27 Mar 2018
Central government finances and fiscal policy often receive most of the attention, but for many countries, especially emerging markets (EM), local government spending far outweighs the central government.
Take China for example; approximately 85% of total government spending is done at the local level where governments are responsible for the vast majority of infrastructure investment but also key social services. While this extreme level of decentralisation is not ideal (as discussed in this edition’s EM section), evidence shows that decentralisation can bring economic benefits. The thinking is intuitive; local governments would generally be best positioned to provide public goods because of their better understanding of local preferences, particularly in large countries where regional differences are vast.
Fiscal devolution to local governments, also known as fiscal federalism, has played an important role in China’s rapid development; both by creating competition between regions to build infrastructure and institutions that could attract foreign direct investment, but also by providing capital that can help develop local industries. India is attempting to follow on a similar path in which the states occupy a prominent position in shaping India’s growth prospects. The central government is promoting the ideas of cooperative and competitive federalism, both to encompass better central-local cooperation but also to promote competition between states. While EMs such as China, Russia, India and South Africa are decentralising spending and working to improve the central-local balance, how have developed markets approached this issue? Judging by a simple metric of local government spending a proportion of total government spending, they are moving in the opposite direction. Over the past 10 years, the percentage of government expenditure conducted at the local level has declined in the US, Japan and the UK, among others (see Chart 1). But of course devolution is not solely about taxes; the UK has made significant progress in devolving responsibilities to its four countries and in the US, state and local governments have taken greater responsibility in tackling pressing problems. These are positive signs but more efforts should be made to empower local governments.
Jeremy Lawson is Chief Economist for Standard Life Investments.
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