MACRO FEDERALISM AND LOCAL FINANCE Edited by ANWAR SHAH PUBLIC SECTOR GOVERNANCE AND ACCOUNTABILITY SERIES (c) The International Bank for Reconstruction and Development / The World Bank MACRO FEDERALISM AND LOCAL FINANCE (c) The International Bank for Reconstruction and Development / The World Bank Introduction to the Public Sector Governance and Accountability Series Anwar Shah, Series Editor A well-functioning public sector that delivers quality public services consistent with citizen preferences and that fosters private market-led growth while managing fiscal resources pru- dently is considered critical to the World Bank’s mission of poverty alleviation and the achievement of the Millennium Development Goals. This important new series aims to advance those objectives by disseminating conceptual guidance and lessons from practices and by facilitating learning from each others’ experiences on ideas and practices that pro- mote responsive (by matching public services with citizens’ preferences), responsible (through efficiency and equity in service provision without undue fiscal and social risk), and account- able (to citizens for all actions) public governance in developing countries. This series represents a response to several independent evaluations in recent years that have argued that development practitioners and policy makers dealing with public sector reforms in developing countries and, indeed, anyone with a concern for effective public gov- ernance could benefit from a synthesis of newer perspectives on public sector reforms. This series distills current wisdom and presents tools of analysis for improving the efficiency, equity, and efficacy of the public sector. Leading public policy experts and practitioners have contributed to this series. The first 14 volumes in this series, listed below, are concerned with public sector account- ability for prudent fiscal management; efficiency, equity, and integrity in public service pro- vision; safeguards for the protection of the poor, women, minorities, and other disadvantaged groups; ways of strengthening institutional arrangements for voice, choice, and exit; means of ensuring public financial accountability for integrity and results; methods of evaluating public sector programs, fiscal federalism, and local finances; international practices in local governance; and a framework for responsive and accountable governance. Fiscal Management Public Services Delivery Public Expenditure Analysis Local Governance in Industrial Countries Local Governance in Developing Countries Intergovernmental Fiscal Transfers: Principles and Practice Participatory Budgeting Budgeting and Budgetary Institutions Local Budgeting Local Public Financial Management Performance Accountability and Combating Corruption Tools for Public Sector Evaluations Macro Federalism and Local Finance Managing Natural Resources and the Environment (c) The International Bank for Reconstruction and Development / The World Bank PUBLIC SECTOR GOVERNANCE AND ACCOUNTABILITY SERIES MACRO FEDERALISM AND LOCAL FINANCE Edited by ANWAR SHAH THE WORLD BANK Washington, D.C. (c) The International Bank for Reconstruction and Development / The World Bank ©2008 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org E-mail: feedback@worldbank.org All rights reserved 1 2 3 4 11 10 09 08 This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgement on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The Inter- national Bank for Reconstruction and Development / The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center Inc., 222 Rosewood Drive, Danvers, MA 01923, USA; telephone: 978-750-8400; fax: 978-750-4470; Internet: www.copyright.com. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street, NW, Washing- ton, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org. ISBN: 978-0-8213-6326-3 eISBN: 978-0-8213-6327-0 DOI: 10.1596/978-0-8213-6326-3 Library of Congress Cataloging-in-Publication Data Macro federalism and local finance / Anwar Shah, editor. p. cm. Includes bibliographical references and index. ISBN 978-0-8213-6326-3 — ISBN 978-0-8213-6327-0 (electronic) 1. Intergovernmental fiscal relations—Case studies. 2. Federal government—Case studies. 3. Local finance—Case studies. 4. Decentralization in government—Case studies. 5. Finance, Public—Case studies. I. Shah, Anwar. HJ197.M33 2008 336—dc22 2008006103 (c) The International Bank for Reconstruction and Development / The World Bank v Contents Foreword xi Preface xiii Acknowledgments xv Contributors xvii Abbreviations xxi Overview 1 Anwar Shah Part I Macro Federalism Macro Federalism: An Introduction with Principal Reference to the Canadian Experience 9 Thomas J. Courchene Globalization, Confederalism, and the Information-Knowledge Revolution 11 Defining Macro Federalism 18 Outline of the Analysis 19 Internal Economic Integration 20 Transfer Dependency: A Macro Federalism Approach to Regional Policy and Fiscal Federalism 34 Monetary Policy and Central Banking 47 1 CHAPTER (c) The International Bank for Reconstruction and Development / The World Bank Fiscal Policy 53 Miscellaneous Macro Federalism Issues 57 Overall Conclusions 68 Notes 74 References 75 Globalization, the Information Revolution, and Emerging Imperatives for Rethinking Fiscal Federalism 77 Anwar Shah Governance Implications of Globalization and the Information Revolution 78 Localization 84 Emerging Jurisdictional Realignments: Glocalization 85 Emerging Imperatives for Rethinking Fiscal Federalism 86 Federalism and Regional Equity: Reflections on Alternative Approaches to Reducing Regional Disparities 93 Conclusions: The New Vision of Multicentered Governance 103 Notes 104 References 104 Federalism and Macroeconomic Performance 107 Anwar Shah Institutional Environment for Macroeconomic Management 109 Fiscal Decentralization and Fiscal Performance: Some Conclusions 136 Notes 137 References 137 Regional Income Disparities and Convergence: Measurement and Policy Impact Evaluation 143 Raja Shankar and Anwar Shah Measures of Regional Inequality 144 vi Contents 4 2 3 (c) The International Bank for Reconstruction and Development / The World Bank Regional Disparities: A Cross-Country Snapshot 149 Regional Income Disparities and Convergence 157 Regional Inequalities and Convergence: A Scorecard on National Policies for Regional Development 169 Annex 4A: Regional Disparity Trends 171 Annex 4B: Data Sources 188 Notes 189 References 189 Harmonizing Taxation of Interstate Trade under a Subnational VAT: Lessons from International Experience 193 Mahesh C. Purohit Brazil 194 Canada 196 European Union 198 The Little Boat Model 200 India 202 The Recommended Options 208 Conclusion 210 Notes 210 References 212 Subnational Borrowing, Insolvency, and Regulation 215 Lili Liu and Michael Waibel Benefits and Risks of Subnational Borrowing 217 Rationales for Regulating Subnational Borrowing 221 Frameworks for Subnational Borrowing: Ex ante Regulation 223 Regulatory Frameworks for Subnational Borrowing: Insolvency Mechanisms 226 Conclusions 231 Notes 234 References 239 Contents vii 5 6 (c) The International Bank for Reconstruction and Development / The World Bank Part II Local Finance A Local Perspective on Fiscal Federalism: Practices, Experiences, and Lessons from Industrial Countries 245 Melville L. McMillan Expenditure Responsibilities of Local Government 246 Local Government Revenue 263 Summary, Conclusions, and Lessons 283 Notes 287 References 288 Decentralized Governance in Developing and Transition Countries: A Comparative Review 291 Sebastian Eckardt and Anwar Shah The Building Blocks of Citizen-Centered Governance in Decentralized Systems 292 A Simple Scorecard to Measure Decentralized Citizen-Centered Governance 301 Conclusion 314 Annex: Country Sample 316 Note 318 References 318 Index 323 BOXES 2.1 Emerging Rearrangements of Government Assignments: Glocalization 85 3.1 Legislated Fiscal Rules: Do They Matter for Fiscal Outcomes? 124 FIGURES 1.1 The Economic Integration Continuum 24 1.2 A Geometry of Regional Dependence 37 4.1 Regional Disparities in Industrial Countries 151 4.2 Regional Disparities in Nonindustrial Countries 155 4.3 Regional Disparity Trends in Federal Countries 158 4.4 Regional Disparity Trends in Unitary Countries 162 4A.1 Regional Disparity Trends in Canada 171 viii Contents 7 8 (c) The International Bank for Reconstruction and Development / The World Bank 4A.2 Regional Disparity Trends in the United States 172 4A.3 Regional Disparity Trends in Brazil 173 4A.4 Regional Disparity Trends in India 174 4A.5 Regional Disparity Trends in Mexico 175 4A.6 Regional Disparity Trends in Pakistan 176 4A.7 Regional Disparity Trends in the Russian Federation 177 4A.8 Regional Disparity Trends in Chile 178 4A.9 Regional Disparity Trends in China 180 4A.10 Regional Disparity Trends in Indonesia 181 4A.11 Regional Disparity Trends in the Philippines 182 4A.12 Regional Disparity Trends in Romania 183 4A.13 Regional Disparity Trends in Sri Lanka 184 4A.14 Regional Disparity Trends in Thailand 185 4A.15 Regional Disparity Trends in Uzbekistan 186 4A.16 Regional Disparity Trends in Vietnam 187 8.1 Political Freedom and Bureaucratic Quality: Partial Correlation Controlling for Per Capita GDP Log 293 8.2 Accountability 303 8.3 Fiscal Responsibility 310 TABLES 1.1 Globalization and the Information-Knowledge Revolution: Variations on the New Technoeconomic Paradigm 12 1.2 Selected Institutional Features of Mature Federations 21 1.3 Comparison of Constitutional Provisions 22 1.4 Central Bank Structure 48 2.1 Governance Structure: 20th versus 21st Century 87 3.1 Fiscal Decentralization and Fiscal Performance: Selected Regressions 114 3.2 Fiscal Rules at a Glance 123 3.3 Fiscal Decentralization and Fiscal Performance: A Summary of Empirical Results 136 4.1 Regional Disparities in Industrial Countries 150 4.2 Regional Disparities in Nonindustrial Countries 153 4.3 Regression Results 156 4.4 Spearman Rank Correlation 157 4.5 Beta Convergence Results in Federal Countries 159 4.6 Beta Convergence Results in Unitary Countries 164 4.7 Regional Inequalities and Convergence: A Summary View 170 4A.1 Regional Disparity Trends in Canada 171 Contents ix (c) The International Bank for Reconstruction and Development / The World Bank [...]... national and global economies on the one hand and the resultant emerging changes in the nature of federalism itself on the other The purpose of the next section is to highlight aspects of these trends in terms of how they may relate to macro federalism (c) The International Bank for Reconstruction and Development / The World Bank Macro Federalism: An Introduction 11 Globalization, Confederalism, and the... dynamic-efficiency and growth implications of fiscal arrangements, and (c) providing a comparative evaluation of local government organization and finances The book addresses glocalization, a term that embodies globalization and two additional distinct yet interconnected concerns: (a) macro federalism, or the institutional dimensions of macroeconomics I 1 (c) The International Bank for Reconstruction and Development... factor and goods mobility and that level the playing field by ensuring common minimum standards in merit public services and infrastructure offer the best hope for overcoming the economic divide within nations The chapter concludes with a bold new vision of a globalized and localized world where citizens reassert their roles as governors and principals and, in the process, local governments and “beyond-government”... particularly urban and local economics, fiscal federalism, and demand and supply of public goods and services He has also provided policy advice to governments in both industrial and developing countries in those areas MAHESH C PUROHIT is director of the Foundation for Public Economics and Policy Research Previous appointments included member-secretary of the Empowered Committee of State Finance Ministers... arrangements agreed on by the grantor and recipients; (e) higher-level government assistance for expanding local access to capital finance is important in dealing with infrastructure deficiencies; (c) The International Bank for Reconstruction and Development / The World Bank 6 Anwar Shah and (f) democratic accountability and local autonomy are central to successful local government operations The ultimate... include international finance and trade, investment and monetary law, and public finance and economic history His work experiences include the European Central Bank, the International Monetary Fund, and the World Bank He holds law degrees from the University of Vienna, Austria, and an MSc in Economics from the London School of Economics (c) The International Bank for Reconstruction and Development / The... globalization and the information revolution on multiorder governance structures, (b) reviewing the dynamic-efficiency and growth implications of intergovernmental fiscal relations, and (c) providing a comparative review of local government organization and finances and their consistency with a changing role of local government in the new economic era xiii (c) The International Bank for Reconstruction and Development... 7.5 Local Government Consumption of Fixed Capital and Debt, 2004 262 7.6 Main Taxes and Selected Other Own-Source Revenues of Local Governments in OECD Member Countries as a Percentage of GDP, 2003 264 7.7 Composition of Local Government Tax Revenue in OECD Countries, 2003 267 7.8 Tax, Nontax, and Grant Revenue of Local Governments, 2003 274 7.9 Sources of Nontax Own-Source Revenue, 2003 275 7.10 Local. .. regulation of capital markets Part II: Local Finance Globalization and the information revolution are motivating a large and growing number of countries worldwide to reexamine the roles of various orders of government and their partnership with the private sector and civil society These reforms typically involve shifting responsibilities to local governments and “beyond-government” providers, with... State Finance Ministers, secretary of the Committee of Chief Ministers on Value Added Tax and Incentives to Backward Areas, and member-secretary of the Committee of Finance Secretaries on Backward Area Incentives Purohit has been a professor at the National Institute of Public Finance and Policy, New Delhi; a senior research fellow at the Centre for Advanced Studies in Industrial Economics and Public Finance, . for Reconstruction and Development / The World Bank MACRO FEDERALISM AND LOCAL FINANCE (c) The International Bank for Reconstruction and Development / The. Evaluations Macro Federalism and Local Finance Managing Natural Resources and the Environment (c) The International Bank for Reconstruction and Development