charges, voters are highly aware of both resource and preference costs. Fiscal decentralization with ear-marking essentially means that taxes are benefit levies. Increasing the quantity of production of road quality will result in a higher ear-marked tax bill, making the opportunity cost of road services much clearer to the voter. The country studies in the next section allow us to gain a better understanding of these issues.

# **_Decentralization of Construction Expenditures_**

Figure 2(a) shows the relationship between decentralization of construction expenditures and performance as obtained from the data set described in section 4. On the ordinate we have the countries in increasing degrees of decentralization of construction in terms of percentage local government expenditure for road construction. On the abscissa, we measure performance in terms of preference costs<sup>1 4</sup> , defined as the cost of roads in bad condition (roads not paved (million $/km)) and resource costs, defined as unit cost of construction (expenditure on construction per km (million $/km)). In figure 2(b) we present the same costs normalized by GNP per capita to adjust for differences in technology. The determination of the proper level of decentralization for construction of roads involves minimizing total cost of provision, expressed as the sum of preference and resource costs for a given level of effort.

A first look at the graph shows that there are multiple-equilibria of decentralization, as countries attain different levels of unit costs with increasing degrees of decentralization. The countries selected in the case study in figures 2(a) and (b) fall into four categories. Brazil, the Philippines and Indonesia'<sup>5</sup> are all centralized with regard to financing of their road construction operations falling under the category [0-10] percent decentralization; Argentina, Colombia and Germany are more decentralized with the central government and local governments sharing the fiscal responsibly for construction activities. Moving further to the right, in South Africa, financing of construction works is with local governments at [70-90] percent decentralization. Finally, the USA is the most decentralized of all countries. Counties and townships and state governments are almost 100 percent responsible for financing of construction activities in their jurisdictions.

_14_ Quality of roads is used as a proxy for preference costs and quality is further interpreted as paved roads. The expenditure data is separated into three activities: construction, maintenance and administration. It was assumed that, the three activities would contribute differently to preference costs and that the actual effect is latent and hence unobservable. Furthermore, preference costs are assumed to be related to user savings due to better quality roads. Quality of roads has been transformed into costs using a latent variable model specification where the indicator of quality is related to the three expenditure categories to get the separate effect of the three activities on preference costs. For more detail on the ability to relate indicators of quality to user costs using a latent variable model specification see Ben-Akiva and Gopinath (1995) The analysis was performed on a panel data set. The years for which data is available may not be totally representative of the current situation in these countries.

13