# **7. Concluding remarks**

Within the growing literature on fiscal federalism, a rigorous understanding of the impact on welfare of transfers to subnational governments is an important research question. The present paper contributes to this body of work by identifying the causal effects of a fiscal transfer fund on local welfare. It makes use of a social infrastructure fund in Mexico as a case study to illustrate a larger problem that has implications at the global level, that is, how to raise the effectiveness of transfers to local governments to achieve higher-quality spending and, ultimately, improve social outcomes.

Existing systems vary in scope and arrangements. They include systems in resource-rich countries with fiscal rules for sharing or not sharing natural resource revenues among producing and nonproducing regions and systems that rely on transfer agreements in countries with no tax revenues from natural resources. In the context of these arrangements, it is critical to develop an agenda to assess the effectiveness of the resource allocations, and to push for revenue decentralization, which, in many developing countries, remains weak (Gadenne and Singhal 2014). Local governments that do not face the political cost of higher revenue collection may come across perverse incentives to overspend, leading to vertical fiscal imbalances. Meanwhile, adequate data and formulas to distribute funds can create incentives to invest efficiently. They can help in evaluating the effectiveness of transfers, such as earmarked funds dedicated to specific programs, to close coverage gaps, create appropriate incentives in design, and boost the quality of social spending.

This paper takes advantage of a novel data set to assess the effects on welfare of federal earmarked transfers in Mexico. The results show that the fund earmarked for social investment known as FAIS had a modest, but positive and statistically significant effect on average household income between 2005 and 2014. It also had a positive effect on several nonmonetary measures of well-being, such as access to services (electricity, sewerage, drinking water), the quality of the dwelling (floor materials, access to toilets), education, and health care. Overall, it finds a general, positive effect on access to services, which is markedly higher in urban areas. Yet, it does not find evidence of a significant impact on extreme and moderate poverty rates. This is likely because of the fact that, while the fund did have a positive and significant income effect in rural and semi-urban areas, the effect was only found among the highest income deciles, that is, it was concentrated among people who ran the lowest risk of poverty. This was not the case in urban areas, where the fund had a significant, positive, and greater effect at the lowest level of the distribution (deciles 1–7). A possible explanation for the greater equalizing effect of the fund in urban areas is the fact that resources are usually invested in the periphery of cities, which tends to attract higher numbers of low-income people. Simultaneously, because of factors such as economies of scale, lower unitary costs of investment, and less government capacity, FAIS resources in rural and semi-urban areas tend to be invested in cabeceras (the county capitals). Because the cabeceras typically attract people with relatively higher incomes and fewer deprivations compared with the rest of the county, the program could be exacerbating inequalities.

After 20 years of implementation, the FAIS has not delivered the expected results on welfare, at least not where they are most direly needed. To improve the targeting of FAIS resources, the program could be reformed to reflect consideration of an indicator of gaps in local social infrastructure as a component in the allocation of funds to municipalities, instead of the index of poverty and social deprivation gaps. Separating FAIS allocations from the results the program aims to achieve (multidimensional poverty) is key to minimizing potential perverse incentives, such as incentives encouraging municipalities to maintain higher rates of deprivation so they may receive more resources through the program. Resource distribution in an initial period could be determined on the basis of a component that reflects the gaps in investment in social infrastructure. In subsequent periods, 20