dd ee zz riri oo hh utut AA e e rr uu ss oo clcl ss DiDi c c blibli uu PP dd ee PUBLIC SECTOR zz riri oo hh GOVERNANCE AND utut AA e e ACCOUNTABILITY SERIES rr uu ss oo clcl ss 44638 DiDi MACRO FEDERALISM c c blibli uu PP AND LOCAL FINANCE dd ee zz riri oo hh utut AA Edited by ANWAR SHAH e e rr uu ss oo clcl ss DiDi c c blibli uu PP dd ee zz riri oo hh utut AA e e rr uu ss oo clcl ss DiDi c c blibli uu PP MACRO FEDERALISM AND LOCAL FINANCE Introduction to the Public Sector Governance and Accountability Series Anwar Shah, Series Editor A well-functioning public sector that delivers quality public services consistent with citizen preferences and that fosters private market-led growth while managing fiscal resources pru- dently is considered critical to the World Bank’s mission of poverty alleviation and the achievement of the Millennium Development Goals. This important new series aims to advance those objectives by disseminating conceptual guidance and lessons from practices and by facilitating learning from each others’ experiences on ideas and practices that pro- mote responsive(by matching public services with citizens’ preferences), responsible(through efficiency and equity in service provision without undue fiscal and social risk), and account- able(to citizens for all actions) public governance in developing countries. This series represents a response to several independent evaluations in recent years that have argued that development practitioners and policy makers dealing with public sector reforms in developing countries and, indeed, anyone with a concern for effective public gov- ernance could benefit from a synthesis of newer perspectives on public sector reforms. This series distills current wisdom and presents tools of analysis for improving the efficiency, equity, and efficacy of the public sector. Leading public policy experts and practitioners have contributed to this series. The first 14 volumes in this series, listed below, are concerned with public sector account- ability for prudent fiscal management; efficiency, equity, and integrity in public service pro- vision; safeguards for the protection of the poor, women, minorities, and other disadvantaged groups; ways of strengthening institutional arrangements for voice, choice, and exit; means of ensuring public financial accountability for integrity and results; methods of evaluating public sector programs, fiscal federalism, and local finances; international practices in local governance; and a framework for responsive and accountable governance. Fiscal Management Budgeting and Budgetary Institutions Public Services Delivery Local Budgeting Public Expenditure Analysis Local Public Financial Management Local Governance in Industrial Countries Performance Accountability and Combating Corruption Local Governance in Developing Countries Tools for Public Sector Evaluations Intergovernmental Fiscal Transfers: Macro Federalism and Local Finance Principles and Practice Managing Natural Resources and the Participatory Budgeting Environment PUBLIC SECTOR GOVERNANCE AND ACCOUNTABILITY SERIES MACRO FEDERALISM AND LOCAL FINANCE Edited by ANWAR SHAH THE WORLD BANK Washington, D.C. ©2008 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org E-mail: [email protected] All rights reserved 1 2 3 4 11 10 09 08 This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgement on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The Inter- national Bank for Reconstruction and Development / The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center Inc., 222 Rosewood Drive, Danvers, MA 01923, USA; telephone: 978-750-8400; fax: 978-750-4470; Internet: www.copyright.com. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street, NW, Washing- ton, DC 20433, USA; fax: 202-522-2422; e-mail: [email protected]. ISBN: 978-0-8213-6326-3 eISBN: 978-0-8213-6327-0 DOI: 10.1596/978-0-8213-6326-3 Library of Congress Cataloging-in-Publication Data Macro federalism and local finance / Anwar Shah, editor. p. cm. Includes bibliographical references and index. ISBN 978-0-8213-6326-3 — ISBN 978-0-8213-6327-0 (electronic) 1. Intergovernmental fiscal relations—Case studies. 2. Federal government—Case studies. 3. Local finance—Case studies. 4. Decentralization in government—Case studies. 5. Finance, Public—Case studies. I. Shah, Anwar. HJ197.M33 2008 336—dc22 2008006103 Contents Foreword xi Preface xiii Acknowledgments xv Contributors xvii Abbreviations xxi Overview 1 Anwar Shah Part I Macro Federalism CHAPTER Macro Federalism: An Introduction with 1 Principal Reference to the Canadian Experience 9 Thomas J. Courchene Globalization, Confederalism, and the Information-Knowledge Revolution 11 Defining Macro Federalism 18 Outline of the Analysis 19 Internal Economic Integration 20 Transfer Dependency: A Macro Federalism Approach to Regional Policy and Fiscal Federalism 34 Monetary Policy and Central Banking 47 v vi Contents Fiscal Policy 53 Miscellaneous Macro Federalism Issues 57 Overall Conclusions 68 Notes 74 References 75 Globalization, the Information Revolution, 2 and Emerging Imperatives for Rethinking Fiscal Federalism 77 Anwar Shah Governance Implications of Globalization and the Information Revolution 78 Localization 84 Emerging Jurisdictional Realignments: Glocalization 85 Emerging Imperatives for Rethinking Fiscal Federalism 86 Federalism and Regional Equity: Reflections on Alternative Approaches to Reducing Regional Disparities 93 Conclusions: The New Vision of Multicentered Governance 103 Notes 104 References 104 3 Federalism and Macroeconomic Performance 107 Anwar Shah Institutional Environment for Macroeconomic Management 109 Fiscal Decentralization and Fiscal Performance: Some Conclusions 136 Notes 137 References 137 4 Regional Income Disparities and Convergence: Measurement and Policy Impact Evaluation 143 Raja Shankar and Anwar Shah Measures of Regional Inequality 144 Contents vii Regional Disparities: A Cross-Country Snapshot 149 Regional Income Disparities and Convergence 157 Regional Inequalities and Convergence: A Scorecard on National Policies for Regional Development 169 Annex 4A: Regional Disparity Trends 171 Annex 4B: Data Sources 188 Notes 189 References 189 Harmonizing Taxation of Interstate Trade 5 under a Subnational VAT: Lessons from International Experience 193 Mahesh C. Purohit Brazil 194 Canada 196 European Union 198 The Little Boat Model 200 India 202 The Recommended Options 208 Conclusion 210 Notes 210 References 212 6 Subnational Borrowing, Insolvency, and Regulation 215 Lili Liu and Michael Waibel Benefits and Risks of Subnational Borrowing 217 Rationales for Regulating Subnational Borrowing 221 Frameworks for Subnational Borrowing: Ex ante Regulation 223 Regulatory Frameworks for Subnational Borrowing: Insolvency Mechanisms 226 Conclusions 231 Notes 234 References 239 viii Contents Part II Local Finance A Local Perspective on Fiscal Federalism: 7 Practices, Experiences, and Lessons from Industrial Countries 245 Melville L. McMillan Expenditure Responsibilities of Local Government 246 Local Government Revenue 263 Summary, Conclusions, and Lessons 283 Notes 287 References 288 8 Decentralized Governance in Developing and Transition Countries: A Comparative Review 291 Sebastian Eckardt and Anwar Shah The Building Blocks of Citizen-Centered Governance in Decentralized Systems 292 A Simple Scorecard to Measure Decentralized Citizen-Centered Governance 301 Conclusion 314 Annex: Country Sample 316 Note 318 References 318 Index 323 BOXES 2.1 Emerging Rearrangements of Government Assignments: Glocalization 85 3.1 Legislated Fiscal Rules: Do They Matter for Fiscal Outcomes? 124 FIGURES 1.1 The Economic Integration Continuum 24 1.2 A Geometry of Regional Dependence 37 4.1 Regional Disparities in Industrial Countries 151 4.2 Regional Disparities in Nonindustrial Countries 155 4.3 Regional Disparity Trends in Federal Countries 158 4.4 Regional Disparity Trends in Unitary Countries 162 4A.1 Regional Disparity Trends in Canada 171 Contents ix 4A.2 Regional Disparity Trends in the United States 172 4A.3 Regional Disparity Trends in Brazil 173 4A.4 Regional Disparity Trends in India 174 4A.5 Regional Disparity Trends in Mexico 175 4A.6 Regional Disparity Trends in Pakistan 176 4A.7 Regional Disparity Trends in the Russian Federation 177 4A.8 Regional Disparity Trends in Chile 178 4A.9 Regional Disparity Trends in China 180 4A.10 Regional Disparity Trends in Indonesia 181 4A.11 Regional Disparity Trends in the Philippines 182 4A.12 Regional Disparity Trends in Romania 183 4A.13 Regional Disparity Trends in Sri Lanka 184 4A.14 Regional Disparity Trends in Thailand 185 4A.15 Regional Disparity Trends in Uzbekistan 186 4A.16 Regional Disparity Trends in Vietnam 187 8.1 Political Freedom and Bureaucratic Quality: Partial Correlation Controlling for Per Capita GDP Log 293 8.2 Accountability 303 8.3 Fiscal Responsibility 310 TABLES 1.1 Globalization and the Information-Knowledge Revolution: Variations on the New Technoeconomic Paradigm 12 1.2 Selected Institutional Features of Mature Federations 21 1.3 Comparison of Constitutional Provisions 22 1.4 Central Bank Structure 48 2.1 Governance Structure: 20th versus 21st Century 87 3.1 Fiscal Decentralization and Fiscal Performance: Selected Regressions 114 3.2 Fiscal Rules at a Glance 123 3.3 Fiscal Decentralization and Fiscal Performance: A Summary of Empirical Results 136 4.1 Regional Disparities in Industrial Countries 150 4.2 Regional Disparities in Nonindustrial Countries 153 4.3 Regression Results 156 4.4 Spearman Rank Correlation 157 4.5 Beta Convergence Results in Federal Countries 159 4.6 Beta Convergence Results in Unitary Countries 164 4.7 Regional Inequalities and Convergence: A Summary View 170 4A.1 Regional Disparity Trends in Canada 171