survey carried out by UCLG in 2009 shows that local capital expenditures have actually increased in some countries because municipalities have participated in national economic stimulus programs that have targeted local infrastructure projects (United Cities and Local Governments 2009). However, in a great variety of countries, including Bulgaria, Mexico, Nicaragua, Philippines, Russia, and Ukraine, municipalities have cut back on capital spending. In Senegal, the reduction in capital transfers to cities has led to a cutback in local investments since these transfers are used to fund the municipal matching share of specific projects for which financing is also received from a national fund supported by multinational institutions (Paulais 2012).

# **Reduced Financing Capacities**

As cities have struggled to regain stability after the crisis, so too have the various external sources of capital on which cities usually rely. Perhaps most importantly, the cost of borrowing has increased during recession, as creditors are wary of buying emerging-market bonds during bad times. This, in turn, prevents emerging-country governments from smoothing the cycle by borrowing, as their rich counterparts can often afford to do. Generally speaking, fiscal policy is procyclical in developing countries, in contrast to high-income countries where it is countercyclical. This is supported by strong evidence in Ilzetzki & Vegh (2008) and Kraay (2012). This being said, even developed nations have been struggling. In the U.S. tightened credit markets have made it increasingly difficult for cities to maintain debt-funded projects, particularly for infrastructure, and have resulted in higher debt costs. Additionally, in many EU countries like Greece, Spain and Portugal, cities have had difficulties to borrow due to legal constraints (including consolidated public sector limits arising from the Maastricht Treaty). The downturn has also reduced foreign direct investment in developing country cities.

The ability to weather this crisis, as in previous crises, has been different for central and subnational governments. While the former can incur large deficits financed by debt, the latter (outside of a number of generally federal or quasi-federal countries) are often very constrained by law and financial market realities in terms of the extent to which they can run budget deficits and borrow. Without sufficient ability to borrow, subnational governments will find themselves in a very difficult position. The situation is likely to be most serious for local governments (middle and little cities, municipalities and villages) because of their heavy dependence on transfers as well as their more limited fiscal autonomy and ability to manage external shocks (United Cities and Local Governments 2009).

While the borrowing capacities of many municipalities currently remain limited, recent global trends illustrate a general movement towards the increased financial independence of cities. Canuto and Liu (2010) argue that this phenomenon can be attributed predominantly to three driving forces. First, decentralization has given local governments increased responsibility to plan for and finance local projects. Second, widespread urbanization has forced municipalities to make massive investments in the new infrastructure required to accommodate large increases in the urban population, prompting cities to pursue mechanisms through which to access new sources of capital. Third, subnational debt is becoming a more common practice as cities have started issuing more bonds to finance public investments. This global trend towards decentralization informs much of the discussion that follows, in particular relating to countries’ stimulus packages, and cities’ options for implementing sustainable financial mechanisms.

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