SEMINAR SERIES ON DECENTRALIZATION #4
Topic: A Political Theory of Fiscal Control in Decentralized Systems
Panelist: Barry Weingast (Chair of the Department of Political Science at Stanford University)
Summary
Barry Weingast’s seminar began by highlighting three puzzles in the political economy of federalism. First, how do the economic and political science literatures on federalism mesh? Economists focus on the public finance aspects of decentralization and the potential for efficiency- enhancing competition described by the Tiebout Hypothesis, while political scientists concentrate on the mechanisms for power sharing and the transformation of political rights.[1] Political scientists ignore the economic consequences of decentralization, while economists ignore the political foundations. Second, how do federal systems differ? Weingast emphasized the importance of differentiating between different forms of federalism in order to discern the effects on the economy. Finally, what makes decentralization self-enforcing? How do leaders build up the credibility that they will abide by the rules of federalism? What are the incentives to abide by these rules?
Concentrating on the second puzzle - that of differentiating federal systems - he laid out five conditions which must be fulfilled to have the “market-preserving federalism” that forms the economists’ theoretical ideal. These five conditions could be the basis for a comparative theory.
i. A hierarchy of governments with a delineated scope of authority.
ii. Subnational governments are the primary locus of authority over microeconomic regulation. This allows them to create different environments for business, which is necessary for the Tiebout model to take effect.
iii. National government has the authority to provide national public goods, in particular, a common market and to ensure the mobility of goods and factors across subgovernment jurisdictions. This is also necessary for the Tiebout model to work.
iv. All governments face hard budget constraints, and revenue sharing among governments is limited.
v. An institutionalized degree of durability protects the division of powers. This can help protect incentives for innovation – if subnational governments’ autonomy is threatened, then subnational leaders might not take risks, therefore, the delegation of authority is not at the discretion of the national government.
Of these five conditions, Weingast suggested that the second and the fifth are necessary conditions for the decentralization discussed in economics literature as they ensure competition between subnational units.
Weingast stressed the importance of understanding and striving for market-preserving federalism and made note of the fact that the richest country at any time over the past three centuries has had a market-preserving federal system. Similarly, market-preserving federalism may have played a role in China’s recent growth.[2]
Weingast described the degree to which Chinese federalism matches the five conditions:
i. There was always a hierarchy of governments with delineated authority.
ii. Devolution of regulatory power proceeded gradually and lacked uniformity in the 1980s. There were small experiments in specific provinces, which then spread if they were successful. Also, revenue-sharing agreements between central and provincial governments allowed subnational governments to keep extra revenues for provinces, creating an incentive for innovation and efficiency.
iii. In the mid 1980s and early 1990s, there were trade barriers between provinces, especially in the interior, but these have now disappeared. The labor movement restrictions are still there, but the de facto migration of workers is eroding the de jure factor immobility.
iv. Hard budget: During the 1980s and 1990s, provinces have had access to central bank branches which has led to some problems, including mild inflation (approximately 10% to 20%). [State-owned enterprises have been protected from financial crises by way of government intervention. As a result, they have not always performed efficiently. Unlike state-owned enterprises, local governments’ township-village enterprises have not received large subsidies and policy loans from state banks. Enduring hard budget constraints, TVEs need to perform well to stay in business as they are operating under competitive conditions.][3] Stemming from their hard budgets, township-village enterprises have became some of the most dynamic areas of the state.
v. Institutionalized durability: There have been three waves of decentralization and recentralization in history. In the latest attempt to recentralize – after Tiananmen Square – the provincial governors refused and recentralization fell through. This institutional durability seems to have been helped by political learning. Based on the experiences in Tiananmen Square, one might suggest that local governments’ strength to say no to recentralization had less to do with the institutional power in place and more to do with the experience of going back and forth between decentralization and recentralization. Local governments realized that they could refuse recentralization – not because their existing power was unusually strong, but because they had learned from past experience.
Mexico, in contrast, fulfills only some of these five criteria. Condition two, for example, is not very strong in Mexico – the central government still controls many aspects of subnational government. Furthermore, condition five is not really present – the PRI still has substantial power over subnational governments’ choices.
Briefly turning to the other two puzzles, Weingast began by discussing the reconciliation of economic and political literature of federalism. He suggested that one way to reconcile political science and economics in the study of federalism is to look at the kinds of institutions and practices that create conditions one through five. This raises issues of the power distribution, the interplay between elected leaders at different levels of government, as well as the aspects of federalism that can improve economic efficiency.
Weingast then discussed the nature of self-enforcing federalism suggesting that to keep federalism self-sustaining one must look at the balance between the powers and legitimacy of the central and subnational governments. For example, if all states are united in opposition to the central government, then the central government will not be able to react. However, if states are divided, then the central government can impose its will. One can see an example of this power balance in Russia. After 1993 the governors began to be elected, and thus gained added legitimacy. When there was a competition between Yeltsin and Evgenii Nazdratenko, head of administration in the Primorskii Krai, Nazdratenko was able to resist Yeltsin’s attempts to take away his authority. The governor went to the Federal Council and obtained a unanimous resolution from his fellow governors to denounce Yeltsin’s actions, suggesting that an institutional protection exists in Russia keeping some degree of federalism in check.
Questions and comments focused on the practical applications of the five conditions.
Participants raised the point that federalism is not the only set of checks and balances that can limit central government growth and/or predatory behavior. The market –preserving federalism Weingast highlighted seems rare and somewhat fragile. Therefore, it is better to see it as one of several ways to check central government power. Democracy –the ability of citizens to present their interests through different channels is also an important factor in restraining “Leviathan.”
People also questioned the degree to which the five conditions could be helpful in analyzing real-world federalism. It was pointed out that even China, the example highlighted by Weingast did not really meet the criteria for having market-preserving federalism. Several suggested that the framework could be useful in asking the question, “What kinds of outputs can we expect to see under certain sets of these five conditions?” Others suggested expanding the analytical framework to weigh other values and/or goals of federalism, such as ethnic preferences. A participant also emphasized the need to have some sort of discussion of the minimum set of local government characteristics for market-preserving federalism to come about.
1
[1] Tiebout, Charles. 1956. “A Pure Theory of Local Expenditures.” Journal of Political Economy
[2] Gabriella Montinola, Yingyi Qian, and Barry R. Weingast, “Federalism, Chinese Style: The Political Basis for Economic Success in China” World Politics (October, 1995) 48: 50-81.
[3] Weingast, Barry and Qian, Yingyi “ Institutions, State Activism, and Economic Development: A Comparison of State-Owned and Township-Village Enterprises in China” in Aoki et al, eds. 1996. “Role of Government in East Asian Economic Development” New York: Oxford University Press, 255-262