Fiscal responsibility laws for subnational discipline : the Latin American experience

This paper discusses fiscal responsibility laws in Latin America, with special attention to their provisions for fiscal discipline by subnational governments. It discusses why and when such laws might be useful-to help resolve the coordination problem in getting diverse governments to avoid overusing the common national credit market and to help individual governments make a time-consistent commitment for fiscal prudence. It examines the cases of Brazil, Colombia, Peru, and Argentina, as well as the case of Mexico where other types of laws and regulations aim to achieve the same objectives of solidifying incentives for fiscal discipline at all levels of government. Fiscal responsibility laws are found to be useful in some cases, although the experience is not long enough to be certain, but they are clearly not necessary in every case, nor always sufficient to assure fiscal stability.Urban Economics,Banks&Banking Reform,Public&Municipal Finance,Public Sector Economics&Finance,National Governance,National Governance,Banks&Banking Reform,Public Sector Economics&Finance,Urban Economics,Public&Municipal Finance

Laws for fiscal responsibility for subnational discipline : international experience

Fiscal responsibility laws are institutions with which multiple governments in the same economy -- national and subnational --can commit to help avoid irresponsible fiscal behavior that could have short-term advantages to one of them but that would be collectively damaging. Coordination failures with subnational governments in the 1990s contributed to macroeconomic instability and led several countries to adopt fiscal responsibility laws as part of the remedy. The paper analyzes the characteristics and effects of fiscal responsibility laws in seven countries -- Argentina, Australia, Brazil, Canada, Colombia, India, and Peru. Fiscal responsibility laws are designed to address the short time horizons of policymakers, free riders among government units, and principal agent problems between the national and subnational governments. The paper describes how the laws differ in the specificity of quantitative targets, the strength of sanctions, the methods for increasing transparency, and the level of government passing the law. Evidence shows that fiscal responsibility laws can help coordinate and sustain commitments to fiscal prudence, but they are not a substitute for commitment and should not be viewed as ends in themselves. They can make a positive contribution by adding to the collection of other measures to shore up a coalition of states with the central government in support of fiscal prudence. Policymakers contemplating fiscal responsibility laws may benefit from the systematic review of international practice. One common trait of successful fiscal responsibility laws for subnational governments is the commitment of the central government to its own fiscal prudence, which is usually reinforced by the application of the law at the national as well as the subnational level.Debt Markets,Banks&Banking Reform,Subnational Economic Development,Public Sector Economics,Access to Finance

Fiscal management in federal democracies : Argentina and Brazil

In shifting to decentralized public finances, a country's central government faces certain fiscal management problems. First, during and soon after the transition, unless it reduces pending or increases its own tax resources, the central government tends to have higher deficits as it shifts fiscal resources to sub-national governments through transfers, revenue sharing, or delegation of tax bases. Reducing spending is hard, not only because cuts are always hard, but because sub-national governments might not take on expected tasks, leaving the central government with a legal or political obligation to continue spending for certain services. Second, after decentralization, the local or state government faces popular pressure to spend more and tax less, creating the tendency to run deficits. This tendency can be a problem if sub-national governments and their creditors expect or rely on bailouts by the central government. Econometric evidence from 32 large industrial and developing countries indicates that higher sub-national spending and deficits lead to greater national deficits. The authors investigate how, and how successfully, Argentina and Brazil dealt with these problems in the 1990s. In both countries, sub-national governments account for about half of public spending and are vigorous democracies in most (especially the largest) jurisdictions. The return to democracy in the 1980s revived and strengthened long-standing federal practices while weakening macroeconomic performance, resulting in unsustainable fiscal deficits, high inflation, sometimes hyperinflation, and low or negative growth. Occasional stabilization plans failed within a few years. Then Argentina (in 1991) and Brazil (in 1994) introduced successful stabilization plans. National issues were important in preventing and then bringing about macroeconomic stabilization, but so were intergovernmental fiscal relations and the fiscal management of sub-national governments. State deficits and federal transfers were often out of control in the 1980s, contributing to national macroeconomic problems. Stabilization programs in the 1990s needed to establish control, and self-control, over sub-national spending and borrowing.National Governance,Public&Municipal Finance,Banks&Banking Reform,Public Sector Economics&Finance,Municipal Financial Management,Urban Economics,National Governance,Banks&Banking Reform,Public Sector Economics&Finance,Municipal Financial Management

Decentralization and fiscal management in Colombia

Colombia's political geography contrasts sharply with its economy. Physical characteristics and guerilla war fragment the country geographically, yet it has a long tradition of political centrism and macroeconomic stability. Recently, with political and economic decentralization, there has been some weakening of macroeconomic performance. The authors explore institutional arrangements that have helped Colombia manage the fiscal aspects of decentralization, despite the country's political problems. Fiscal decentralization proceeded rapidly in Colombia. Education, health, and much infrastructure provision have been decentralized to the departmentos and municipios. Decentralization has led to substantial but not overwhelming problems, both in maintaining fiscal balance nationally ( as resources are transferred of subnational levels) and in preventing unsustainable deficits by the subnational governments. The problems have arisen because central government interference prevents departments from controlling their costs and because of expectations of debt bailouts. Both are legacies of the earlier pattern of management from the center, and some recent changes - especially about subnational debt - may improve matters. Colombia's traditional political process has had difficulty dealing with problems of decentralization because traditional parties are weak in internal organization and have lost de facto rule over substantial territories. The fiscal problems of subnational government have been contained, however, because subnational governments are relatively weak politically and the central government, for the time being, has been able to enforce restrictions on subnational borrowing.Urban Economics,Banks&Banking Reform,Public Sector Economics&Finance,Municipal Financial Management,Public&Municipal Finance,Banks&Banking Reform,National Governance,Public Sector Economics&Finance,Municipal Financial Management,Urban Economics

Political economy of policy reform in Turkey in the 1980s

Turkey's adjustment experience was a tremendous success in terms of structurally reorienting the economy. The share of output for export rose from 5 percent in 1979 to 23 percent in 1989, and real output roughly doubled. The financial markets opened and have developed depth and sophistication. The program failed to reduce fiscal deficits, inflation, income inequality, and the size of the inefficient public enterprise sector, but the transformation of trade and finance fundamentally altered the context of the problems, changing their effects on the private sector and changing the government's options for dealing with them. The first phase of economic adjustment was sustained, although not initiated, in an authoritarian context, but the Turks restored democracy when the agenda for reform was incomplete. The Motherland Party (ANAP) won office on the platform of economic success and eventally lost partly because of the failure of economic policy. ANAP's electoral defeat in 1991 did not mean, however, the demise of the pro-structural adjustment or the pro-liberalization coalitions. The long period of ANAP rule helped consolidate reforms to such a degree that all of the principal parties agreed on a broadly similar economic program. The ideological differences between the left and the right - a state-directed versus a marked-oriented economy - substantially diminished. The reforms of the early 1980s greatly reduced the importance of rent-seeking, particularly through foreign trade, but patronage politics became widespread again in the second half of the decade. The initial strength ANAP derived from privileged access to state resources progressively became a disadvantage, creating resentment and reaction among the populace. One source of discontent was the over-invoicing of exports (that is, fictitious exports), designed to take advantage of favorable export subsidies, and the government's failure to discipline or penalize the companies involved. This jeopardized attempts to build a pro-export coalition, and some key features of import substitution continued. The authors attribute the failure of Turkey's macroeconomic policies in the late 1980s to the government's failure tocultivate popular support for macroeconomic stability; to the top bureaucrats'lack of autonomy to counteract political pressures to expand the fiscal deficit; and to the continuation of top-down individualistic linkages between policymakers and key economic interests.National Governance,Parliamentary Government,Politics and Government,Environmental Economics&Policies,Economic Theory&Research

Bargaining for a new fiscal pact in Mexico

The authors consider the malaise with the present set-up of fiscal federalism in Mexico from the points of view of the main players-the federal government, the states, the municipalities, and the citizen voters-in order to identify the areas of potential common interest as well as the direct conflicts. There is a zero-sum game on some issues, like the size of aggregate transfers, but not on others, likeraising tax collection and improving accountability for service delivery. The authors consider bargain packages that combine mutually beneficial changes and thus might obtain broad enough political support. They analyze the bargaining packages in two main tracks-one concerning tax assignments, revenue sharing, and tax administration, and another concerning the conjunction of earmarked transfers and accountability for service provision. An important result is that almost all states would find it fiscally attractive to impose a sales tax that replaced part of the federal value-added tax (VAT), even if the federal government reduced revenue sharing enough to cover half the cost of reducing the VAT rate to make room for the state tax.National Governance,Urban Governance and Management,Public Sector Economics&Finance,Banks&Banking Reform,Regional Governance,National Governance,Public Sector Economics&Finance,Banks&Banking Reform,Municipal Financial Management,Regional Governance

The effect of demographic changes on saving for life cycle motives in developing countries

If developing countries follow the same paths that industrialized countries have followed, saving for retirement will initially become more important as the population growth rate declines. To calculate the potential importance of life-cycle savings (saving for retirement), the paper presents a simulation model that translates demographic projections into savings-rate projections. It simulated aggregate rates for life-cycle savings for Brazil, China, Korea, Mexico, Nigeria, Pakistan and Turkey. The savings rates increase 5 or 6 percentage points when the last baby boomers enter the work force and begin to save after their children leave home. The effect on life-cycle savings is dramatic; the effect on total savings rates which are often three or four times as high, is not. Simulated life-cycle savings rates peak at an absolute 10 percent or less in all cases. The patterns of these projections seem robust with regard to assumptions about productivity growth, interest rates, and age-specific participation in the labor force.Banks&Banking Reform,Environmental Economics&Policies,Economic Theory&Research,Health Monitoring&Evaluation,Inequality

Borrowing, resource transfers, and external shocks to developing countries : historical and counterfactual

Since the late 1970's the buildup and servicing of external debt has dominated the economic situation in many developing countries. This paper gathers some statistical evidence on the magnitude of lending and repayment and on the question of whether repayment reduces the resources available for development. The evidence largely confirms commonly held beliefs. Although most debtor countries have made net transfers of resources to creditors, middle-income countries that have not had to reschedule their debts have averaged smaller net transfers than those that did reschedule. Adverse changes in terms of trade since 1978 accounted for most of the debt buildup in many non-oil developing countries. The mostly favorable terms of trade for oil exporters, on the other hand, gave them large gains that could have more than covered the losses of the oil importing developing countries. Heavy borrowing by oil exporters during favorable times seems to have been a major factor in precipitating the debt crisis. Since the debt crisis, the highly indebted countries have greatly increased their official borrowing. Increased official lending might help the resource balance and domestic investment of lower-income countries more than those of middle-income countries with high commercial debts.Environmental Economics&Policies,Economic Theory&Research,Banks&Banking Reform,Strategic Debt Management,Financial Intermediation

Household saving in developing countries : first cross-country evidence

This study uses time-series of household data from eleven developing countries to test several hypotheses about saving behavior. Besides just widening the scope of information being used to test the hypotheses, the data set in this study has the advantage of a consistent definition across countries. With these data the authors test how household saving in developing countries responds to the level of per capita disposable income, the rate of growth of disposable income and its deviation from trend, real liquid wealth at the start of the period, the real interest rate, the inflation rate, foreign saving, government transfers to households, and some demographic variables. The results show that income and wealth variables affect saving strongly and in ways consistent with standard theories. Inflation and the interest rate do not show clear effects on saving, which is also consistent with their theoretical ambiguity. Foreign saving and monetary wealth have strong negative effects on household saving, indicating the importance of liquidity constraints in developing countries.Economic Theory&Research,Inequality,Environmental Economics&Policies,Banks&Banking Reform,Economic Conditions and Volatility

Stabilizing intergovernmental transfers in Latin America : a complement to national/subnational fiscal rules?

The traditional theory of fiscal federalism assigns the role of macroeconomic stabilization to the federal government. In addition to this long-standing theoretical result, there is empirical observation that federal governments in developing countries typically have cheaper and more stable access to capital markets, relative to subnational governments. Drawing on the recent experience of four large federal countries in Latin America-Argentina, Brazil, Colombia, and Mexico--the authors examine how intergovernmental transfers affect the division of the burden of stabilization across the levels of government, when the nation as a whole faces economic fluctuations. Imposing stabilizing rules on federal transfers that protect subnational governments from fluctuations in the business cycle can serve two purposes. During boom periods, stabilizing rules prevent subnational governments'tendency to increase inflexible expenditures. And during downturns, stabilizing rules place the burden of borrowing at the federal level-the level most appropriate for macroeconomic stabilization and often the level with superior access to credit. Despite the logic of these rules, recent experience of the four countries reveals that these rules can be risky, particularly inthe face of high GDP volatility. Protection against falling revenues in the downturn constitutes a contingent liability for the central government. Argentina's stabilizing rule contributed to fiscal and political tensions during its ongoing crisis. Colombia is beginning to implement similar rules. Meanwhile, Brazilian and Mexican transfers do not implement such rules and fiscal and economic results do not appear to have fared any worse for this absence. The authors draw on the country experience to establish that certain conditions should be in place before establishing a stabilization rule to federal-to-subnational fiscal transfers-in particular the elimination of long-term structural fiscal imbalances, either within levels of government or across levels of government.Municipal Financial Management,Public Sector Economics&Finance,Public&Municipal Finance,Banks&Banking Reform,Urban Economics,Banks&Banking Reform,National Governance,Public Sector Economics&Finance,Municipal Financial Management,Urban Economics