions, and on securing
additional sources of finance from subnational jurisdictions. This has been the main elements of
decentralization in Latin America, for instance, since the early 1990s (i.e., Brazil, Mexico,
Colombia, Bolivia). Private-sector providers coexist with the public health care system, privatepublic service quality differentials are sizeable, and the incidence of public spending tends to be
better than that of education because the better-off tend to rely on private health care providers.
Developed countries, on the other hand, typically focus on efficiency gains through
decentralization outside the public sector. This includes the increased use of co-payment
schemes, delisting of entitlements, shifts toward the public contracting model, separation of
provision and management from purchasing functions, contracting out of hotel functions and
other supporting services, and private capital investments.
The experience of the OECD countries has been diverse.16 Health care is one of the largest
sectors in OECD countries, and accounts now for over 8 percent of GDP on average. Recent
health care reforms in many OECD countries have focused on increasing private-sector
involvement in service delivery, as well as institutional and managerial restructuring,
consolidation and regionalization of purchasing functions, and consolidation of health care
16
See OECD (2003), for further discussion.
16
institutions through mergers and vertical integration of services (Ranade, 1998).17 In many
countries, there is widespread public opinion support for national health insurance schemes (i.e.,
Canada, Germany, the Netherlands, New Zealand, Sweden, the United Kingdom). As a result,
proposals to privatize the funding of health care have faced opposition and attention has focused
on improving the allocation of funds to health care providers within the framework of public
funding. Efficiency gains have also been sought by improving consumer choice as an incentive
toward greater competition and cost-effectiveness among service providers.18
Financing plays a crucial role in the decentralization of health care. Most health care services
provided publicly are financed by the central government through general taxation, often in
conjunction with the social security system. As in the case of education, many countries resort
to earmarking of revenues to finance health care, particularly in the developing world (i.e.,
Brazil, Colombia).19 In general, subnational governments rely on block grants from the center,
The New Zealand government’s proposal to institute “managed competition” in the
purchasing and provision of care—undertaken in 1991 at the same time as reforms in the United
Kingdom—was motivated by a relatively fragmented funding system, rising levels of user
charges and ensuing barriers to access, long waiting lists, and overcapacity of rural hospitals.
The reforms were also motivated by public opinion support for greater private sector
involvement in service delivery, and by the overall pro-market reforms that were implemented
at the time in New Zealand.
17
18
See Hurst and Jee-Hughes (2000), for a discussion of performance indicators in health care
systems in OECD countries.
19
In 2000, legislation was passed in Brazil requiring the states and municipalities to earmark
12 percent and 15 percent, respectively, of their revenues (net of intergovernmental transfers) to
finance outlays on health care (Afonso and de Mello, 2002). Per capita transfers to subnational
governments were also introduced to finance the provision of preventive health care. In
Colombia, a share of central government transfers to the municipalities is earmarked to finance
health care spending. In Bolivia, 3.2 percent of central government transfers to municipalities
(continued…)
17
often based on historical input costs, rather than on equalizing grants based on per capita
expenditure needs and standardized costs. Input-oriented budgeting tends to bias public
spending towards curative, rather than preventive, care. In the developing world, financing
shortfalls are common, and intergovernmental grants are often aimed at financing capital
outlays and fail to take into account the need for recurrent spending associated with expensive
curative care programs (i.e., operations and maintenance). Moreover, despite the effort to
increase spending on health care in the course of decentralization, financing formulas have
seldom included equalization components in many countries.20 Because of the need for
alternative sources of finance for the provision of health care, many countries have introduced
fees and user charges, which are more widespread in the case of health care than education. In
many countries, these revenues are collected in separate funds, not often consolidated in the
government accounts (i.e., transition economies).21 Increased cost recovery through user
are earmarked to finance the provision of a priority benefits package for mothers and children
(Bossert, 2000).
20
In an attempt to equalize spending capacity in the course of decentralization, a horizontal
equity fund (Municipal Common Fund) was set up in Chile reassigning up to 60 percent of the
revenues of wealthier municipalities to their poorer counterparts using a formula based on
population and municipal income (Bossert, 2000).
21
Bossert (2000) shows that per capita spending on health care increased during
decentralization in Chile and Colombia. Although wealthier municipalities spent more on a per
capita basis than poorer municipalities, the gap between them narrowed over time, resulting in
more equitable allocations among the subnational jurisdictions.
18
charges, as well as reliance on the private sector to provide health care services, may affect the
access of certain social groups to these services.22
Empirical evidence of a positive impact of decentralization on the quality of publicly-provided
health care services is limited. Anecdotal evidence of a relationship between decentralization
and the quality of publicly-provided health care is available in a number of countries (i.e.,
Gilson, 1997, Kolehmainen-Aitken, 1998). However, it is not easy to isolate the determinants of
successful decentralization programs (Bossert, 1998).23 As in the case of education, more
sophisticated statistical methods to assess decentralization-driven efficiency gains in the health
care sector would require comparisons between countries that have implemented comparable
decentralization programs in the sector relative to a control group of countries where similar
programs have not been implemented, and controlling for additional observable determinants of
health status. Quality assessments based on opinion surveys among the users of health care
services are not readily available in many countries.
Information on the incidence of public spending on health care is limited (Table 3) and suggests
that, as in the case of education, the decentralization of spending on health care is weakly
22
Community financing has been a prominent feature of health care decentralization in Bolivia
after 1994 (ECLAC, 1998). However, local governments continue to rely heavily on the central
government for financing.
23
Incidentally, using panel data for low- and high-income countries in the period 1970-1995,
Robalino, Picazo, and Voetberg (2001) show that fiscal decentralization, defined as the ratio of
total local government expenditure to total central government expenditure, is associated with
lower infant mortality rates, particularly in less developed countries.
19
correlated with incidence rates. For example, data available for Chile show that almost a third of
public spending on health care accrue to those in the poorest quintile and subnational
governments account for only 2 percent of central government spending on health care. Rather
than dismissing a relationship between decentralization and incidence rates, it is important to
take into account other factors affecting the ability of subnational governments to reach the
poor, as well as the financing mechanisms for subnational spending. In many countries, gender
and ethnicity remain important determinants of access to health care services. In other countries,
where formal access to services is universal, long surgical waiting lists and the prevalence of
informal user charges, among others, are good indicators of limited effective access to services.
C. Social Assistance and Welfare
Delegation is more widespread than decentralization in the provision of social assistance and
welfare programs. It is agreed that subnational service delivery is useful in reducing poverty and
in the provision of social safety nets, particularly when poverty indicators vary considerable
within the country. Nevertheless, the role of subnational governments in the implementation of
social assistance programs has been limited to the extraction of information on local needs and
preferences and to administrative tasks in income certification and personnel management,
among others. Subnational funding of social assistance and welfare programs is confined almost
exclusively to developed countries.24
24
For example, in the United States, the state of California has traditionally provided income
support transfers to low-income individuals. Outlays on health care and welfare programs
account for slightly over 30 percent of the state’s general fund budget. The state also requires
(continued…)
20
The effectiveness of subnational governments in providing social assistance programs depends
on how efficient they are in reaching the targeted beneficiaries relative to higher levels of
government. Program financing and design are known to affect the incidence of decentralized
spending, as suggested above. In the case of welfare programs, particularly income transfers to
households and individuals, means-testing is often difficult, particularly for the poor working in
the informal sector, and categorical targeting—based on broad individual and household
characteristics strongly correlated with poverty—may not be easily applicable to all social
assistance programs. In general, when subnational governments play an active role in the
implementation of welfare programs, financing is provided by the central government through
block grants. Funds are allocated to subnational jurisdictions based primarily on poverty
incidence rates, rather than on how successful these governments are at reaching the poor and at
reducing poverty.
Empirical evidence on the incidence of subnational social assistance programs is limited in the
developing world. Ravallion (1999) analyses an poverty-alleviation program in Argentina
(Trabajar II) to assess performance in reaching the poor and to measure the relative
contributions to the program’s performance—before and after reforms—of the center’s
counties to provide cash transfers to all indigent individuals who do not qualify for state
assistance. Most social welfare programs in California are administered by local governments.
State agencies set overall policies, benefit levels, and eligibility criteria, and monitor local
governments (Geen and others, 1995). In Spain and Switzerland, subnational jurisdictions are
free to set benefit levels and eligibility conditions for most central government-financed welfare
programs.
21
provincial reallocation and decentralized targeting. Galasso and Ravallion (2000) use data on
the implementation of a partially decentralized food-for-schooling program in Bangladesh. In
this program, the central government decides on the intercommunity allocation of funds, while
local governments focus on intracommunity assignments. They find that targeting is somewhat
propoor, and local capture does not seem to be sizeable. Anecdotal evidence available for
Brazil’s Bolsa-Escola program—a transfer payment granted to poor households to keep at
school school-age children who might otherwise drop out of school to work—points to high
incidence rates. The program, originally designed and funded by a few subnational
governments, has now motivated the implementation of a federally-funded school attendancelinked income transfer program. Some subnational governments in Brazil also have their own
income support programs.
D. Housing and Infrastructure
Subnational provision of housing and infrastructure services has been carried out predominantly
through the devolution, rather than decentralization, of expenditure functions. Important
deterrents to the decentralization of housing and infrastructure expenditure functions to
subnational governments are the sunk costs involved in funding these programs in view of
subnational governments’ more limited revenue mobilization capacity, including borrowing,
and the spillovers associated with these services. These spillover effects would reduce the
incentives for subnational service delivery, as in the case of social assistance and welfare
programs. In fact, in many countries, government provision of housing and infrastructure
services is justified as social assistance instruments and service delivery tends to be subsidized.
22
Many countries intervene in the housing market, particularly in the developing world. This is
because domestic capital markets are often shallow and to ensure the provision of shelter for
poor households who would not have access to long-term credit from the domestic financial
system, when available. Subsidized credit is often provided by the central government, through
its financial institutions, and subnational governments often participate as agents of the central
government in identifying target groups (i.e., Colombia) and building housing financed through
transfers from the center. Examples of subnational government-financed housing projects are
limited in number. In Brazil, for example, richer states have their own housing programs,
particularly in the area of slum upgrading and urbanization.
The decentralization of infrastructure services has some elements in common with that of
education and health care. As in education, unbundling is relatively easy in the case of
infrastructure services and, as in health care, high provision costs would make programs
unaffordable to most subnational governments. Financing for costly infrastructure investment is
often provided through block or matching grants from higher levels of government and
subnational governments become agents of the center with limited policymaking autonomy. As
in education, the decentralization of infrastructure services often goes beyond the public sector,
through partnerships and contracting-out arrangements with the private sector (i.e., water and
transport companies).
Cross-border joint ventures among subnational jurisdictions have been encouraged in many
countries to maximize economies of scale and to internalize the externalities associated with the
23
provision of regional public goods. In France, for instance, small communes contract out service
delivery to private regional water companies, and contiguous municipalities often create
regional associations to manage services such as waste disposal. Peru attempted to decentralize
much of its road network to provincial and municipal governments but then failed to provide
financing for operations and maintenance (Gutman, 1999). This resulted in widespread
deterioration of the network and, ultimately, recentralization (Burki, Perry, and Dillinger, 1999;
Humplick and Moini-Araghi, 1996). In Brazil, the privatization of water and sanitation services
has been delayed due to disagreement over the jurisdictional power of states and municipalities
in the provision of these services, particularly in the case of large metropolitan areas, where the
water and sanitation networks straddle local government borders.
There is some empirical evidence that decentralization increases subnational spending on
infrastructure projects, but the correlation between decentralization and performance indicators
in the infrastructure sector is less clear-cut. The cross-country evidence reported by Estache and
Sinha (1995) suggests that decentralization is associated with higher spending on infrastructure
projects, particularly in the developing world. Decentralization tends to increase both total and
subnational spending on infrastructure possibly because of differences in local preferences.
Moreover, using cross-country data, Humplick and Estache (1995) estimate the impact of
decentralization on the performance of several infrastructure projects, including roads,
electricity, and water. Using different measures of decentralization in each sector, the authors
find that at least one performance indicator improved in each sector under examination as a
result of decentralization. Nevertheless, the correlation between decentralization and
performance was not strong in general.
24
V. PENDING ISSUES AND POLICY IMPLICATIONS
The choice between administrative deconcentration and full decentralization depends on
incentives. Principal-agent considerations, rather than the Musgravean classical functions of
government, have now become the main theoretical benchmark for the assignment of
expenditure functions to subnational levels of government. Subnational governments have
become important providers of public services in sectors where activities can be more easily
unbundled and incentives for performance can be more effectively put in place. Education is a
case in point. Decentralization tends to be more difficult in sectors with significant spillover and
economies of scale effects, such as infrastructure development and social welfare.
Decentralization can lead to the creation of unfunded mandates. In certain cases, expenditure
functions are decentralized to subnational governments without a commensurate assignment of
revenue sources.25 In other cases, greater private-sector involvement is sought in the provision
of public services to eliminate unfunded mandates at the central government level but the
required principal-agent structure of incentives is not in place. In this case, private-sector
involvement may be deterred by lack of an adequate regulatory framework, particularly pricing
regulations. The infrastructure sector is a case in point. Moreover, the quality of services may
25
In transition economies, many social services were provided by state-owned enterprises. With
privatization, unfunded mandates were created and local government budgets were not adjusted
for these new responsibilities, thus creating unfunded mandates or unmet local demands (Gupta
and others, 2003).
25
suffer as a result of decentralization when the center fails to set minimum standards for privatesector and/or subnational providers. Again, principal-agent incentives can be strengthened
through adequate enforcement and performance monitoring, as well as the choice of financing
instruments, such as reliance on matching grants and conditionality on block grants based on the
fulfillment of explicit, quantifiable performance objectives, among others. Open-ended, gapfilling block grants and lump-sum transfers seldom create strong incentives for costeffectiveness and efficiency in service delivery. Greater private sector involvement in service
delivery, and the need to increase cost recovery through the restructuring of publicly-provided
services, may prevent the poor’s access to social services. Central governments may also set
minimum standards beyond the means of some subnational governments, thus raising operating
costs and discouraging service delivery.
Decentralization has been motivated in many cases by theoretical, rather than empirical,
considerations. The measurement of efficiency gains in decentralized service delivery remains
open to empirical investigation, particularly in the developing world, where decentralization
programs have been more ambitious and implemented more recently. The impact of
decentralization on access to, and incidence of, public programs is harder to measure. Most
empirical evidence, often predominantly anecdotal, focuses on the education and social
assistance sectors. A crucial question that requires careful empirical study is whether
decentralization results in significant innovations in program design and management, and
changes in financing arrangements.
26
Vested interests may be a deterrent to decentralization. For decentralization to be successful,
there must be willingness on the part of central government to share power and on the part of
local governments and communities to assume new responsibilities. In many countries, civil
servants have objected to decentralization efforts for fear of status loss when decentralization
involves a transfer of personnel from the center to subnational governments. Fear of loss of
benefits, including pensions and a variety of nonpecuniary entitlements, has deterred
decentralization programs in many countries. Central government officials may also be reluctant
to transfer functions to subnational governments for fear of loss of control and political prestige.
A precondition for successful decentralization is good governance at the implementing level.
There is some evidence in the literature that decentralization is correlated with corruption
(Pritchett and Kaufmann, 1998; Kaufmann, Kraay, and Zoido-Lobatón, 1999; de Mello and
Barenstein, 2002). Although decentralization tends to expand the volume of the service
delivered, greater subnational spending on social programs does not generate efficiency gains
when accompanied by overprovision of public service to local elites (Bardhan and Mookherjee,
2000).
Table 1: Summary of Subnational Expenditure Functions
Health Care
Traditional assignment
Primary schooling
Preventive care
Conventional financing
General taxation, input-based
block grants, equalization
grants
Output-orientation, rewards for
extended coverage, penalties
for poor performance; user
charges apply in certain cases
General taxation, input-based
block grants, capitation,
equalization grants
Output-orientation, rewards for
extended coverage; user charges
apply in certain cases
Universal in most countries for
primary education; user
charges apply in certain cases;
access depends on coverage of
service provision network;
enrollment rates vary across
and within countries.
Rates vary by type of program
(typically higher for primary
education); limited empirical
evidence, particularly at
subnational level
Universal in most countries for
preventive care (basic health
package in some cases); access
depends on coverage of service
provision network
Increasing over time for
personnel management and
local curriculum development.
Emphasis on school-level and
community-based
management.
Increasing for personnel
management and administration.
Increased diversity in financing
options and private-sector
involvement.
New financing options
Access to services
Incidence of public
spending 1/
Subnational
policymaking autonomy
Rates vary by type of program
(typically higher for preventive
care); limited empirical
evidence, particularly at
subnational level
1/ Defined as the share of public spending reaching the intended beneficiary.
Social Assistance and
Welfare
Only as agents of central
government
Block grants
Infrastructure
…
Market-orientation;
concession and
privatization; user charges
and price subsidies apply in
many cases (i.e., urban
transportation)
Access varies according to
type of service; access
depends on coverage of
service provision network
Increased use of categorical
and regional targeting in
certain cases; access
depends on coverage of
service provision network;
enrollment rates vary across
programs.
Rates vary by type of
program; middle class
capture in poverty
alleviation programs;
limited empirical evidence,
particularly at subnational
level
Delegation rather than
decentralization.
Subnational-financed
programs are more common
in industrial countries.
Mainly as agents of higher
levels of government
Block and matching grants
Rates vary by type of
program (typically higher
for sanitation services)
Delegation rather than
decentralization. Central
government subsidization
combined with subnational
service delivery is more
common in the developing
world. Limited intervention
in the housing market in
industrial countries.
- 27 -
Education
- 28 -
Table 1: Decentralization Indicators, 1980-97
(period averages, in percent) 1/
Number of
Size
Fiscal decentralization 2/
Subnational
Tax
Nontax
Vertical
Subnational
autonomy
autonomy
imbalances
spending in percent
spending in percent
of GDP
of total gov. spending
Countries
Africa
42.7
26.1
31.4
2.1
7.6
14
Asia
34.6
23.1
39.5
3.4
13.8
9
Latin America and Caribbean
49.5
23.8
28.4
3.3
14.7
16
...
...
30.5
1.0
1.5
2
OECD 3/
41.3
18.0
40.4
14.7
30.8
24
Transition economies
53.5
11.0
34.7
9.6
30.3
17
Large federations 4/
48.9
19.2
32.0
13.5
36.5
13
World
45.0
19.5
35.1
7.7
21.2
82
Middle East
Sources: Government Finance Statistics, IMF.
1/ Unweighted averages.
2/ Tax (nontax) autonomy is defined as the share of subnational tax (nontax) revenues in total government revenues. Nontax revenues include
primarily royalties, fees, penalties, and user charges. Vertical imbalances are defined as the share of grants and transfers from higher levels of
government in total subnational revenues.
3/ Includes Israel.
4/ Comprises India, Malaysia, Argentina, Brazil, Mexico, Australia, Austria, Belgium, Canada, Germany, Spain, Switzerland, and United States.
- 29 -
Table 2. Selected Social Spending by Government Level, 1970-2000.
(In percent of total government spending by government level, period averages)
Education
Social Spending
Health
Social Security
Care
and Welfare
Housing
Sample
Size
All countries
Cental government
Middle-tier governments
Local governments
13.5
28.7
22.0
8.7
15.3
12.2
19.6
12.9
9.6
4.6
3.3
14.0
108
15
44
Federations 1/
Cental government
Middle-tier governments
Local governments
7.3
25.4
20.9
7.4
18.0
8.0
33.7
10.2
8.4
1.9
3.3
12.2
13
8
7
Latin America and Caribbean
Cental government
Middle-tier governments
Local governments
25.8
36.3
16.7
16.6
14.0
8.2
21.7
4.8
2.6
13.7
3.7
8.9
20
3
4
OECD 2/
Cental government
Middle-tier governments
Local governments
8.3
25.5
18.7
9.0
19.3
10.8
34.1
12.6
14.8
2.4
2.8
12.3
23
7
14
Source: Government Finance Statistics; and IMF staff calculations.
1/ Based on the classification of federal states available from Elazar (1995).
2/ Excludes the new members admitted in the 1990s.
- 30 -
Table 3: Decentralization and Benefit Incidence of Public Spending.
Percent share of public spending accruing to: 1/
Q1
Q2
Q3
Q4
Q5
Decentralization
indicator 2/
Year of
incidence data
Health care
Chile
Colombia
Indonesia
Romania
32.0
27.4
11.5
12.2
26.0
25.6
16.1
14.8
21.0
18.7
19.3
20.2
15.0
15.9
24.4
24.3
6.0
12.5
28.7
28.6
0.02
0.22
0.26
9.59
1992
1992
1990
1994
1.82
0.20
0.78
0.51
2.09
1993
1990
1992
1992
1991
1.82
0.20
0.78
0.51
2.09
1993
1990
1992
1989
1994
Primary education
Argentina
Chile
Colombia
Guyana
Pakistan
37.0
35.7
39.4
28.9
19.3
23.2
26.9
26.2
24.9
22.7
15.4
18.1
19.4
18.5
21.9
15.0
12.6
10.8
19.0
21.2
9.4
6.7
4.3
8.6
14.9
Secondary education
Argentina
Chile
Colombia
Indonesia
Romania
22.0
23.5
20.6
5.4
18.3
20.8
24.1
26.8
10.6
21.7
21.4
21.0
25.3
16.5
21.7
21.4
18.1
17.7
25.5
20.7
14.5
13.3
9.6
42.0
17.6
Source: GFS and Davoodi, Sachjapinan, and Kim (2001); and IMF staff calculations.
1/ Refers to income quintiles, where Q1 denotes the lowest (poorest) quintile.
2/ Ratio of average local and/or middle-tier government spending to average central government spending
by sector between 1970 and 1985.
- 31 -
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