Decentralization and Macroeconomic Management


WP/97/155-EAWP/97/155


.Decentralization and Macroeconomic Management.
by Teresa Ter-Minassian


There is a vast and growing body of literature covering the potential
efficiency and welfare gains from decentralization. The literature has also
amply discussed the potential trade-offs between decentralization and income
redistribution, as well as various mechanisms designed to attenuate these
trade-offs. By contrast, in the literature on fiscal federalism there has been
relatively little emphasis on the effects of decentralization on macroeconomic
management, although policymakers worldwide increasingly have to grapple with
these effects. This is the focus of the present paper, which draws on a range
of country experiences in this area.


The paper discusses the constraints that a high degree of decentralization
places on the central government.s ability to carry out its traditional
stabilization functions; the macroeconomic impact of subnational governments
operations, both under balanced budget and deficit conditions; and the case
for, and possible approaches to, the control of subnational government
borrowing.


The paper concludes that decentralization--as desirable as it might be on
efficiency, as well as political, grounds--can entail significant costs in
terms of the effectiveness of the central government in stabilizing the
economy. The paper explores various ways to minimize these costs, including the
setting of hard budget constraints on subnational governments and a more active
involvement of these governments in the central government.s macroeconomic
management and adjustment efforts.