VoxEU Column

Intergovernmental relations: How the global crisis led to further decentralisation

The global financial and economic crisis has affected economies and societies, including in the ways governments allocate fiscal, financial, policy and political responsibilities among the different layers of administration. This column describes how, in particular, the crisis was associated with an increase in the subnational shares of general government spending and revenue, which are conventional quantitative gauges of fiscal decentralisation. Effects on subnational authority over politics, policy and fiscal-financial management are more nuanced. 

The global financial and economic crisis had a marked impact on public finances and intergovernmental relations around the world. In particular, in many countries post-crisis counter-cyclical efforts included sharp increases in public investment that were carried out predominantly at the subnational level and financed by the centre through grants and transfers (OECD 2009). These increases show up in public finance statistics as an increase in subnational revenue and spending shares, which are conventional gauges of fiscal decentralisation. By the same token, when stimulus packages were subsequently withdrawn, the attendant fall in subnational revenue and spending shares could be interpreted as evidence of greater centralisation in intergovernmental fiscal relations, complicating empirical analysis and policy advice.

The crisis also set in motion wide-ranging institutional reforms to intergovernmental fiscal-financial management in support of medium-term fiscal consolidation programmes. The EU is a case in point, with the introduction of the ‘European Semester' (since 2011), the ‘Six Pack' (valid since December 2011), the ‘Fiscal Compact' (since January 2013) and the ‘Two Pack' (since May 2013) to strengthen rules for budgeting and deficit making, as well as monitoring and enforcement procedures. These institutional reforms have shaped, and to some extent they have been shaped by, changes in the ability of subnational governments to influence national policymaking. In some cases, the need to engage the regional and local governments in nationwide fiscal consolidation programmes – and to secure their political support for reform – has actually empowered the subnational jurisdictions, given them a stronger voice in intergovernmental policy fora. 

Post-crisis reforms also sought to improve the managerial efficiency of subnational governments and ensure the delivery of cost-effective services to the population at times of fiscal duress. Reforms included, for example, the reorganisation of regional governments in Finland, France and Greece. In some cases, these reforms were already in motion before the crisis and recognised the scope for economies of scale in the delivery of some services that could be reaped in support of medium-term fiscal consolidation. 

Another legacy of the crisis has been a rekindled interest in the study of comparative federalism and reform of intergovernmental fiscal relations. Case studies have been used to describe institutional changes that have been brought about or catalysed by the crisis (Kincaid et al. 2010, Eccleston and Trevor 2017).

Setting the scene: Measuring intergovernmental fiscal relations

The cross-country empirical literature on federalism and intergovernmental relations has grappled with measurement challenges since its inception. However, efforts have been made over the years to develop numerical indicators and collect data allowing for a much finer analysis of the causes and consequences of institutional reforms. Two broad categories of indicators can be identified.

First, conventional quantitative indicators focus on the public finances and measure the relative level and composition of expenditure, including those financed by intergovernmental grants and transfers, as well as revenue among the different levels of administration. These indicators are available for relatively long time series for large sets of countries from sources such as the IMF’s Government Financial Statistics, the OECD’s Regional Dataset, Eurostat and other organisations. The data set collected by Sow and Razafimahefa (2017) is a case in point, covering a range of OECD and non-OECD countries since 1990. Indicators can also be constructed based on the classification of the main budgetary aggregates from a functional viewpoint, as in the case for example of the Dziobek et al. (2011) dataset, which covers about 80 countries since 1990.

Of course, public finance indicators provide useful information on the budgetary resources that are available to the subnational governments, as well as their spending commitments and financial obligations. However, these indicators do not necessarily reflect the authority enjoyed by the subnational jurisdictions in politics, policy and management. A complementary suite of indicators has been developed over the years to focus on these prerogatives, including those developed by Hooghe et al. (2010, 2016), which cover a broad range of aspects of intergovernmental relations with a focus on the regional (middle-tier) jurisdictions and exhibiting sufficient time series variation to be used in empirical analysis. Their key indicators measure two broad aspects of subnational authority: self- and shared rule. The self-rule indicators are based on the policy, fiscal-financial and representation autonomy of the subnational governments within their own jurisdictional borders, whereas the shared-rule indicators measure the extent of joint prerogatives of subnational governments based on their capacity to influence national legislation and policy. Ladner et al. (2016) provide indicators of local government policy autonomy.

Alternative indicators are also available to measure subnational autonomy in tax policy, essentially by weighing tax revenue ratios by some measure of subnational tax policy autonomy (Stegarescu 2005). Kearney (1999) is a precursor to these more recent measurement efforts whose decentralisation index include several aspects of subnational autonomy, such as government structure, executive selection and central veto power, in additional to revenue and spending authority. 

What do these indicators show? There is indeed a shift to the right in the distributions of expenditure and revenues between 1990 and 2012, suggesting increased decentralisation (Figure 1). These trends were in motion before the crisis and underscore a gradual process of fiscal decentralisation around the world that is consistent with increased subnational authority. The literature on comparative federalism based on constitutional provisions also documents a trend towards greater decentralisation over the years leading up to the crisis (OECD and KIPF 2016). 

Figure 1 Kernel densities of selected fiscal decentralisation indicators

a) Subnational share of spending

b) Subnational share of revenue


Note: These estimates were generated with an Epanechnikov kernel and a band-width proportional to the sample size raised to the power -2.

The empirical evidence on the effects of the crisis on intergovernmental fiscal relations

In de Mello and Jalles (2020), we provide new evidence based on panel regressions and use a range of decentralisation indicators to compare pre- and post-crisis changes in intergovernmental relations. We find that the crisis indeed had a short-term decentralising effect on the public finances, at least as far as measured by conventional budgetary aggregates. In other words, increases in general government spending and debt ratios have been associated with rising subnational shares in spending and revenue since the crisis. To a large extent, as noted above, this finding is consistent with the role played by the subnational governments in the execution of stimulus programmes that were implemented in the immediate aftermath of the crisis and financed by the centre in the form of intergovernmental grants and transfers, as noted above.

More nuanced findings emerge from the analysis of the longer-term effects of the crisis on the institutional indicators of subnational authority in politics, policymaking and fiscal-financial management. While increases in general government spending after the crisis appear to have reduced subnational authority across a range of self- and shared-rule prerogatives, the converse is true for increases in general government indebtedness.

We reconcile these findings by recalling that the increase in government spending that occurred in the years following the crisis reflected to a large extent the implementation of stimulus packages executed by the subnational governments but financed predominantly by the centre. This centre-led policy response was accompanied, in several cases, by an increase in conditionality in intergovernmental grants and transfers, as well as the introduction of stricter fiscal rules, such as balanced budgets, debt breaks and deficit caps, that is reflected in a reduction in subnational policymaking and fiscal-financial management autonomy. Indeed, there has been a tightening of regulation on subnational borrowing and spending since the crisis, as shown by Braun and Trein (2014) for 11 federations during 2007-12. Interestingly, Bordo et al. (2011) investigated the consequences of the Great Depression and also found a centralising effect on federal relations.

By contrast, dealing with government indebtedness to address the needed post-crisis fiscal consolidation requires a longer-term, concerted policy response. In many cases, fiscal consolidation plans, such as the adjustment pacts that were put in place in several EU countries, included the introduction of stricter fiscal rules for both the central and subnational governments. But, in some cases, these rules included generous side-payments by the central government and/or acceptance of veto powers for the subnational governments in monitoring and sanctioning procedures. The cases of Austria and Germany are instructive in this regard (OECD 2010, 2011, 2012). The ability of subnational governments to influence national policymaking may have been enhanced, and an increase in subnational self-rule may have been a necessary quid pro quo for securing subnational government participation in national fiscal consolidation programmes.

What does this analysis teach us?

Intergovernmental relations are underpinned by slow-moving institutions, but they are hardly immutable, especially against the backdrop of a deep economic and financial crisis such as the one of 2008-09. Whereas public finances remain an essential source of statistics to measure relative subnational revenue and spending shares, a finer depiction of changes in intergovernmental relations emerges when attention is focused on the assignment of policy, political and managerial responsibilities across the different levels of government. This calls for further statistical work and use in empirical analysis of as broad as possible a range of indicators covering different aspects of intergovernmental relations beyond the public finances.     


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