Decentralization and Political Institutions in Developing Countries Ekaterina Zhuravskaya New Economic School ESNIE, May 19, 2008

Decentralization and Political Institutions in Developing

Countries

Ekaterina ZhuravskayaNew Economic School

ESNIE, May 19, 2008

Ekaterina Zhuravskaya ESNIE 2008 2 of 44

Motivation • Decentralization has been at the center of the

stage of policy experiments in the last three decades in a large number of developing and transition countries– Latin America, Africa, Asia, CE Europe

• On account of its many failures, centralized state everywhere has lost legitimacy

• The world bank, for example, has embraced decentralization as one of the major governance reforms on its agenda (World Bank 2000)


Goal and RoadmapQuestions:

– “Is decentralization good or bad?” – “Does it result in more efficient governance, higher

economic growth, and/or better public goods?”• Virtue of decentralization is a very popular notion, but often this

notion is driven by a series of misconceptions – E.g., Dictators (Hitler, Stalin, etc) chose centralization and they are

vicious, but that does not necessarily imply any causality from centralization to outcomes

– Discuss: • Arguments for and against decentralization and (rather scares)

empirical evidence• Generalizations (if any) that one could make about “when” and

“for what”

– Background material: • Treisman (2007) “Architecture of Government” Cambridge UP• Bardhan (2002) JEP


Defining terms

Lots of scholarly arguments about decentralization are characterized by different sides having different things in mind

One must define terms!

Types of decentralization:

1.Administrative decentralization

2.Political decentralization

1.Decision-making decentralization

2.Appointment decentralization

3.Constitutional decentralization

3.Fiscal decentralization


Defining terms: Administrative decentralization

• At least one policy is implemented not by the central government directly but by locally based agents appointed by and subordinate to the central government


Defining terms: Political decentralization

• Decision-making decentralization– At least one subnational tier of government has excusive authority

to make decisions on at least one policy issue

• Appointment decentralization– Government officials at one or more subnational tiers are selected

by local residents independent of higher level governments• via democratic elections or a non-democratic selection by local elites

– Federal state:a) Decision-making decentralization (e.g., China)b) Decision-making decentralization + Appointment

decentralization (at the same tier) (e.g., Argentina)

• Constitutional decentralization– Subnational governments (or their representatives) have a formal

right to participate in non-trivial way in central policy-making (e.g., US Senate)


Defining terms: Fiscal decentralization

a) Theory: Decision-making decentralization on tax and/or expenditure issues

b) Empirics: Subnational governments account for a large share of total government revenues or spending

• Very little connection between the two

(Theoretical) reasons for and against various kids of

decentralization


1st (potential) advantage: Administrative efficiency

“How could the general of an army be instantaneously obeyed by all its solders if the army were not divided into regiments, the regiments into companies, the companies into squadrons? But the effect of order is still more admirable in a state than in an army [because of higher territory and longer horizon]”

Charles Loyseau (1610)


Administrative efficiency 1: optimal scale

• Technology of public goods provision varies – National defense vs. garbage collection (economies

of scale)

In a multi-tier structure, provision of different PG can be assigned to most efficient level

• Is political decentralization necessary?– If one concerns with just technical costs of PG provision political

decentralization is not needed, just administrative decentralization is sufficient

• Optimal scale argument implies, however, that all jurisdictions at a certain level should be the same

– which certainly is not true


Administrative efficiency 2: Heterogeneous tastes and policy differentiation

• Another (potential) reason for decentralization – preference heterogeneity– Hayek (1945): local governments have more information about people’s

preferences and lower costs of acquiring it

• Alesina and Spolaore (2003) -- size of countries and degree of decentralization depends on:– a tradeoff b/w economies of scale (favors large size and central

provision) and heterogeneity (small size and decentralized provision)• Defense of ethnic groups against each other

• Is administrative decentralization sufficient?– Technically, the central government is able to give different orders to

its alderman in different regions, and collect information from them • USSR, Persian Empire, etc.


Administrative efficiency 3: Agency costs - theory

• Do the agency costs multiply with added tiers?– If yes, above a certain number of tiers, it may be too

expensive to pay the subordinates enough so that they do not cheat

• then, administrative centralization may not work

– Persson and Tabellini (2000) present several models which say “yes”

– The answer, however, depends on incentive structures• How could hierarchy solve agency problems?

– Career concerns (Holmstrom 1999) – Yardstick competition (Maskin, Qian, Xu 2000)

» Chinese provincial leaders vs. Russian governors (1 vs. 120 criteria)


Administrative efficiency: Agency costs - practice

• Large bureaucracies with many tiers have extremely bad reputation– However, they occur in very autocratic regimes (i.e.,

USSR, medieval Europe, imperial China)– It might be the case that bad performance is due to

problems with accountability of the central government rather than inefficiency of hierarchy

• Counter example to both – Chinese miracle

• But, it is also true that many bureaucratic hierarchies do accumulate agency costs


Turning to political decentralization

• Are there advantages to letting local communities choose their own political leaders and policies? – whatever the technical efficiency of different

administrative structures

• What are the costs?


2nd (potential) advantage: Competition among governments

“Competition forces governments to avoid all sorts of taxation which would drive capital or labor elsewhere”

Hayek (1939)

1. Does competition occur under political decentralization?

2. If yes, is it beneficial?• Consider separately: competition for residents

and competition for capital


Competing for mobile residents• Tiebout (1956): under decentralization citizens sort

themselves into local communities with efficient taxation/PG mix– Local governments’ competition for citizens has three effects:

• (1) Reveals information about preferences; (2) induces efficient sporting; and (3) enhances accountability

– Restrictive assumptions:• Mobility (in many developing countries restricted)• No land (if real estate prices reflect efficiency of PG provision,

pressure on governments may be reduced)• Constant returns in PG provision (if there are economies of scale,

there may be multiple equilibria, including inefficient ones) • Externalities (consider below)


Competing for mobile capital• Capital is more mobile than residents

– Qian&Roland (1998), Qian&Weingast (1998): Tiebout logic can be generalized to mobile capital (local governments reduce corruption and offer better business environment to attract capital)

• Main conceptual difference with Tiebout:– Preferences of capital owners are homogenous, i.e., best risk-

adjusted return

• This generates problems with this argument:– “Race to the bottom” in PG provision, particularly, if local

governments get private benefits of investment => distortions– Large differences in initial conditions (i.e., infrastructure) =>

backward regions give up (even with t=0, capital flows elsewhere)– Externalities (consider below)


1st (potential) disadvantage: Externalities

In order to attract residents and capital local governments pursue policies with external effects:

• “Beggar your neighbor” policies – Attract firms with high pollution – Erect inter-jurisdictional trade barriers

» China: Young (2000), Poncet (2004) » Russia: Guriev, Yakovlev and Zhuravskaya (2008)

• “Beggar your superior” policies – Compete in protection from paying federal taxes and ignoring federal

regulation » Russia: Ponomareva and Zhuravskaya (2004); Sonin (2008)

“State-corroding” federalism (Cai and Treisman 2004)


Externalities in fiscal policy

2 fiscal policy examples of “state-corroding federalism” (a la Cai and Treisman 2004):

1. “Common pool”: Local governments may consider central budget as the “Common pool”

• Each locality bears a fraction of the cost of spending from central budget, but enjoys the full benefit – Argentina (Saliehg & Tommasi 2001)

2. “Soft Budget Constraints”: local governments may blackmail the central government if they can commit to a policy undesirable to the center (but center cannot commit)

• Russian Far North (Tanzi 1996)• Bailouts under local insolvency


3rd (potential) advantage: Policy experimentation

Justice Brendeis called decentralized governments “local laboratories for policy experiments”– Completely wrong argument:

• As long as central government can pursue different policies in different parts of the country– Risk-aversion

• Centralized government bares less electoral risk when experimenting in one locality

– Positive information externality• Local governments do not take into account that other local

governments benefit from learning from their failures when deciding whether to experiment – a version of free-rider problem

• Central authorities can design randomization experiments to maximize useful information from experimentation

– In reality, it actually is a disadvantage (!)


4th (potential) advantage: Effect of bundling of policy on accountability

• Besley and Coate (2003):• When both local and central public officials are elected,

their respective policy areas are the only salient issues at their respective elections

• When local public officials are appointed, in the central elections, local policy area (e.g., local roads) becomes bundled with central policy issues (e.g., foreign policy) which may be more salient during the central elections

– Appointment centralization => capture of local policies by special interests

• No informational asymmetries necessary to generate this result


5th (potential) advantage: Checks and balances

• Weingast (1995), Tsebelis (2002): Number of veto players in forming central governments’ policy increases with constitutional decentralization

• This increases stability of local policies– But it is not clear if stability is a good thing:

• decreases likelihood of changes both for the better and for the worse


2nd (potential) disadvantage: Fiscal coordination

Berkowitz and Li (2000): Vertical competition– Overlapping tax bases for central and local

governments may result in “vertical overgrazing,” i.e., over-taxation, as each level of government tries to extract as much and as fast as possible

– Shared responsibility over some PG may result in free riding on each other’s contribution

• Not overlapping tax bases and expenditure responsibilities

– In practice, hard, different taxes often have effect on the same tax base


3rd (potential) disadvantage: State capture

• Federalism often leads to local tyranny in developing countries – Bardhan and Mookherjee, 2000; Sonin, 2003; Slinko, Yakovlev,

and Zhuravskaya, 2005

• Bardhan and Mookherjee (2000) write down conditions under which local governments are more captured by special interests than central governments– Intuition: local capture is higher when local markets for influence

are more concentrated while the central is not• Russia – many cities are built around one plant

• India – local land inequality is very high

– At the central, dissipation of rent make lead to breakdown of the market for influence


Ethnic conflict, secession, and decentralization

• Example: Iraq• “It is virtually impossible to make broad generalizations

about effectiveness of federalism in multinational societies” (Simeon and Conway 2001)– Political decentralization may help to:

• satisfy moderate demands for autonomy of geographically concentrated ethnic minorities

• reduce social tension of “winner takes all” by splitting the political prizes

• to resist discriminatory central policies– But it also may:

• enable local majorities to abuse local minorities and inflame local cleavages that are salient at the local and not central level

• empower local majorities to mobilize for succession • trigger inefficient redistribution under secession threat• increase “regionalist” mentality

– Stepan and Linz (2008):• “Coming-together” vs. “Holding-together” federalism


Pitfalls of empirical research• Different measures should have different effects in theory

– Average size of a jurisdiction– Number of tiers– Number of jurisdictions– Mode of subnational appointments– Subnational expenditure and revenue share– Constitutional arrangements

• Very scares data on decision-making decentralization• Little panel data (more being collected)• Little over time variation for political decentralization• Most of the literature focused on the subnational revenues

and expenditures (very imperfect)


Evidence before EZ2007 was inconclusive; Treisman (2007) things it is still the case

Results vary with samples and time periods

Effect of decentralization onGrowth:

(-): Zhang and Zou, 1998 (Chinese provinces); Davoodi and Zou, 1998 (developing countries)

(0): Woller and Phillips, 1998 (developing countries);(+): Jin et al., 1999 and Lin and Liu, 2000 (Chinese provinces);

Corruption:(-): Fisman and Gatti, 2002; de Mello and Barenstein, 2001 (X-

country)(0): Treisman, 2000 (X-country)

These papers overlooked importance of political institutions


William Riker (1964) “Federalism: Origins, Operation, and Significance”

• To sum up: – both centralization and decentralization have costs and

benefits:• Information, inter-jurisdictional competition, less policy bundling

vs. externalities and local capture

• Riker: One could get the best of both worlds by providing local politicians with national career concerns, but preserving political decentralization– Strong national political parties

• Reduce both “local capture” and “externalities” • But leave incentives to cater well to the needs of the citizens


Appointment centralization vs. decentralization

Why strong national political parties help?– Local officials need financial and political

support of national parties during elections– Career concerns

Why administrative centralization will not?• Riker’s view: administrative centralization

undermines the benefits of decentralization in the first place – Politicians will stop caring for the preferences of local

population and only care for pleasing superior» All would depend on incentives of the superior and

superior’s informational disadvantage


Russia vs. ChinaBlanchard and Shleifer (2001):• Fiscal decentralization occurred in both countries during

transition• Decentralization was a major growth-promoting factor in

China and an obstacle to growth in Russia– Jin, Qian, Weingast (2005) on China– Zhuravskaya (2000) on Russia

• The reason is the difference in the strength of national political parties and administrative centralization (in different periods):– China - tight administrative and political control of the communist

party– Yeltsin’s Russia - large-scale political decentralization and no

national parties


Argentina vs. ChileEnikolopov and Zhuravskaya (2007): Both countries undertook

fiscal decentralization in the 80s and 90s– Chile - improved provision of public health and education– Argentina - macroeconomic destabilization and a large-scale economic

crisis

• Chile - strong party system with national parties and strong career concerns– Mayors of Santiago

• Argentina - national political parties are weak; provincial parties dominate political arena at the national and provincial level– Career concerns in Argentina work the other way:

• Those national politicians who managed to produce more benefits to their provincial constituencies (possibly at expense of other regions) can return back home after serving in the national government


Enikolopov & Zhuravskaya (2007): Measures of Political institutions

1. Age of main parties– Intuition: career concerns– Control for: the age of democracy and time since

independence2. Fractionalization of governing parties

– Intuition: career concerns– Control for:

• majoritarian vs. proportional electoral rule• presidential vs. parliamentary regime

– Persson & Tabellini 2003 • secessionist tendencies

– segregation of voting patterns at the local level– presence of contiguous autonomous regions

3. Administrative centralization– Are municipal executives appointed? – Are province-level executives appointed?


Measures of decentralization and outcomes

Fiscal Decentralization • Subnational revenue share• Subnational exp. share

Quality of government • Corruption indices • Control over corruption• Government effectiveness• Regulatory quality • Rule of law

Growth• GDP per capita growth rate,

PPP

Public goods provision• Infant mortality • DPT Immunization • Illiteracy rate• Pupil to teacher ratio


Empirical Methodology• Standard methodology for growth and the quality of governance

regressions– Treisman (2000); La Porta et al. (1999); Barro and Sala-i-Martin (1995)

• Add fiscal decentralization measure and political institutions measures and their interaction:

• How results of fiscal decentralization are affected by political institutions?

• Sample of developing and transition countries (73 countries)– In OECD, our measures poorly reflect career concerns

• Use geographical area of countries as an instrument for decentralization

• Initial levels of political institutions as an instrument for current political institutions (corrects only measurement error)


Standard control variables

• Fixed investments • Population • Openness • Fertility• Current level of democracy • Democratic tradition • Ethno-linguistic fractionalization• Protestants share • Latitude • Legal origin


ALB

ARG

ARM

AZE

BLR

BOL

BRA

BGR

CHLCHNCRI

HRV

CZE

DOM

EST

GEO

HUNIND

IDN

ISR

KAZ

LVA

MYS

MUSMEX

MDA

MNG

NIC

PAKPER

POL

ROM

RUS

SVK SVN

ZAF

THATTO

UKR

-3-2

-10

1R

esid

ua

ls o

f R

ule

of

La

w in

de

x

0 10 20 30government parties fractionalization * Subnational revenues share

ALB

ARG

ARM

AZE

BLR

BOL

BRA

BGR

CHN

CRI

HRV

CZEDOM

EST

GEO

HUN

IND

IDNISR

KAZ

LVA

MYS

MUS

MEX

MDA

MNG

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PAK

PER

POL

ROMRUS

SVK

SVN

ZAF

TJK

THA

TTO

UKR

-10

12

3R

esid

ua

ls o

f R

ule

of

La

w in

de

x

0 50 100 150 200Logarithm of age of the main parties * Subnational revenues share

Gov. fractionalization measure

Party age measure

Residual partial plots – party strength

80% of the developing countries have parties younger than needed for decentralization to have a positive effect on indices of government quality


Within country relationship

ARG

ARG

ARG

ARG

AZEAZE BOL

BOL

BRA

BRABRABRABRA

BRA

BRA

BRA

BRA

BRABRA

BRABRA

BGRBGR

BGRBGR

CHNCHNCOL

COL COLCOL

COL

COL

COL

CRI

CRI

CRI

CRICRI

CRI

CRI

CRI

CRI

CRICRI

CRI

HRV

HRV

CZE

CZE

DOM

DOM

DOM

EST

FJIFJIFJI FJI

FJI

FJI

FJI GMBGMBGMBGTM

HUN

HUN

HUN

IND

IND

IND

INDIND

IND

IND

IND

INDIND

IDNIDN

IDN

IDN

IDN

IDN

IDNIDN

IDNIDN

IDNIDN

IDN

IDN

IDNIDN

IDN

IRN

IRN

IRN

IRN

IRNIRN

ISR

ISR

ISR

ISRISR

ISRISR

ISR

ISR

ISRISR

ISR

ISR

ISR

KEN

KENKEN

KEN

KEN

KEN

KENKEN

KENKENKEN

KEN

KEN

LVA

LVALTULTU

LTU

MDG

MDG

MDG

MWI

MWI

MWI

MWI

MWI

MYS MYSMYSMYSMYS

MYS

MYSMYS

MYSMYS

MYSMYS

MYS

MYS

MUSMUS

MUSMUS

MUS

MUS

MUS

MUSMUS

MEXMEX

MEXMEX

MEX

MEX

MEX

MEX

MEXMEX

MEXMEX

MEXMEX

MEX

MEX

MEX

MDA

MNG

MNG

MNG

NIC

NIC

NIC

NIC

NIC

PAN

PAN

PANPAN

PNGPNGPER

PERPHLPHLPHLPHL

PHLPHLPHL

PHL

PHLPHL

PHL

PHL

POL

ROM

ROM

ROMROM

ROMROM

SVN

SVN

SVN SVN

ZAF

ZAF

ZAF

LKA

LKALKA

LKA LKATHA

TTOTTO

TTO

TUNZMB

ZWE

ZWEZWEZWE

ZWE

ZWEZWE

ZWEZWE

ZWE

-.2

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esid

ual

s o

f ln

(Pup

il to

Te

ach

er R

atio

)

-.2 -.1 0 .1 .2Age of main parties * Subnational Revenues

• Sufficient data only for PG, not QG or growth• All outliers work against the results• Immunization and pupil to teacher ratio are significant;

literacy and infant mortality are not. – Short term vs. long term effect

ARG

ARG

ARG

ARGBLR BLR

BOL

BOL

BRA

BRABRABRABRA BRA

BRA

BRA

BRA

BRABRA

BRA

BRA

BGRBGR

BGR

BGR

CHLCHL

CHL

CHL

CHNCHNCOLCOLCOLCOL

COL

COL

COL

CRI

CRI

CRI

CRI

CRI

CRICRI

CRICRI

CRI

CRI

CRI

CRI

CRICRI

CRI

HRV

HRV

CZE

CZE

DOM

DOM

DOM

ESTFJI

FJIFJIFJI

FJI

FJI

FJIGMB

GMBGMBGTM

GTM

GTMGTM

GTM

HUN

HUN

HUN

IND

IND

IND

INDIND

IND

IND

INDIND

IND

IDNIDN

IDN

IDN

IDN

IDN

IDNIDNIDN

IDN

IDN

IDNIDN

IDN

IDN

IDNIDN

IRN

IRN

IRN

IRN

IRNIRN

IRN

ISR

ISR

ISR ISRISR

ISR

ISR

ISRISR

ISR

ISR

ISR

ISR

ISR

KEN

KENKEN

KEN

KEN

KENKEN

KEN

KENKENKEN

KEN

KEN

LVA

LVALTULTU

LTU

MDG

MDG

MDG

MWI

MWI

MWI

MWI

MWI

MYSMYS

MYSMYSMYS

MYS

MYS

MYS

MYS

MYSMYSMYS

MYS

MYS

MUSMUS

MUS

MUS

MUS

MUSMUS

MUS

MUS

MUS

MUSMUS

MEX

MEX

MEXMEX

MEXMEX

MEX

MEXMEX

MEXMEXMEX

MEX

MEX

MEX

MEXMEX

MDA

MNGMNG

MNG

NIC

NIC

NICNIC

PAN

PAN

PANPANPAN

PRY

PRY

PRY

PRY

PRYPRYPRYPRY

PRY

PRY

PER

PER

PHL

PHL

PHLPHLPHL

PHLPHL

PHL

PHLPHL

PHL

PHL

POL ROM

ROM

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SVNSVN

SVN

SVN

ZAF

ZAF

ZAF

LKA

LKALKALKA

LKA

THA

THA

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TTO

TUN

URY

URY

URY

ZMB

ZWE

ZWEZWEZWE

ZWE

ZWE

ZWE

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-.1

0.1

.2R

esid

ual

s o

f ln

(Pup

il to

Te

ach

er R

atio

)

-4 -2 0 2Government parties fractionalization * Subnational Revenues


Residual partial plots – state-level appointment decentralization

ALB

ARGBRA

HRV

KORMEX

SVK

ZAF

URY

-1-.

50

.51

Re

sid

ua

ls o

f G

ove

rnm

en

t E

ffe

ctive

ne

ss in

de

x

10 20 30 40 50 60Subnational expenditures share

State executives elected

ARMBHR

BLR

BOLBGR

CHL

CHN

CRICZE

DOM

EST GEOHUN

IND

IDNISR

KAZ

KGZ

MYS

MDA

MNG

NIC

PAK

POL

ROM

TJK

THAUKR

-.5

0.5

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sid

ua

ls o

f G

ove

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t E

ffe

ctiv

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ess

ind

ex

0 20 40 60Subnational expenditures share

State executives appointed

• Appointment centralization also seem to help fiscal decentralization

• But, not robust to controlling for FE!

• Thus, must be driven by unobserved X-country heterogeneity


Results - Solid support Riker’s theory

1. Strong parties (low government fractionalization and high party age) make decentralization more efficient: improve quality of government, growth, public goods

2. No robust evidence for the effect of administrative centralization

– Results depend on the set of controls and particular samples

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party_age* rev_dec 0 +* +* +** +** +*** +* +*** + +

gov_frac* rev_dec - -*** -*** -** -*** -*** -*** -*** -** -***


Economic significance - example

A 10% in decentralization:

• at a level of party age lower than the mean by 1/2 of its SD in government quality indices of 1/2 of their SDs

• at a level of party age higher than the mean by 1/2 of its SD zero change on government quality


Sensitivity analysis• Influential observations

– China is influential; without China results go through

• Controlled for other possible driving forces for results– Transition

• Additional controls– Initial GDP per capita squared, federation dummy,

regional dummies, colonial origin, etc.

• Results are stable


Endogeneity of political institutionsEconomic performance can have different effect on political institutions in fiscally centralized and decentralized states1. Government fractionalization:

• In centralized countries, better performance leads to relative strengthening of the national governing parties (and lower fractionalization because the success is attributed to national policies

• In decentralized countries, voters attribute success to regional policies which leads to an increase in fractionalization due to strengthening of local political organizations

2. Administrative centralization: • In centralized countries, good performance may allow the central

authorities to get public support to switch from elected to appointed subnational governments

• With decentralization, this may be harder OLS - an upward bias in the coefficient of the interaction term– Story for party age?


Conclusions from E&Z’s test of Riker• Key finding: political institutions play an important role in

determining the results of fiscal decentralization

– Provided we buy causality

• Solid support for Riker:

– strong national party system is an effective way of securing political accountability needed for efficient fiscal decentralization, whereas administrative control is not

– If one does not buy causality, an interesting empirical association: countries that make decentralization work also manage to have stronger national political parties

• Important finding: for most of developing countries Riker’s conditions for successful federations are not met


Open questions• What makes political parties stronger (positive)? • How to strengthen political parties (normative)?• (Related): How can one explain Chinese miracle?

– The evidence is that administrative centralization does not guarantee good outcomes

– Why Chinese central officials seem to be growth maximizing?

– Why there is no adverse effect of absence of local electoral incentives?

• Low level of development – No need to think about social safety and public good (just yet)

• Enlightened leaders• Local capture vs. Central entrenchment


To take away:• Very hot topic for research• A lot more data are becoming available

now (on political institutions and on decentralization)– Including time series– There is surprisingly little good empirics done

of the subject• Both at country-level and • At within country level

– See Guriev, Yakovlev, Zhuravskaya for an example» The paper (in some sense) indigenizes Riker

Documents

Decentralization and Political Institutions in Developing Countries Ekaterina Zhuravskaya New Economic School ESNIE, May 19, 2008