EHTISHAM AHMADNOVEMBER 2012

Underpinnings for successful decentralization

Design and Management of Decentralized Expenditures and

Transfers

Key questions

Why do countries decentralize? Keeping the country together—political economy objectives Improving service delivery; generating sustainable growth Tradeoffs between local discretion and minimum standards Subsidiarity principles versus political economy of inter-jurisdictional

competition? Expenditure management and accountability

How to prevent “game-play” and leakages? What are the underpinnings for transparency, coordination and efficiency? How to design coordinated budget frameworks, information systems and tracking

of cash? How to prevent PPPs from degenerating into postponement of liabilities?

Designing and managing transfer systems How to ensure effective equalization or generating disincentives through

transfers? How can performance based transfers be used without overriding accountability? Scope for financing investment needs?

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Spending and accountability

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Making decentralization work: Subsidiarity and competition?

Can one achieve accountability solely through spending devolution?

Is there a clearly defined role for the “level at which services are delivered”? Externalities in provision: climate change; health care;

national standards Do voters care unless they pay, at the margin, for clearly

defined services? Accountability needed for effective decentralization

But can voters compare and punish badly performing local governments (yardstick competition)?

Role of information on budgets, use of funds and outcomes available to electorates and governments

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Modified subsidiarity principles

Centralization needs• Cooperation• Coordination• HarmonizationFactors• Economies of

scale• Spillovers• Congestion

Political economy• Equalization• Interpersonal

equity

Decentralization

• Devolution• Participatory

democracy• Control• Accountability

and effective provision

Political economy

• Yardstick competition

Supranational (EU)• Rules;

regulations• Common

policies

National/federal• Policy• Financing• Equalization

Provincial• Financing at margin• Accountability

Local• Financing at margin• Accountability

Adapted from Dafflon, in Ahmad and Brosio, Handbook of Fiscal Federalism

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Whose responsibilities?

Major problems in poorly designed assignments: Lack of clarity in assignments (overlapping functional and economic

responsibilities) or excessive earmarking complicate accountability See Dafflon (2006; Handbook of Fiscal Federalism);

Assignments without: Adequate financing; or Ability to implement

Attempts to “unload” responsibilities in Big Bang, especially without own-source revenues and adequate financing—may backfire: Nigeria: local governments stopped paying primary teachers Pakistan: inadequate financing for devolved responsibilities—functions

either not carried out, or performed badly Indonesia: effectiveness of service delivery—incentives for LGs? Bolivia and Colombia (until recently); overlapping functions

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Can Minimum Standards offset Assignment problems?

Minimum standards represent central objectives superimposed on local preferences Should be financed by special purpose transfers

In a decentralized framework, could use these as part of the “social contract” leading to local autonomy Rationalization in terms of “outcomes”: e.g., years of

schooling; immunization standards Sanctions if not met through shared and equalization funds

But not detailed input norms (like Soviet Gosplan) These are contrary to effective decentralization and reduce

local accountability

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INFORMATION GENERATION AND INSTITUTIONS

Expenditure management and accountability

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Incentive structures and accountability

With incomplete information: Incentives to hide spending and liabilities

Off-budget operations SoEs PPP may be a problem without proper accounting for liabilities

Weak prudential management of systemic private liabilities Mexican roads (1990s); Spain and Irish property development

Well within limits set by rules (Spain and Ireland formally compliant with Maastricht)

Irrational private spending at local level condoned by local power elites (Spain, Portugal) comes home to roost

In both cases, liabilities can be shifted to future governments; or higher levels—accountability not guaranteed

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Game-play on spending, debt and liabilities?

Hiding spending, assets and liabilities Reduce deficits in cash (C)or financial assets (F), without

affecting all recognized liabilities (R) or extended net worth based on future flows (E)

Selling non-financial assets in R, for cash in F Assuming future pension liabilities in E, for cash and financial

assets in F Securitization C of future revenue streams F (common in Latin

American local governments Treating borrowing F as revenue C (several US States)

Solution: maintain parallel reporting on C, F, R and ENew accounting and reporting standards for PPPs

(IPSAS32); Plus the design of contracts, involving firm-level commitments

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Rights and obligations associated with all future cash flows, E

FFCash C

Financial assets and liabilities, F

All currently recognized assets and liabilities, R

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Need for standardized information: Who does what and what outcomes?

Clarify functions (UN-COFOG)Economic components (GFSM2001)

Wages, O&M; Capital, etc… But distinguish between decentralized and deconcentrated

operations Outcomes can be added onto the Chart of Accounts

But distinguish between own-account and deconcentrated operations on both spending and revenue sides

Programs and sub-programs as componentsBudget, accounting and reporting critical for “yardstick

competition”Focus on outcomes (performance budgeting) useful, but

insufficient without the component building blocks

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Economic Classification

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Preventing game-play

Need harmonized medium-term budget frameworks, for all levels of government

Standardized framework (GFSM2001), with multiple criteria, for accounting and reporting

Follow the cash (TSAs at each level—or correspondent arrangements)

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Follow the cash: why the resistance to TSAs?

Regardless of budgeting model, TSA is a critical element of good management Track sources and uses of funds; Separate “pots” complicate cash management; more

importantly facilitate rent seeking; International best practice is appropriate

Even if there is a Central TSA, what about sub-national entities? Should there be subnational TSAs? Chinese example

Role of donor agencies: Use of correspondent accounts within a TSA? Zero-balance arrangements?

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TSA with donors/local government16

Designing and Implementing Transfer

Systems17

Transfers to ensure accountability?

Need for own-revenues at the margin Important for incentives Does not always require sub-national tax

administrationsAvoid debilitating ‘gap-filling’ transfersMinimize earmarked transfers,

address monitoring and reporting capabilitiesCombination of specific purpose and

general (equalization) grants See Ehtisham Ahmad (ed.), Financing Decentralized

Expenditures (Elgar, 1997)

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Design of transfers

Equalization principles (mainly for current spending) Revenue capacities only (Canadian model), or Also expenditure responsibilities (Australian model)

Cost of service provision Modeling Institutional design (grants commission) Information flows

Need standardized factors—actuals lead to “gap filling”Minimum standards in areas of local competence?

Inimical to decentralization Could be undertaken directly by center Financial or physical inputs (e.g., wages or capital); or outputs (e.g.,

number of years of school); or outcomes (e.g., literacy rates). Selected performance based transfers, especially for capital

spending?

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Equalization Frameworks and Institutions

Need to be designed in incentive-compatible manner For sub-national entities not to play games:

Full information should be made public on the formulations and data used to make the assessments Independent agency with representation by the

provinces/subnationals Commonwealth Grants Commission formulations Indian Finance Commission

Or government body, under the direction of the Ministry of Finance?

Issues of credibility and trust

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Managing performance-based transfers: need for information flows and sanctions

Increasing emphasis on “performance-based” transfers, including by international agencies

Difficulty if the object of the transfer falls in areas of LG competence Diversion of resources; not just transfers, but own revenues Dilution of accountability Potential distortions, if outputs rather than outcomes targeted

(standardized tests in US “No Child Left Behind”, while deterioration in standards

Could be useful to address externalities—including for investments Contract federalism (Spahn, 2006; OECD, 2011)

Repeated games and credibility of sanctions

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Central government conditions or objectives

Typical problem: supra-national, or donor country objectives, sub-national administrations Capital transfers (DAK in Indonesia) Standard solution: conditional transfers, often with

matching grant provisions often ineffective: the poorest regions unable to meet matching

requirements With weak information on the uses of funds, scope for diversion of

resourcesExtreme example (infrastructure):

China: grain silos, central government responsibility, financing channeled through provinces and counties, county-level administration

How to ensure that central funds will be used to build silos?

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Possible solution

Use local monitoring and sanctions for efficient outcomes

1. Use standardized information on the sources and actual uses of funds

Permits the use of inter-jurisdictional competition to sanction non-performance

And if performance below minimum standard—use of central sanctions

2. Plus use of performance-based transfer to meet infrastructure gaps in a cost-effective manner

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