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Fiscal Decentralization and the Challenge of Hard Budget Constraints. Edited by JONATHAN A. RODDEN, GUNNAR S. ESKELAND, and JENNIE LITVACK. Cambridge, MA: The MIT Press, 2003, pp. 476.
The virtues of fiscal decentralization have long been recognized. Local fiscal decision-making allows public services to be tailored to local preferences and circumstances, and offers households a menu of choices of local outputs. At the same time, healthy competition among local jurisdictions can encourage efficiency in the public sector and hold in check excessive growth in public budgets. Decentralization, moreover, can promote democratic processes through more direct involvement of the citizenry in public decisions. For all these reasons and more, proposals and actual reforms involving decentralization have been widespread in the developing world and among transition countries. Even in the evolution of the European Union, a basic principle has been that of "subsidiarity," the assignment of functions to the lowest level of government with the capacity to carry them out.
The literature, however, has moved more slowly in exploring the dark side of fiscal decentralization. To be sure, there has been some attention to the problem of corruption and the potential for local leaders to line their own pockets at the expense of their constituencies. There is, in fact, an extensive, if inconclusive, literature on whether the problem of corruption is likely to loom larger in highly centralized government sectors or in more decentralized systems. But it is only within the last decade or so, with the advent of some major fiscal and economic collapses, that there has emerged a real and coherent sense of the potential dangers inherent in a decentralized fiscal structure (Prud'homme, 1995; Tanzi, 1996). This is not simply a matter of corruption; it is an issue of institutions and the set of incentives that they embody both for public decision-makers and the electorate. In the extreme, a decentralized fiscal system can contain the seeds of its own destruction by providing mechanisms through which provincial (or state) governors or city mayors can effectively raid the larger fiscal commons to such an extent as to destabilize the entire financial structure of the economy. Even in less extreme cases, decentralization in certain forms can undermine the performance of the public sector.
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