_III.1. Fiscal Decentralization and Fiscal Autonomy in Developing Countries_ Developing countries share some characteristics when it comes to decentralization:

- (i) There is a huge gap between devolution of competencies as stated by the law and competencies that are eventually implemented by subnational governments. Furthermore, in most of developing and transition countries, subnational governments enjoy very little fiscal autonomy (i.e. they have a very limited discretionary control on their own expenditures) even if, in some cases, the subnational government share in total government expenditure may look important at first glance;

- (ii) Tax revenue are very centralized and, for those limited resources which are under the control of local governments, subnational governments are granted little tax autonomy;

- (iii) Vertical transfers (including revenue sharing arrangements) play an important role to fill the gap arising from the lack of balance between subnational revenue and expenditures responsibilities. The effects of both vertical gap and vertical transfers have been widely documented by the fiscal federalism literature (see Weingast 2006 for a survey).  The disconnect between taxing and spending responsibilities and the resulting vertical transfers raise a major problem of accountability at the subnational level since lower level governments do not really enjoy fiscal autonomy. Ensuring accountability means that ability to raise tax revenue should be matched as closely as possible with expenditure needs (see Bahl and Linn 1992 and Shah 1997a, 1997b for developing countries).  Vertical transfers and revenue sharing systems should be designed to provide incentives to subnational governments (especially in terms of new revenue generation) to foster local economic growth.<sup>17</sup>

- (iv) In most developing countries, jurisdictions face restrictions on trade or factor movements across jurisdictional boundaries. Both people and firms cannot move easily from one location to another because of mobility restrictions set by the central (federal) government but also more generally because the set of location choices is narrow (few cities offer a public services bundle capable of attracting business and people). The failure of the common market condition creates a pathology in which sub-national government become a de facto “national government” within its jurisdiction (Weingast 2006). Along the same line, one can argue that “voice” and yardstick competition are less likely to work efficiently in developing countries than in developed countries because of a lack of local political accountability and, to some extent, because of the perversion of democracy that Weingast (2006, p. 38) calls “tragic brilliance”. However some empirical studies (e.g., Alderman 2002 for Albania and Faguet 2004 for Bolivia) tend to qualify this blanket statement and show that there is scope for improvement in the delivery of public services when the latter are granted at the local level.

In the final section, we review a few studies providing empirical evidence of interactions between local governments in developing countries despite limited fiscal autonomy.

> 17 Careaga and Weingast (2003) call poor incentives of fiscal transfers “the law of 1/n”

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