CONFERENCE ON DEMOCRATIC TRANSITION AND CONSOLIDATION
Working Group 6: The Reform of the State Bureaucracy
Coordinator: Byung-Kook Kim
Coordinate or Decentralize?
Kathleen O'Neill
To the question "coordinate or decentralize?" I answer, "both." Decentralization
offers the promise of increased efficiency, accountability, and democratic practice while
coordination increases policy coherence; however, the two are in tension with one another.
Decentralization increases the number of people involved in making decisions, thus making
coordination inherently more difficult. The goal of this memo is to discuss some of the
ways that decentralization can be structured both economically and politically to try to
reconcile efficiency and coherence. One must keep in mind, however, that the choice of
where a government positions itself along the centralized-decentralized continuum will
always involve a tradeoff between efficiency and policy coherence.
The thrust of my argument is that the potential efficiency benefits of decentralization
are too significant to pass up and that they are best served by:
 Transfer of some tax authority to subnational governments,
 Transparency in fiscal transfers,
 Clarity of responsibility across levels of government, and
 Competitive election processes at the subnational level to raise accountability.
Coordination is necessary where sectors of policy cross jurisdictional boundaries and
it can be enhanced by:
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 Imposing hard budget constraints,
 Strengthening national control within parties,
 A coordinating agency that shares information across levels of government, and
 A strong, autonomous central bank whose monetary policy constrains subnational
governments.
The Logic of Decentralization
The appeal of fiscal federalism is the idea that, all else equal, subnational (regional,
provincial, local) governments have informational advantages over a distant central
government in knowing the bundle of local services desired by local residents. If people
can move freely across local boundaries and congregate with others who share like
preferences, and if local governments have incentives to be responsive to local residents,
then local goods provision will be more efficient than central provision of those goods.
Though the assumptions of this basic model are rarely met in practice, its basic logic has
seeped into justifications for decentralization for several decades.
Efficiency is greatly enhanced when local governments not only apportion money for
local goods provision, but when they also must raise those funds so that they internalize the
marginal costs of raising each additional unit of local finance. While this is theoretically
elegant, in practice few local governments raise substantial resources; instead, transfers
from the center support most subnational spending. In large part, the efficiency loss that
central collection and subnational expenditure of funds occasions is offset by the economies
of scale the central government enjoys over subnational governments in revenue collection.
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In addition, central collection and disbursement allows for greater redistribution of income
across territory than subnational collection of resources.
At the same time, many
governments encourage subnational revenue collection to supplement transfers to increase
the extent to which the marginal unit of resources spent is internalized by the subnational
government.
Highly competitive elections for subnational governments also provide increased
transparency and efficiency at the subnational level, as well. Those who would challenge
incumbents face strong incentives to keep close tabs on the practices of incumbents. Where
selection of subnational governments is not competitive, rent seeking will rise.
Pros and Cons of Different Types of Decentralization
Decentralization can take many forms and I will begin by roughly dividing the
possibilities into types: (Type 1) or centralization involves appointed subnational officials
without substantial fiscal resources; (Type 2) election of subnational officials without
substantial decentralization of fiscal resources; (Type 3) appointment of subnational
officials with substantial decentralization of fiscal resources; and (Type 4) election of
subnational officials along with substantial decentralization of fiscal resources.
Centralized systems ignore the efficiency benefits outlined above. Neither categories
2 nor 3 is likely to increase efficiency of local goods production.
In the first case
(exemplified by Ecuador's decentralized system), elected officials with no real spending
capability will be unable to provide local goods for which they are nominally responsible.
They will either be forced to toe the central government's policy line in exchange for
resources or they will face incentives to trade policy influence with local contractors to
implement policies at odds with the central government. Not only do these options put a
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Kathleen O'Neill
brake on policy innovation and efficiency gains, but they also increase distrust amidst the
subnational electorate as officials either renege on campaign promises or engage in
corruption. In the second case (exemplified by Chile under Pinochet), subnational officials
who serve at the central government's pleasure, may increase efficiency by being
responsive to their constituents to a point - but only to the extent that constituents' desires
do not conflict with central government policy goals.
Appointed officials have little
autonomy to innovate or to disagree with the center.
The fourth combination, political and fiscal decentralization, is the most likely to lead
to efficiency gains, but it is also the most difficult to implement, since central governments
would rather not give away substantial fiscal resources to subnational officials they do not
control. This is particularly true when subnational politicians may fashion themselves as
political rivals to the central government1. To the extent that governments seek efficiency
benefits, moves toward type 4 decentralization will provide the best possibility of gains.
Given that a government would like to move forward along this track and would like to
maximize efficiency gains and coordination at the same time, what is the best way to
proceed? I will touch on two economic topics before moving on to discuss political and
institutional structures that might improve coordination.
Structure of Fiscal Transfers and Responsibilities
The conduit through which central-subnational affairs are most tightly connected is
the stream of fiscal resources collected by the central government and distributed to the
elected subnational government. The manner in which these resources are distributed is
one of the most consequential ways that particular decentralizing arrangements differ and it
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is an arena of policymaking that is frequently renegotiated over time. Two dimensions
along which differences arise are the formula for distributing transfers and the discretion of
subnational government over spending these transfers.
Transfer Formulas
Each decentralizing government chooses a slightly different mechanism for
transferring fiscal resources to subnational governments. In Bolivia for example, a large
amount of resources is transferred purely on the basis of population, with another
substantial degree of transfers dependent purely upon the administration's discretion. In
Colombia, by contrast, a highly technical and multi-faceted formula that includes such
criteria as the fiscal effort of subnational units governs these transfers. There are two
aspects of transfers that I will discuss here: the extent to which they are discretionary and
the exact items that make up the formulas for disbursement of non-discretionary transfers.
To the extent that transfers depend upon the central government's discretion, a
country drifts closer to Type 2 decentralization (with its concomitant problems). Under
Fujimori, Peru's transfer system moved from a more formulaic to a more discretionary
system, with the result that funds meant for impoverished areas were directed toward areas
of most importance to Fujimori's re-election campaigns. A similar situation occurred in
Mexico with PRONASOL funds under Salinas de Gartori. In general, formulaic transfers
increase transparency and dependability; they expand the planning horizon of subnational
governments who will be more able to predict future financial inflows from a knowledge of
the formulas and thereby allow for the implementation of longer-term planning.
1
In fact, it is becoming increasingly common for subnationally elected officials to run for president or other
national office on the basis of their record of governance as governor or mayor.
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While formulaic transfers are generally preferable to discretionary transfers, not all
formulae are equal. Formulae that include needs-based criteria can help to redistribute
resources more equitably across subnational units; formulae that include some measure of
fiscal effort can increase efficiency by rewarding those subnational units that attempt to
raise their own revenues in addition to using intergovernmental transfers. At the same time
that including redistributive and effort-based criteria can improve transfers, simplicity of
the formula has a value of its own by increasing transparency, the perception of fairness
and the ability of subnational governments to anticipate future streams of transfers.
Policymakers must weigh these tradeoffs when they establish or amend transfer formulae.
Discretion in Spending Transfers
Much has been written here about the levels of discretion enjoyed by the central
government in apportioning fiscal resources. The central government can also control
subnational government policy by limiting the uses to which subnational governments put
transferred money.
Where subnational governments are overly constrained in how they
must spend transfers, they approximate the Type 3 decentralization discussed above.
Constraints like Colombia's Law 60, which forces regional governments to spend 60% of
one category of transfers on education, and 20% on health with only 20% discretionary
may seem extreme. While many experts reject complete discretion because it makes
coordination between levels of government difficult, others argue that spending mandates
unduly restrict the responsiveness of local governments to their constituencies. Critics also
argue that some projects may require large expenditures in one year in a specific sector
while the following year may require larger expenditures in another sector so that there is
an averaging out over the term toward the percentage spending goals and these particular
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goals make this type of long-term investment difficult.
One possibility would be to
increase national oversight for the programs that require coordination across different levels
of government and for longer-term projects, but to increase subnational government
spending discretion in as many other areas as possible.
Discretion in transfers decreases efficiency; discretion in spending increases
efficiency except where several levels of government share responsibility for a sector or
where political contests for subnational officials are not highly competitive; read on for
more on both of these cases.
Clarity of Responsibilities
Beyond the question of how to structure transfers and how to regulate their use is
the related question of how to divide responsibilities between levels of government,
particularly where power has been devolved to a number of different levels. In most
systems (Bolivia, for example), different levels of government have overlapping
responsibilities. Using education as an example, some systems give national governments
responsibility for hiring and paying teachers, while local governments are responsible for
teaching materials and regional governments are responsible for inputs like school
construction and maintenance. Without strong coordination between these three levels in
this example, one can imagine a large endowment of teachers coming to an inadequately
small school with a large number of math books and no science books whatsoever. This
kind of disorganization may sound comical, but it is frequent in Latin America, where clear
lines of responsibility have rarely been laid out.
More immediately consequential to the nation than disorganized education or health
care is the fact that a lack of clear responsibilities often leads to overlap in spending by
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multiple levels of government, increasing the federal deficit. While increased violence
surely accounts for some of Colombia's fall from economic grace in recent years, much of
its rising deficit has been blamed on duplication of spending by national and subnational
governments. In fact, a poll of those holding Colombian bonds conducted by Morgan
Stanley to determine what issues most affect their confidence in Colombia's economic
performance showed the top priorities were not related to public order but were instead the
reform of intergovernmental transfers and of pensions2.
Where politics revolves around patronage - as in most of the developing world responsibilities are often left unclarified at the time of reform as politicians at all levels
resist limitations on their ability to impact programs such as health and education.
Budget Constraints/Borrowing/Bail-Outs
Finally, the financial issue which has received the most attention in recent years has
been the importance of establishing hard budget constraints for subnational governments
and avoiding national bailouts of regions or localities who have overextended themselves in
debt markets. The key story to illustrate this point is the financial impact that bailouts of
large states has had on the Brazilian economy and the important restructuring of federal
relations that resulted. While Brazil has certainly been the most widely publicized case of
this phenomenon, it is not the only place that has experienced it. Central governments face
a difficult quandary when subnational units overspend: bail them out and send the signal to
other subnational units that profligate spending will be rewarded with federal bailouts, or
let them fail which could hurt the national economy, as well as the political fortunes of the
parties at the center amidst the electorate in the subnational unit. The best option is to send
2
Reported in Semana magazine, Issue #995 ("La Paz en Ultimo Lugar").
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a strong signal that bailouts will not be forthcoming in the future by refusing to bailout a
large subnational entity or, perhaps, by increasing central bank independence.
Political Structures and Coordination
Not all answers to the question of how to coordinate decentralized government
revolve around economics. Coordination can be improved on the political side through at
least two mechanisms: allowing for the re-election of subnational governments and through
strengthening party systems.
Where mayors and governors are term-limited, their
incentives to invest in long-term projects or to coordinate policies with the center are
diminished; by lengthening planning horizons (even if only probabilistically), re-election
should improve incentives to coordinate. Party organizations can play a major role in
coordinating policies when subnational governors must adopt national party labels or where
national party leaders strongly influence their subnational counterparts (through placement
on the ballot or campaign finance, for example). If national party leaders have strong
influence on the future careers of subnational governors, this can
 lead to easy coordination of policies between center and subnational units
 break the tendency of subnational governments to overspend and seek bailouts
 decrease the need for politicians in subnational units to rely on patronage.
A final suggestion for increasing coordination across jurisdictions is to encourage the
sharing of information across jurisdictions of what has been successful in some subnational
units so that others could learn from the experimentation across units.
The finance ministry could play a major role in this regard as it has frequent contact
with subnational administrations through transfers and taxation policies.
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Sequencing
Latin America provides a variety of experiences in the sequencing of decentralizing
reforms. Chile decentralized financial resources under Pinochet but did not allow for
popular election of subnational officials until after his rule ended; Ecuador has allowed for
the election of subnational officials without giving them substantial financial resources;
Colombia and Bolivia decentralized both political and fiscal resources simultaneously,
through dramatic reforms; Venezuela and Mexico took a more gradual route, with
Venezuela requiring subnational governments to petition the national government - and
receive its approval - for greater decentralization once they can prove capacity (although
popular elections determine subnational office holders).
Where fiscal resources are
decentralized without the popular election of subnational officials, decentralization does not
gain the strong support of constituents, as they may see no signs of change and incentives
for appointed officials to increase subnational efficiency are low. Where fiscal resources
lag behind political resources, politicians may engage in corrupt practices to gain scarce
resources, delegitimizing the decentralization process in the longer term. The best outcome
is to decentralize both, simultaneously or in close succession. Decentralizing the political
side alone will almost always lead to fiscal decentralization in the longer term, so I would
suggest this as a second-best solution.
Interest Intermediation:
Should the state try to build a particular mode of interest intermediation with business
associations and labor federations? My experiences offer no clear answer and experts offer
different suggestions on how to address this question. Some argue that a state insulated
from society provides the most effective coordination of policies. Others argue that societal
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groups and organizations are the channels through which the state coordinates policy and
that, without an effective system of interest intermediation, heads of state will be unable to
mobilize resources, coordinate policy, and implement decisions. In most cases, interest
groups will adapt to their environment and the center is limited in its capacity to shape
interest groups. Where decision making over relevant issues to these groups is centralized,
they will organize to pressure the government at the center; where decision making is
decentralized, they will follow suit. Some of the greatest resistance to the decentralization
of policy making in Latin America has been led by teachers' unions, who have built highly
centralized structures for bargaining over salary at the center. Given their centralized
structure and strength, they are loath to see decision-making devolved, requiring them to
negotiate with numerous subnational governments. At the same time, the idea that social
organizations may play a major role in helping decentralized levels of government
coordinate with one another has theoretical strength; however, the ability of social
organizations to play this role depends on the homogeneity of the group, its ability to
organize and coordinate across its own decentralized structure, and its overall capacity to
gather information and interact with the government. Policies that have been shaped and
coordinated through interest groups interactions with government are bound to be more
easily implemented and, at least as far as the particular interest group is concerned, more
popular.
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Executive Summary
Decentralization offers the promise of increased efficiency, accountability, and democratic
practice while coordination increases policy coherence; however, the two are in tension
with one another.
The potential efficiency benefits of decentralization are best served by:

Transfer of some tax authority to subnational governments
-
This forces subnational governments to internalize the costs of their
spending programs

Transparency in fiscal transfers
-
Simple formulae are least likely to breed corruption; constituents find them
easier to follow and, therefore, more transparent
-
More complicated formulae allow governments to target such priorities as
redistribution, fiscal effort and other goals

Clarity of responsibility across levels of government
-
This avoids duplication of spending by many levels of government
-
This avoids shirking of responsibility for basic services by all levels of
government who blame the absence of services on another level
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
Competitive election processes at the subnational level
-
This raises the accountability of subnational policy makers to their
constituents
-
This raises the efficiency of local goods provision due to competition for
stewardship of the subnational government
Coordination can be enhanced by:




Imposing hard budget constraints
-
This avoids overspending at subnational levels in hope of bailouts
-
This allows the central government to engage in long-term fiscal planning
Strengthening national control within parties
-
This provides discipline to subnational government leaders
-
This lengthens the time horizons of subnational leaders
Sharing information across levels of government
-
Allowing governments to learn from successes and failures of peers
-
Raises expectations of constituents for better performance
A strong, autonomous central bank whose monetary policy constrains
subnational governments.
-
Maintains central control of monetary policy
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