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Article Summary

Prud’homme, Remy (1995).  “The Dangers of Decentralization,” World Bank Research Observer 10(2):201.

This article is a critique of fiscal federalism theory, which is a form of decentralization. Fiscal Federalism refers to a system in which local governments act autonomously in taxation and expenditure activities. There are no transfers between local governments. The central government, in general, “retreats” on all fronts. Prud’homme, in his study, highlights the dangers of such a system. He points to several major issues:

Redistribution (of any sort) cannot be undertaken at the local level. Centralization is a necessary prerequisite for redistribution, otherwise, a “capital flight” will occur wherever redistribution occurs. Ultimately, the generous local governments will be punished for enacting generous redistribution standards. A race to the bottom will occur. Prud’homme terms this “destructive competition.”

Economic Stability is much more difficult to attain with a high degree of decentralization, because the central government has lost power over fiscal policy. Even if the national government does have power over fiscal policy, its policies will have no authority unless they are backed up by actual recourses, such as the holding of a significant share of total taxation and expenditures. Otherwise, “fiscal perversity” can occur: the local governments may distort the national government’s ability to use fiscal mechanisms as a tool for stabilization. In the developing world, this will be particularly devastating.

Allocative Efficiency may be jeopardized under fiscal federalism. The focus on “demand efficiency” is inappropriate, particularly for the developing world: here, the problems are not “Tiebout model”-type mismatches in preferences and tastes, but a great want for basic needs (which are the same everywhere). Consequently, decentralization will bring negligible benefits, if any, to the 3rd world.

Corruption – or “informal taxation,” will be decentralized along with everything else. In general, central government officials tend to be of higher rank, of higher status, and more mobile, therefore less tied to a particular locale. There are indications that this makes them more difficult to corrupt than local officials. If this is the case, corruption will rise with greater decentralization.

Beyond the Centralization-Decentralization Dichotomy. In general, some activities, cultures, regions, and services are more suitable to decentralization than others. Decentralization is certainly useful in some circumstances, but it is certainly not a universal cure-all. There is a critical mass beyond which smaller units of government will lack the capacity and/or incentive to engage in the task at hand. Units of government must be set up in such a scale that it is responsive to the needs of its citizens.