# **<u>Introduction</u>**

Decentralization has been gaining increasing attention as a means of improving the provision of public goods and services<sup>1</sup> as reforming public-service delivery has moved to the forefront of the current policy agenda.<sup>2</sup> The main economic reason behind this increased interest is the prospect of improving citizens’ welfare through efficiency gains (Tanzi 1995). In other words, welfare is maximized if each local government provides the Pareto-efficient<sup>3</sup> level of output for its constituents through benefit pricing (Oates 1972, p. 34-35). The argument is that local government is more efficient to provide public goods and services tailored toward the preferences and tastes of individual residents, so as to achieve an increased level of satisfaction for them.

At the same time, experience shows that decentralization has often been motivated by political reasons (e.g., dealing with a mounting budget deficit) rather than economic rationale (e.g., efficiency gains, increase in employment, economic stabilization, equity). For example, an overburdened central government may try to delegate or pass on the responsibility for the provision and maintenance of public goods and services to local government, but without ensuring adequate institutional and financial provision. In this case, decentralization neither improves welfare or the quality of life for residents nor increases the efficiency of the public sector.

High expectations from decentralization seem to stem partly from recent experiences of failed centralized states under planned economic and political systems.<sup>4</sup> Strong pressures for the restructuring of the public sector are present today, and have been before in countries at differing stages of economic development. It has been argued that fragmenting central authority and introducing more “Tieboutian” intergovernmental competition (e.g. “voting with feet”) can generate a range of benefits including making government more efficient and responsive.<sup>5</sup> Some economists and political scientists also have questioned the effectiveness of central government in improving the distribution of income and stabilizing the economy, while advocating a smaller public sector by giving markets and local jurisdictions more power. These arguments have been put forward along with support for privatization to improve the efficiency of the public sector,<sup>6</sup> although it is not evident that decentralization can improve income distribution

> 1 See John G. Head (1974) for discussion on public goods and welfare.

> 2 See the World Bank publications for discussion on reforming public service delivery: World Development Report (2004); Berlin Workshop Series (2004); Annual Bank Conference on Development Economics-Europe (2005) and Besley and Ghatak (2003).

> 3 Pareto-efficiency refers to the situation when nothing could be done to make at least one person better off without hurting someone else.  The implication is that no one needs to be made worse off, while at least one person will have an increased level of welfare.

4 The World Development Report 1997 (World Bank) argues that development requires an effective state that plays a facilitator role in encouraging and complementing the activities of private businesses and individuals versus reducing government to a minimalist state. Governments with both centrally-planned and mixed economies are shrinking their market role because of failed state interventions. 5 Chareles M. Tiebout (1956) argues that the Musgrave-Samuelson analysis, which is valid for federal expenditures, need not apply to local expenditures.

6 Vito Tanzi, 1996, “Fiscal Federalism and Decentralization: A Review of Some Efficiency and Macroeconomic Aspects,” in _Annual World Bank Conference on Development Economics 1995_ , pp. 296.

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