Fiscal Decentralization in Developing Countries: A Review of Current Concepts and Practice

The reform of economic systems in developing countries during the 1980s focused largely on increasing the role of the market and improving the environment in which it operates. For some years, there was a preoccupation with the private sector, such that reformers almost seemed to forget the potential role of the public sector in promoting development. In recent years, there have been widespread attempts both to redefine the role of the public sector in developing countries and to improve its performance. An increasingly important component of these reforms is the introduction of policies to decentralize the functions of government.

During the 1990s, fiscal decentralization and local government reform have become among the most widespread trends in development. Many of these wide-ranging and costly efforts, however, have made only modest progress toward meeting their stated goals. Given this uneven performance, there has been extensive debate about the desirability of fiscal decentralization and how to approach it.

This paper examines the origins, conceptual foundations and practice of fiscal decentralization in developing countries. First, it considers why fiscal centralization has been so prominent historically in developing countries, and why this trend has been reversing. Second, it summarizes conventional fiscal decentralization theory and considers its relevance for developing countries. Third, it reviews some popular claims made for and against fiscal decentralization, and considers the available empirical evidence. Fourth, it outlines some key elements of fiscal decentralization as it is being promoted in selected countries, including some of the problems being faced and successes being realized. The paper concludes with some observations on how to think about designing more appropriate and effective fiscal decentralization in developing countries.

As economic and political pressures for fiscal decentralization escalate and forces driving democratization develop, many countries will feel increasing pressure to decentralize. In spite of this growing interest and support, fiscal reform of local government is likely to be a slow and painful process because serious constraints on decentralization are not going to disappear suddenly, and some standard analytical tools may have limited applicability. Available con-ceptual frameworks for analysing fiscal decentralization are useful, but they are not designed to deal with some of the most important factors affecting effective fiscal decentralization.

The most critical problem fiscal decentralization analysts face is a dearth of good comparative information on the extent to which and the conditions under which the alleged benefits and disadvantages of fiscal decentralization have been realized. Anecdotal evidence and case studies provide some insights, but additional policy experimentation and more systematic research are needed to understand more broadly the realities of and prospects for fiscal decentralization in developing countries. Such information would lead the way to better conceptual development and more effective public policy.