Transferring fiscal power

• Pages: 363-364

Page 363

Several transition countries are currently weighing the pros and cons of devolving (transferring) revenue, spending, and borrowing powers to lower levels of government at a time when they also want to reduce their deficits.

What advice does experience elsewhere offer them? A recent IMF study by Paulo Drummond (Economist in the IMF's European ID epartment) and Ali Mansoor (Senior Economist in the Independent Evaluation Office), Macroeconomic Management and the Devolution of Fiscal Powers, looks at how central governments can successfully manage fiscal policy while decentralizing.

Given the challenges associated with fiscal devolution, what prompts countries to move toward greater decentralization? The main benefits, according to the authors, are increased efficiency and a more responsive government. As long as local governments are knowledgeable and responsive to local conditions, devolving resource allocation to them should, in principle, better match public spending with the preferences of the local population. In practice, however, countries have not always found decentralization a straightforward path to realizing these benefits.

What can countries do to reap the benefits of decentralization? First, Drummond and Mansoor stress, local spending should match local resources. Local governments need to be committed to fiscal discipline.

Second, successful decentralization also depends on the local availability of expertise. Third, effective decentralization requires significant local administrative capacity and locally responsive and responsible officials with substantial discretionary control to deliver services.

Fourth, countries need to pay careful attention to how local institutions are set up and should include safeguards to ensure good governance.

Link with deficits?

Does devolution pose undue risks to the meeting of central government fiscal targets? In other words, what is the link between reducing deficits for the government or public sector as a whole and decentralization?

To investigate this link, the authors analyzed data for 174 countries, first grouped by income level and then separated into centralized and decentralized economies.

For middle-income countries, the results showed that greater decentralization is associated with better governance, less variability in government balances, and greater success in reducing deficits.However, the findings showed no...