World Bank Supports Fiscal Decentralization

by Robert Ebel and Karen Hotra

Economic decentralization has been a defining feature of Central and Eastern Europe's dramatic reform. Equally crucial has been the decentralization of government itself. Indeed, if transition economies want to achieve their reform goals, a well-functioning decentralized (intergovernmental) system is key. This system affects macroeconomic stability, the provision of social services, the pace and depth of privatization, and the ability of the public sector to mobilize and allocate resources.

Decentralizing countries with a limited tradition of self-government must sort out local and central government roles and responsibilities and develop effective subnational (local) fiscal and political institutions. Local governments should be able to plan and administer expenditures and raise revenues, thereby becoming more responsive and accountable to their constituencies.

To help transition economies carry out intergovernmental reform and create a corresponding knowledge base for disseminating best practices, a joint multiyear program called the Fiscal Decentralization Initiative was launched in 1995. Initiated by the Council of Europe, Organisation for Economic Co-operation and Development (OECD), U.S. Agency for International Development (USAID), and the World Bank's Economic Development Institute (EDI), the initiative coordinates donor activities and serves as a development and dissemination learning center. The donors have established a trust fund and disburse grants in response to proposals made by experts in selected countries. The grants typically range from $2,000 (for research papers) to $20,000 (for a national or regional conference).

Eleven client countries (Albania, Bosnia-Herzegovina, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Macedonia, Romania, Slovakia, and Slovenia) participate in the program, which also attracted Canada, Denmark, Germany, and Italy as donors. Funds are made available only if the proposals-be they for policy study, research, or national or regional seminars that disseminate best practices-are designed to contribute to the knowledge base and build local institutional capacities in the recipient countries. The best products are replicated and disseminated. The decision to fund a client-proposed event is made by a review committee of the donors. All programs require the client to share 10 to 15 percent of program costs.

One feature of the initiative that increases its acceptance and attests to its proven success is that all funded activities must be identified and carried out by experts of the client country. This is not a program that "recycles" funding to consultants from donor countries.

Clients range from local governments and central government institutions responsible for legislating, implementing, regulating, and monitoring decentralization to universities, research institutes, and associations of local authorities. When an invitation is received to operate in a country, it is reviewed by EDI and its partners. Once an invitation is accepted (not all are), the program typically starts by convening a conference called the National Forum on Fiscal Decentralization, organized by experts in the client country. The forum helps explore the issues and identify an agenda for research and training, as well as promote the initiative's grant process.

Although each country has its own policy research agenda, several common concerns have emerged:
• Ensuring that subnational expenditure responsibilities correspond with available financial resources (including how to structure central-local transfers).
• Strengthening own-source local revenues.
• Consolidating the large numbers of newly created small municipalities (for example, those with fewer than 5,000 people) with a view to creating regional governments or special districts.
• Promoting intergovernmental cooperation in service delivery.
• Facilitating the privatization of locally controlled "socialist style" state-owned enterprises.
• Establishing the conditions by which local governments can gain access to private credit markets.

Municipalities in transition economies-small and large alike-complain that their views often are not adequately considered when central governments draft legislation affecting local governments. In Hungary, for example, the 1996 Act on Municipal Debt-which will have a profound effect on municipalities-was enacted without much prior consultation with local governments.

To discuss this and other problems, last July the Council of Europe hosted a three-day regional Fiscal Decentralization Initiative seminar in Budapest (see next articles). It brought together central and local officials to examine topics ranging from reviewing the credit needs and fiscal characteristics of a local government, to the more technical issues of measuring municipal creditworthiness and the creation of central-local monitoring systems. Attention was also given to the changing role of multilateral lending institutions.

Another common theme is the need for local governments to find ways to bridge the information gap not only between them and the central government, but also among themselves. For example, a recently approved proposal from Latvia will compile official financial and demographic data that have not been shared with municipalities. The book will also enable local governments to formulate and analyze their budgets.

Grants have also supported:
• A workshop on historic preservation and the revitalization of the Vilnius (Lithuania) city center.
• A seminar on the operational problems of transferring a state-run district heating company to the city of Kaunas (Lithuania). • Budget training in Tartu (Estonia).
• A regional conference on the role of associations of local authorities in the process of decentralization and the strengthening of local government.
• A conference on the relevance of the "top down" Japanese model of fiscal decentralization for the still centrally dominated postsocialist economies.

New activities include: support of a series of economic studies in the Baltic countries; assisting a Lithuanian working group to develop regulations relating to borrowing by Lithuanian municipalities; initiation of national forums in Albania, Bosnia-Herzegovina, Macedonia, Romania, Slovakia, and Slovenia; and replicating the Budapest conference on municipal creditworthiness and the financial risks of local authorities, experts from Latin America and Central and Eastern Europe will be brought together to share common experiences.

If fiscal decentralization is done correctly, there are significant benefits in terms of enhanced economic efficiency and increased fiscal and political accountability. If implemented badly, however, the efficiency and accountability outcomes can be perverse. The Fiscal Decentralization Initiative is designed to achieve effective fiscal decentralization.

For additional information on the Fiscal Decentralization Initiative contact Robert Ebel or Karen Hotra, at the Economic Development Institute of the World Bank, Room M-8096, tel. 202-473-0740, Email: khotra@worldbank .org; Alessandro Mancini, Council of Europe, Email: Alessandro.Mancini @dela.coe.fr; or Michael Engelschalk, OECD, Email: Michael.Engelschalk @oecd.org.