process for allocating administrative, fiscal, or political power to subnational governments, rather than being defined precisely by these specific features.

For example, in measuring fiscal decentralization, the most widely used indicator is the population weighted average share of subnational expenditure and revenue in the total public sector, as reported in the Government Finance Statistics (GFS) of the International Monetary Fund. The average expenditure and revenue shares of subnational governments in twenty-eight countries have been increasing steadily over time since 1980. However, GFS is not an ideal data set for measuring fiscal decentralization: although it provides a breakdown of expenditures by function and economic type, it lacks information on the degree of expenditure autonomy. On the revenue side, GFS does not provide information on whether taxes are collected through shared taxes, piggy-backed taxes, or locally determined “own-source” taxes, or what proportion of intergovernmental transfers is conditional or unconditional (Ebel and Yilmaz 2002).

Another effort is underway by the Organization for Economic Cooperation and Development (OECD) to measure the degree of subnational autonomy over expenditure decisions as well as own-revenues and grants (see Bell and Ebel 2006). Roy Bahl sums up that “fiscal decentralization refers to an intergovernmental system where the balance of power moves more toward the subnational government sector than has been the case.” 14

# **<u>Why Decentralization?</u>**

In recent years, many countries around the world have begun to undertake decentralization in response to “government failure” in delivering public goods and services. It is viewed as a way to make government more efficient, responsive, and accountable. These perceived benefits of decentralization have attracted a diverse range of supporters<sup>15</sup> that favor small government, free-markets, and a bottom-up approach, while privatization is encouraged as a way to advance decentralization (Tanzi 1996, Bardhan 2002). Before discussing the rationale for decentralization, a brief note on efficiency regarding the provision of public services is in order since the government’s resource allocation policies (e.g., revenue and expenditure) influence it. First, two dimensions of efficiency are discussed: productive and allocative. Second, arguments for improving welfare through government allocation are considered.<sup>16</sup>

**_Productive efficiency_** is when the economy is working on its production possibility frontier: this is when production of one good is achieved at the lowest cost possible, given the production of the other good(s).<sup>17</sup> In other words, it is the highest possible output of one good, given the production level of the other good(s).  Meanwhile, **_allocative efficiency_** is the market (in this case the public sector) condition whereby

> 14 Bahl (1999, pp. 4)

> 15 Pranab Bardhan calls them “anarcho-communitarians” (2002, pp. 186).

> 16 Allocation function is one of the three major economic functions of government identified by among others, Musgrave (1956), Oates (1972); the other two functions are the distribution function and the stabilization function.

> 17 A production possibilities curve (PPC) or “transformation curve” is a graph that shows the different quantities of two goods that an economy can produce if it uses its limited productive resources efficiently. Points along the curve describe the trade-off between the two goods.  This curve shows the possibilities open for increasing the output of one good by reducing the output of another.

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