Framework for Expenditure Assignment Decentralization and Intergovernmental Fiscal Reform Course Kai Kaiser Economist PRMPS Monday, May 8, 2006, 11:20-12:20

Design Determines Impact Expenditures = government services Design affects availability, quality, access and appropriate use of public services e.g. health, education, water, roads etc. Can ultimately affect macroeconomic stability Economists discuss “expenditures” – assigning expenditures, delivering expenditures, financing expenditures… - in fact, what we’re talking about s public services. This is helpful to keep in mind since when we discuss technical aspects of designing a system of IGFR, the implications can be felt with regard to service delivery. What services are available; what quality are they; who has access to them; what are the chances they’ll be used and maintained appropriately? Also, detail design can ultimately affect macroeconomic stability. So, the impacts of IGFR, and expenditure assignment in particular, can be felt in the three areas of traditional concern to public finance economists: efficiency, equity and macroeconomic stability.

Macroeconomic Stability Key factor is “hard budget constraint” Creates incentives for subnational fiscal discipline (“no bailouts”) Limits risk of central government Can be “softened” through several channels Intergovernmental fiscal system Financial system SOEs etc. One often hears about the potential (and sometimes realized) risk of macroeconomic stability in decentralized countries. The critical factor influencing subnational fiscal behavior and central government liabilities is the presence of “hard budget constraints”. A hard budget cosntraint exists when the central government can and does refuse to provide additional resource to a sub-national government beyond a pre-agreed resource envelope. The problem often in decentralized countries is that despite local governments being”autonomous”, they will tend to overspend, under tax or overborrow if they believe that the central governent will provide additional resources to them (or “bail them out”) If central governments do bail out local governments, their discipline is compromised, national fiscal deficits can grow and this can ultiamtely be destabilizing. A budget constraint can be softened by a number of channels:

Equity Disequalizing nature of decentralization Tools for fiscal equalization/targeting poor places Targeting poor people Proximity to target group Identify beneficiaries and willingness to pay Add comment that experience with local solidarity will depend, amongst other things, on social capital and homogeniety of local populations.

Efficiency Considerations for assignment: Public goods Externalities Subsidiarity Economies of scale Public sector competition Considerations – give rise to a set of “normative” assignments, where it is usually said that the national government retain responsibility for key national services like macroeconomic management, defense, interstate highways, national teaching hospitals, funding redistributive welfare programs. Subnational governments assume responsibility often for much of health care and education and infrastructure within state. Local governments should be responsible for truly local activities such as maintenance of streets, parks, garbage collection etc. There are an excellent set of tables in the back of the McClure and Martinez paper (in course reading material ) that provides many countries experiences.

Efficiency (cont’d) Do local services respond to local needs? Do citizens have meaningful opportunities for voice? Do officials face incentives to respond?

Common Problems Unclear delineation between public and private sectors Lack of formal assignment Inefficient assignments Concurrent assignment among levels of government Parallel structures of devolved and deconcentrated entities No mechanisms for coordination and conflict resolution

Decentralization of Functions Organization Planning Personnel Infrastructure Resources Regulation

Unbundling Assignments Policy Making Who sets the main policy guidelines for a service (e.g., free primary education as a national policy)? Standards Setting Who sets the standards (e.g., national tests versus local building standards)? Administration/contracting Who is the primary government authority that administers services on a day to day basis? Financing Who provides the financing for services? Capital investments, wages, O&M? Service delivery Who actually produces/delivers the service (e.g., this can often be private)? Regulation Who regulates a service (e.g., professional accreditation in health)? Monitoring & Evaluation Who monitors and evaluate a service (e.g., how can local citizens provide feedback)?

Comparative Assignments

Key Points Ultimately, no single best assignment Ideally, services should be provided at lowest level of government where benefits lie Public provision doesn’t imply public production Clarity is critically important