Journal of Economic Perspectives—Volume 16, Number 4—Fall 2002—Pages 185–205

Decentralization of Governance andDevelopment

Pranab Bardhan

A ll around the world in matters of governance, decentralization is the rage.Even apart from the widely debated issues of subsidiarity and devolution inthe European Union and states’ rights in the United States, decentraliza-

tion has been at the center stage of policy experiments in the last two decades ina large number of developing and transition economies in Latin America, Africaand Asia. The World Bank, for example, has embraced it as one of the majorgovernance reforms on its agenda (for example, World Bank, 2000; Burki, Perryand Dillinger, 1999). Take also the examples of the two largest countries of theworld, China and India. Decentralization has been regarded as the major institu-tional framework for the phenomenal industrial growth in the last two decades inChina, taking place largely in the nonstate nonprivate sector. India ushered in alandmark constitutional reform in favor of decentralization around the same timeit launched a major program of economic reform in the early 1990s.

On account of its many failures, the centralized state everywhere has lost agreat deal of legitimacy, and decentralization is widely believed to promise a rangeof benefits. It is often suggested as a way of reducing the role of the state in general,by fragmenting central authority and introducing more intergovernmental com-petition and checks and balances. It is viewed as a way to make government moreresponsive and efficient. Technological changes have also made it somewhat easierthan before to provide public services (like electricity and water supply) relativelyefficiently in smaller market areas, and the lower levels of government have now agreater ability to handle certain tasks. In a world of rampant ethnic conflicts andseparatist movements, decentralization is also regarded as a way of diffusing socialand political tensions and ensuring local cultural and political autonomy.

These potential benefits of decentralization have attracted a very diverse range

y Pranab Bardhan is Professor of Economics, University of California, Berkeley, California.

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of supporters. For example, free-market economists tend to emphasize the benefitsof reducing the power of the overextended or predatory state. In some interna-tional organizations pushing structural adjustment and transitional reform, decen-tralization has sometimes been used almost as a synonym for privatization; similarly,in the literature on mechanism design, an informationally decentralized system ofindividual decisions coordinated by a price mechanism is pitted against a system ofcentral commands and plans. Even those who are convinced of the pervasiveness ofmarket failures are increasingly turning for their resolution to the government atthe local level, where the transaction costs are relatively low and the informationproblems that can contribute to central government failures are less acute. Theyare joined by a diverse array of social thinkers: postmodernists, multiculturaladvocates, grassroots environmental activists and supporters of the cause of indig-enous peoples and technologies. In the absence of a better unifying name, I woulddescribe this latter group as “anarcho-communitarians.” They are usually bothanti-market and anti-centralized state, and they energetically support assignment ofcontrol to local self-governing communities.

As is usually the case when a subject draws advocates from sharply differentviewpoints, different people mean different things by decentralization. In thispaper, we shall focus on a particular kind of decentralization in developing andtransition economies, the devolution of political decision-making power to local-level, small-scale entities. In countries with a long history of centralized control—asin the old empire states of Russia, China or India—public administrators oftenmean by decentralization the dispersion of some responsibilities to regional branchoffices at the local level of implementation on a particular project. For the purposeof discussion in this paper, we shall distinguish decentralization in the sense ofdevolution of political decision-making power from such mere administrative del-egation of functions of the central government to local branches. We should alsoseparate the political and administrative aspects of decentralization from those offiscal decentralization and, in the latter, the more numerous cases of decentraliza-tion of public expenditure from those involving decentralization of both tax andexpenditure assignments. We shall include cases where local community organiza-tions become formally involved in the implementation of some centrally directedor funded projects. Not all these aspects of decentralization operate simultaneouslyin any particular case, and it is quite possible that a given economy may bedecentralized in some respects, not in others. It should also be clear that the effectsof a policy of deliberate decentralization—which is our concern here—can bequalitatively different from those following from an anarchic erosion of centralcontrol, which can be due either to the collapse of the state, as has happened insome countries in Africa, or lack of administrative or fiscal capacity on the part ofthe central authority leading to abandonment of social protection functions, as hashappened in some transition economies.

The territorial domain of subnational governments, of course, varies enor-mously from country to country. A typical province in India or China is larger inpopulation than most countries in the world, and so federalism in the sense of

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devolution of power to the provincial state governments may still keep power overpeople pretty centralized. Unfortunately, data below the provincial governmentlevel are often very scarce, and most quantitative studies of decentralization—forexample, those based on share of the central government in total expenditure orrevenues—do not pertain to the issues at the local community level (even apartfrom the fact that the share of expenditure or revenues is not a good index ofdecision-making authority). Even at the latter level, the units are diverse, rangingfrom megacities to small villages, and the boundaries are often determined byaccidents of history and geography, not by concerns of decentralization of admin-istration. In this paper, we shall in general confine the analytical focus of decen-tralization to the governing authority at the local community level: say, village,municipality or county levels of administration.

Our discussion begins with a description of why decentralization poses somedifferent issues in the institutional context of developing and transition countriesand, thus, why it may sometimes be hazardous to draw lessons for them from, say,the experiences of U.S. states and city governments. We try to give the flavor ofsome new theoretical models that extend the discussion to political agency prob-lems that may resonate more in the context of developing and transition econo-mies. We then refer to some of the ongoing empirical work in evaluating the impactof decentralization on delivery of public services and local business development.

Decentralization has undoubted merits and strengths. However, the idea ofdecentralization may need some protection against its own enthusiasts, both fromfree market advocates who see it as an opportunity to cripple the state and fromthose anarcho-communitarians who ignore the “community failures” that may be asserious as the market failures or government failures that economists commonlyanalyze.

Departures from the Fiscal Federalism Literature

There is a large literature on decentralization, often referred to as “fiscalfederalism,” mostly relating to the case of the United States.1 The principlesdiscussed in this literature have been fruitfully applied to the national-provincialrelations in developing countries like Argentina, Brazil, Colombia, South Africa,India or China, but in this paper, we shall go beyond this and stress the specialissues that arise in decentralization in developing and transition economies pri-marily because the institutional context, and therefore the structure of incentivesand organization, are in some respects qualitatively different from that in theclassical U.S. case or the recent case of the European Union.

Much of the fiscal federalism literature focuses on the economic efficiency ofintergovernmental competition, which often starts with a market metaphor that is

1 Many of the issues have been well surveyed in the JEP “Symposium on Fiscal Federalism” in the Fall1997 issue.

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rationalized by the well-worn Tiebout (1956) model. In this approach, differentlocal governments offer different public tax-expenditure bundles, and mobileindividuals are supposed to allocate themselves according to their preferences. Theassumptions required for the Tiebout model are, however, much too stringent,particularly for poor countries.2

First, the crucial assumption of population mobility—fully informed citizens“voting with their feet” in response to differential public performance—that en-ables governments in the Tiebout framework to overcome the well-known problemof inducing citizens to reveal their preferences for public goods largely fails in poorcountries. In any case, many of the public goods in question are community- andsite-specific, and it is often possible to exclude nonresidents. Rural communities ofpoor countries, in particular, are often face-to-face, and social norms sharplydistinguish “outsiders” from “insiders,” especially with respect to entitlement tocommunity services.

Secondly, the information and accounting systems and mechanisms of moni-toring public bureaucrats are much weaker in low-income countries. In the stan-dard literature on decentralization and fiscal federalism, the focus is on allocationof funds, and it is implicitly assumed that allocated funds automatically reach theirintended beneficiaries. This assumption needs to be drastically qualified in devel-oping countries, where attention must be paid to special incentives and devices tocheck bureaucratic corruption—and thus the differential efficacy of such mecha-nisms under centralization and decentralization becomes important.

Third, even in the relatively few democratic developing countries, the institu-tions of local democracy and mechanisms of political accountability are often weak.Thus, any discussion of delivery of public services has to grapple with issues ofcapture of governments at different tiers by elite groups more seriously than is thecustom in the traditional decentralization literature.

Fourth, the traditional literature on decentralization, even though not imper-vious to issues of distribution, is usually preoccupied with those of efficiency inpublic provision. When a major goal of decentralization in developing countries isto effectively reach out to the poor (or to diffuse unrest among disadvantagedminority groups), often in remote backward areas, targeting success in povertyalleviation programs is a more important performance criterion than the efficiencyof interregional resource allocation. In the traditional discussion of decentraliza-tion and federalism, the focus is on checks and balances, on how to restrain thecentral government’s power, whereas in many situations in developing countries,the poor and the minorities, oppressed by the local power groups, may be lookingto the central state for protection and relief. Stepan (forthcoming) has made auseful distinction between “coming-together federalism” like the United States,where previously sovereign polities gave up part of their sovereignty for efficiency

2 There are doubts about just how the Tiebout mechanism operates even in relatively mobile societieslike that of the United States. For instance, very few poor people move from state to state in search ofhigher welfare benefits (Hanson and Hartman, 1994).

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gains from resource pooling and a common market, and “holding-together feder-alism” like the multinational democracies of India, Belgium and Spain, where theemphasis is on redistributive or compensating transfers to keep the contendingpolities together. In heterogeneous societies, such redistributive pressures some-times lead fiscal decentralization to allow for state and local borrowing that may belarge enough to cause problems of macroeconomic stabilization, as has happenedin South Africa, Brazil and Argentina.3 Not all state-mandated redistribution,however, is inflationary or unproductive rent creation, as is usually presumed in thetraditional literature. Some redistribution to disadvantaged groups or regions—say in the form of decentralized delivery of health, education or infrastructuralservices—need not be at the expense of efficiency and may even improve thepotential for productive investment, innovation and human resource developmenton the part of communities long bypassed by the elite or the mainstream.

Fifth, the fiscal federalism literature typically assumes that lower levels ofgovernment both collect taxes and spend funds, so localities can be classified as lowtax/low service or high tax/high service. This connection between local revenuesand spending is actually rather tenuous. In most countries, much of the moreelastic (and progressive) sources of tax revenue lie with the central government,and there is a built-in tendency toward vertical fiscal imbalance. Income is oftengeographically concentrated, both because of agglomeration economies and initialendowments of natural resources and infrastructural facilities. Thus, certain localareas will find it much easier to raise significant tax revenue than others. Inaddition, there are limits to interregional tax competition. In many low-incomecountries, the decentralization issues discussed there are primarily about providingcentrally collected tax revenue to lower levels of government, rather than seekingto empower lower levels of government to collect taxes. The focus is on publicexpenditure assignments, unaccompanied by any significant financial devolution.

Sixth, the decentralization literature typically assumes that different levels ofgovernment all have similar levels of technical and administrative capacity. Thisassumption is questionable for all countries. On account of agglomeration econo-mies in attracting qualified people, in most countries, central bureaucracies attractbetter talent. But the problem is especially severe in many developing countries,where the quality of staff in local bureaucracies—including basic tasks like account-ing and record keeping—is very low. Even their more professional and technicalpeople suffer from the disadvantages of isolation, poor training and low interactionwith other professionals. As Bird (1995) puts it, information asymmetry thus worksboth ways: the central government may not know what to do; the local government

3 This paper will not have much to say on the impact of decentralization on macroeconomic stabiliza-tion. For a game-theoretic model of how decentralization or local democratization may increase the levelof central redistribution to prevent spirals of regional revolt and how the macroeconomic consequencesdepend on the initial levels of cultural division and decentralization, see Treisman (1999).

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may not know how to do it.4 Of course, this problem is of differential importancein different services. Providing for street cleaning or garbage collection may notrequire sophisticated expertise, but power production and transmission, bulksupply of clean water and public sanitation do. Decentralization to the local levelwill often work better in the former kind of services than the latter.

In our subsequent discussion, we shall consider the issues of decentralizationin developing countries, keeping in mind these points of difference with thetraditional literature.

Adapting the Theory of Decentralization for Developing Countries

The conventional wisdom in the fiscal federalism literature, as in Oates (1972),is that decentralization is to be preferred when tastes are heterogeneous and thereare no spillovers across jurisdictions. With spillovers and no heterogeneity, a centralgovernment providing a common level of public goods and services for all localitiesis more efficient; with spillovers, decentralization leads to underprovision of localpublic goods, as local decision makers do not take into account benefits going toother districts. The issue of spillovers is relevant to investment in certain areas, likehighway transport and communication, public research and extension and con-trolling pollution or epidemics. It is less relevant when the public goods are morelocal, as in local roads, minor irrigation, village health clinics, sanitation andidentification of beneficiaries of public transfer programs.

Centralization can also exploit economies of scale better in the construction ofoverhead facilities, but these economies of scale are less important in local man-agement and maintenance. In a canal irrigation system—for example, the one inSouth Korea described by Wade (1997)—construction was in the hands of centralauthority, but maintenance was devolved to local communities. Similarly, in pri-mary education, while the local government may run the day-to-day functioning ofschools, the upper-tier government can have the economies of scale in designingcurricula and prescribing and enforcing minimum quality standards. In the publicdelivery of electricity, economies of scale in generation and transmission may bethe responsibility of centralized power plants and grids, while the distribution maybe decentralized to local governments.

The traditional theory of fiscal federalism is now being extended to a politicaleconomy setting, with the introduction of transaction costs in the political marketsor political agency problems between the ruler and the ruled, between the politi-

4 Occasionally, however, the local people come up with ingenious low-cost solutions, whereas centralizedsystems use unnecessarily expensive services of specialized technicians. For some of the basic needs forpoor people, local youths with some minimum training as primary health workers or primary schoolteachers can be adequate. In other, more technical, projects there is a lot of scope for improving accessto engineering, project design and administrative skills. Organizations like AGETIP in Africa or theBrazil-based IBAM have in recent years been helpful in developing local technical capacity.

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cians/bureaucrats and the electorate, and for reasons mentioned above thesetransaction and agency costs may be much more serious in the context of devel-oping countries. It is usually argued that the local government has an informationadvantage over the upper-tier governments. But it may be asked why a centralgovernment cannot procure for itself the same information advantage of proximitythrough local agents. In some countries, the central government uses such repre-sentatives at the local level for this purpose, like the prefets in France and Italy or theintendentes in Chile. It may even be argued that the central government can haveeconomies of scope in the collection of information. But the main reason why inpractice the local government still retains the informational advantage has to dowith political accountability. In democratic countries, the local politicians may havemore incentive to use local information than national or provincial politicians,since the former are answerable to the local electorate while the latter have widerconstituencies, where the local issues may get diluted.

Focusing on accountability, rather than information per se, leads to thinkingabout how the public can monitor and affect elected officials at different levels ofgovernment. Seabright (1996) discusses the problem of political accountabilitytheoretically in terms of allocation of control rights in the context of incompletecontracts, where breaches of contract are observable, though not verifiable inadministrative or judicial review, and are subject to periodic electoral review. Hismodel has both central and local elected officials. In his framework, centralizationallows benefits from policy coordination, which is especially important if there arespillovers across jurisdictions. However, centralization has costs in terms of dimin-ished accountability, in the sense of reduced probability that the welfare of a givenlocality can determine the re-election of the government. Elections are, of course,extremely blunt instruments of political accountability, and other institutionaldevices and unelected community organizations (like nongovernmental organiza-tions) may be deployed to strengthen local accountability.

The mechanism of accountability may also be strengthened by “yardstickcompetition,” where jurisdictions are compared to each other (for example, Besleyand Case, 1995). The effort or competence of public officials is not directlyobservable by citizens, and if poor results occur, public officials can always pleadthat they did the best that was possible under the circumstances. However, if theshocks that create a wedge between effort and outcomes are correlated acrossjurisdictions, then yardstick competition can act as an indicator of relative effort onthe part of agents. As Seabright (1996) points out, this argument of yardstickcompetition under decentralization, which may help voters to know whether theyshould seek to replace their governments, is to be distinguished from his ownargument that decentralization may increase their ability to do so.

The combination of decentralization and yardstick competition allows thepossibility of experimentation in the way a given public service is provided and thendemonstration and learning from other jurisdictions. In China in the early years ofits market reforms, decentralization with jurisdictional competition allowed somecoastal areas to experiment with institutional reform, the success of which showed

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the way for the rest of the country. Economic historians have pointed to thefragmentation and decentralization in early modern Europe, sometimes called“parcelized sovereignty”—see, for example, the discussion in North and Thomas(1973)—as a source of strength, in enabling experimentation and competition,leading to technological and institutional innovations that helped Europe ulti-mately to overtake the more centralized empire states of Asia.

Tommasi and Weinschelbaum (1999) pose the political agency problem interms of the number of principals (relative to agents) in comparing centralizationand decentralization. Citizens are viewed as principals and their elected represen-tatives as agents. The local government has better means (in the form of informa-tion) to be responsive, also better (electoral) incentives. In the case of centraliza-tion, the number of principals is very large, while the number of agents are few,whereas in the case of decentralization, there is one agent per locality. The largerthe number of principals, the more serious is the problem of lack of coordinationin contracting with agents. Decentralization is preferable to centralization when theproblem of interjurisdictional externality is less important than the coordinationeffect.5

Besley and Coate (2000) focus on the importance of political aggregationmechanisms in the trade-off between centralized and decentralized provision oflocal public goods. Under decentralization, locally elected representatives selectpublic goods. Under a centralized system, policy choices are determined by alegislature consisting of elected representatives from each district, so that conflictsof interest between citizens of different jurisdictions play out in the legislature.They then reconsider the traditional questions of the fiscal federalism literature interms of alternative models of legislative behavior, one in which the decisions aretaken by a minimum winning coalition of representatives and the other wherelegislators reach a bargaining solution. They show that the familiar presumptionthat larger spillovers across jurisdictions help the case for centralization is not soclear under such political economy considerations.

Political accountability in poor countries is particularly affected by the likeli-hood of corruption or capture by interest groups. While local governments mayhave better local information and accountability pressure, they may be morevulnerable to capture by local elites, who will then receive a disproportionate shareof spending on public goods.6 (This is in contrast to the Seabright (1996) model

5 The idea of fewer principals in smaller jurisdictions having more political control clearly resembles therelationship between group size and free riding in the voluntary provision of a public good firstdiscussed by Olson (1965). As is well known, this relationship can be ambiguous.

6 In the Federalist Papers (no. 10), James Madison comments on the notion that local governments aremore prone to capture by elites and special interests: “The smaller the society, the fewer probably willbe the distinct parties and interests composing it; the fewer the distinct parties and interests, the morefrequently will a majority be found of the same party; and the smaller the number of individualscomposing a majority, and the smaller the compass within which they are placed, the more easily willthey concert and execute their plans of oppression. Extend the sphere and you take in a greater varietyof parties and interests; you make it less probable that a majority of the whole will have a common motive

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where political accountability is always greater at the local level.) On the otherhand, the central bureaucrat who is in charge of the delivery of, say, an infrastruc-tural service like electricity, telecommunications or canal irrigation may be corruptin a way that leads to cost padding, targeting failures and generally an inefficientlylow and inequitable service delivery. The problem for the central government thatemploys the bureaucrat is that it has very little information on the local needs,delivery costs and the amount actually delivered. Thus, many programs in devel-oping countries have a large gap between a commitment of resources at the centrallevel and delivery of services at the local level. For a particularly egregious example,see Reinikka and Svensson (2001), who study the leakage in the flow of educationalfunds from the central government to schools in Uganda in the period 1991–1995.They found that only 13 percent of the total grant transferred from the centralgovernment for nonwage expenditures in schools on items like textbooks, instruc-tional materials and other costs actually reached the schools. The majority ofschools actually received no money at all from the central transfers for nonwageexpenditures.

Bardhan and Mookherjee (2000a) develop an analytical framework that for-malizes the tradeoff between these conflicting aspects of centralized and decen-tralized delivery systems. Decentralization, by shifting control rights from thecentral bureaucrat (who otherwise acts like an unregulated monopolist) to a localgovernment, typically tends to expand service deliveries as authority goes to thosemore responsive to user needs. But with capture of the local government, in thesense of elites receiving a larger weight in the local government’s maximand of aweighted sum of welfare, there is a tendency for the local government to overpro-vide the service to local elites at the expense of the non-elite. The extent of suchinefficient and inequitable cross-subsidization will depend on the extent of localcapture and on the degree of fiscal autonomy of the local government.

On the latter question, we consider three different financing mechanisms forlocal governments: local taxes, user fees and central grants. With local tax financ-ing, there is the risk that the captured local government may resort to a regressivefinancing pattern whereby the non-elite bear the tax burden of providing servicesto the elite. Restrictions on the ability of local governments to levy taxes may thenbe desirable, even at the cost of reducing flexibility of service provision to localneed. User charges may be a useful compromise between the need for matchingprovision to local needs and avoiding an unduly heavy burden on the local poor.Since no user is compelled to use the service, user charges impose a limit on theextent of cross-subsidization foisted on the poor. So with user fees, financingdecentralization unambiguously welfare-dominates centralization as well as localtax-financed decentralization, irrespective of the extent of local capture. Centralgrant financing, on the other hand, may encourage local governments to claim

to invade the rights of other citizens; or if such a common motive exists, it will be more difficult for allwho feel it to discover their own strength and to act in unison with each other.”

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higher local need or cost, leading to a restriction of the level of service delivery; thewelfare implications are ambiguous, depending on a range of relevant political andfinancing parameters.

User charges cannot, however, be used to finance antipoverty programs suchas targeted public distribution of food, education or health services that by theirvery nature are targeted at groups that do not have the ability to pay for the service(or to pay bribes to the central bureaucrats). In such cases, as is shown in Bardhanand Mookherjee (2000b), the extent of capture of local governments relative tothat of the central government is a critical determinant of the welfare impact ofdecentralization. If local governments are equally or less vulnerable to capture thanthe central government, decentralization is then likely to improve both efficiencyand equity. But the opposite may be the case when capture at the local level is muchgreater than at the central level.

Even though the extent of relative capture of governments at different levelsis crucial in understanding the likely impact of decentralization initiatives, therehas been very little work on the subject, either theoretical7 or empirical. The extentof capture of local governments by local elites depends on levels of social andeconomic inequality within communities, traditions of political participation andvoter awareness, fairness and regularity of elections, transparency in local decision-making processes and government accounts, media attention and other factors.These factors vary widely across communities and countries, as documented innumerous case studies (for example, Crook and Manor, 1998; Conning and Ke-vane, 2001). Of course, central governments are also subject to capture andperhaps even to a greater extent than at the local level on account of the largerimportance of campaign funds in national elections and better information aboutcandidates and issues in local elections based on informal sources. On the otherhand, particularly in large heterogeneous societies, the elites are usually moredivided at the national level, with more competing and heterogeneous groupsneutralizing one another. At the local level in situations of high inequality, collu-sion may be easier to organize and enforce in small proximate groups involvingofficials, politicians, contractors and interest groups; risks of being caught andreported are easier to manage, and the multiplex interlocking social and economicrelationships among local influential people may act as formidable barriers to entryinto these cozy rental havens. At the central level in democratic countries, moreinstitutional mechanisms for checks and balances are usually at place: these includevarious constitutional forms of separation of powers and adjudicatory systems insome countries, more regular auditing of public accounts and more vigilance by

7 For one theoretical analysis of the problem, see Bardhan and Mookherjee (2000c). We argue that theoverall comparison of capture at central and local levels in a democracy would depend on the interplayof a large number of underlying institutional factors, such as relative degrees of voter awareness andcohesiveness of special interest groups, the extent of heterogeneity across districts and the nature of thenational electoral system, and so the issue is ultimately context- and system-specific.

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national media. Such mechanisms are often absent or highly ineffective at the locallevel.

Even in undemocratic but largely egalitarian societies, the problem of localcapture may be less acute. It is generally overlooked in the widely noted successstory of decentralized rural-industrial development of China over the last twodecades that the decollectivization of agriculture since 1978 represented one of theworld’s most egalitarian distributions of land cultivation rights (with the size of landcultivated by a household assigned almost always strictly in terms of its demographicsize), and this may have substantially mitigated the problem of capture of localgovernments and other institutions by the oligarchic owners of immobile factors ofproduction (like land), which afflicts other rural economies (for example, India).

When the potential for capture of local governments is serious, decentraliza-tion programs have to focus a great deal of attention to strengthening localaccountability mechanisms. In fact, in policy debates, when we consider the costsand benefits of redistributive policies (like land reforms, public health campaignsor literacy movements), we often ignore their substantial positive spillover effects interms of enlarging the stake of large numbers of the poor in the system andstrengthening the institutions of local democracy. Comparing across the variousstates in India, it is clear that local democracy and institutions of decentralizationare more effective in the states (like Kerala and West Bengal) where land reformsand mass movements for raising political awareness have been more active. The1996 National Election Survey data in India suggest that in West Bengal, 51 percentof the respondent voters expressed a high level of trust in their local government,whereas in the adjoining state of Bihar (where both land reforms and localdemocracy institutions have been very weak), the corresponding figure is 30percent (Mitra and Singh, 1999). Near-universal literacy in Kerala has helpedsustain widespread newspaper readership, which has encouraged a vigilant press onissues like corruption in local governments.

In both Kerala and West Bengal, it has also been observed that theft andcorruption at the local level are more effectively resisted if regular local elections toselect representatives in the local bodies are supplemented by an institutionalizedsystem of periodic public hearings on items of major public expenditure. But eventhat monitoring device is inadequate if the complaints made in public are notacted upon by the ruling party. There is evidence that sometimes the oppositionparties or minority factions stop attending the village council meetings or thepublic hearings, as they perceive that they cannot do much about the rulingparty’s spending of public funds that takes the form of widespread distribution ofpatronage—like “jobs for the boys,” or what Italians call lottizzazione—which some-times consolidates its electoral advantage. It is important to install public accountscommittees at the local legislative level with their leading members taken from theopposition party, as is the case at the central parliamentary committees in India orBritain. In general, the auditing process at the local level is extremely deficient, notalways by design, but by the sheer dearth in the villages of technical capacity foraccounting, record keeping and auditing.

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In sum, in considering the theory of decentralization in developing countries,it is important to move beyond the traditional tradeoff of how centralization isbetter for dealing with spillovers and decentralization is better for dealing withheterogeneity. It is necessary to delve into political economy issues of institutionalprocess and accountability at both the local and central level.

Empirical Evaluation of Decentralized Delivery of Public Services

In this section, we shall indicate some of the attempts that have been made toevaluate empirically the impact of decentralization on the delivery of social servicesin developing countries. Even though decentralization experiments are going on inmany of these countries, hard quantitative evidence on their impact is ratherscarce. There are a number of scattered studies that we will arrange in terms of thenature of empirical methodology followed.

In two successful cases of decentralization in Latin America, there is someevidence available on the “before-after” comparison of service delivery outcomes.One is the widely noted case of participatory budgeting in municipal governmentin the city of Porto Alegre in Brazil; the other is the less well-known but quitedramatic success of the post-1994 decentralization initiative in Bolivia. In PortoAlegre, where assembly meetings of local citizens and neighborhood associations indifferent regions discuss investment priorities, review accounts and elect represen-tatives to a citywide council that allocates available resources across wards, impres-sive results have followed: between 1989 and 1996, access to basic sanitation (waterand sewage) as well as enrollment in elementary or secondary schools nearlydoubled, while increasing revenue collection by 48 percent (Santos, 1998). Al-though it is difficult from this study to isolate the impact of participatory budgetingreforms from those of other ongoing changes, it seems likely that there has been asubstantial impact on the pattern of resource allocation across localities, particu-larly to poor ones, and in the lessening of the misappropriation of resourcescompared to the past and to other areas in Brazil.

In Bolivia in 1994, the number of municipalities as well as the share of nationaltax revenue allocated to municipalities doubled, along with devolution to themunicipalities of administrative authority, investment responsibility and title tolocal infrastructural facilities. This change has been associated with a massive shiftof public resources in favor of the smaller and poorer municipalities and fromlarge-scale production to social sectors. Faguet (2001) finds that public investmentin education, water and sanitation rose significantly in three-quarters of all munic-ipalities, and investments responded to measures of local need; for example, theexpansion in public education spending was larger on average in municipalitieswith a lower literacy rate or with fewer private schools. Faguet’s analysis is in termsof levels of public spending, rather than outcome variables like school enrollmentsor school performance or access to water and sanitation services. In the studies ofPorto Alegre or Bolivia, not much information is available on the allocation of

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resources within a community across households in different socioeconomicclasses. This means that issues like cost-effectiveness of programs, targeting perfor-mance or the extent of capture of local governments cannot be addressed. Withouthousehold-level data on access to public services, these crucial aspects of the impactof decentralization cannot be properly assessed.

There is hardly any household-level analysis in the literature of the compara-tive effects of centralized versus decentralized delivery. One detailed study oftargeting performance of a decentralized program using household-level informa-tion in a developing country is that of Galasso and Ravallion (2001) studying adecentralized food-for-education program in Bangladesh. In this central govern-ment program, in which two million children participated in 1995–1996, theidentification of beneficiary households within a selected community was madetypically by a local school management committee consisting of parents, teachers,education specialists and school donors. Galasso and Ravallion use data from a1995–1996 Household Expenditure Survey to assess the targeting performance ofthe program. They find that the program was mildly pro-poor; that is, taking allvillages, a somewhat larger fraction of the poor received benefits from the programthan did the nonpoor. They also find some evidence of local capture. For example,within the set of participating villages, targeting performance was worse in com-munities with larger land inequality or in remote locations. But the targetingimproved as the program expanded, suggesting that the program shifted thebalance of power in favor of the poor. It is also clearly the case that the level oftargeting within communities was superior to that achieved across communities bycentral allocation, thus offering little support for the view that the central govern-ment is more accountable to the poor than local communities.

This finding is in some contrast to the experience of the widely acclaimedantipoverty transfer program of Progresa in Mexico. The program follows a two-stagetargeting process. Coady (2001) finds that most of Progresa’s targeting effectivenessis achieved at the first stage when poor localities are selected, rather than in thesecond stage when households are selected within localities, not on the basis ofidentification of beneficiaries by local communities as in the food-for-educationprogram in Bangladesh, but on the basis of information collected from a censusundertaken for this purpose.

Alderman (1998) examines, on the basis of a household survey conducted in1996, a targeted social assistance program (Ndihme Ekonomika) in Albania that wasdecentralized in 1995. He finds that there have been modest gains in targetingefficiency and cost-effectiveness following decentralization, that local authoritiesuse some additional information in allocating program benefits among householdsand that the central allocation of social assistance funds to local authorities isad hoc and not strongly correlated with the level of poverty in the local commu-nities. He does not find evidence that the decentralization initiative caused thewell-off members of the community to capture the benefits of the program.

There is some quantitative evidence on the impact of mandated representa-tions of historically disadvantaged groups like women in leadership positions in

198 Journal of Economic Perspectives

local governance in India. Since 1998, one-third of all positions of chief of thevillage councils in India have been reserved for women: only women may becandidates for the position of chief in a reserved village council, and the councilselects the latter randomly. Taking advantage of this random assignment (and thusavoiding an econometric problem in usual cross-section studies on this type ofquestion that communities that are more likely to take women’s needs into accountmay also be more willing to let them be in leadership positions), Chattopadhyayand Duflo (2001) have measured the impact of this political reservation policy onoutcomes of decentralization with data collected from a survey of all investments inlocal public goods made by village councils in one district in West Bengal. They findthat the women leaders of village councils invest more in infrastructure that isdirectly relevant to the needs of rural women, like drinking water, fuel and roads,and that village women are more likely to participate in the policymaking processif the leader of their village council is a woman. However, without direct evidenceon the nature of women’s preferences relative to men’s and since women’s reser-vation in the leadership positions in local government was not linked to thedistribution of women in the village, this study does not quite address how localdemocracy affects the ability of underrepresented groups in the village to imple-ment their desired outcomes.

Foster and Rosenzweig (2001) use a panel dataset of villages across India toexamine the consequences of democratization and fiscal decentralization. Theyfind that an increase in the demographic weight of the landless households in avillage under democratic decentralization has a positive effect on allocation ofpublic resources to road construction (which, according to them, primarily benefitsthe landless workers) and a negative effect on that to irrigation facilities (whichprimarily benefit the landed). But their dataset does not contain the many severeinstitutional lapses in the implementation of decentralization across India, partic-ularly in manipulations of the local electoral process and in the range of authorityand finances devolved to local governments, making democratic decentralizationnot yet a reality in most parts of India. It is not clear, for example, how much of aleeway elected local village councils have in matters of allocation to projects likeroad construction, which are often centrally sponsored and quite bureaucraticallycontrolled from above. At most the local government gets involved only in thedecision where to locate the road and to identify the beneficiary workers.

Some case studies also exist on the effects of decentralization in different partsof the world, which provide some descriptive and suggestive correlations, but notenough to clinch any hypothesis. Azfar, Kahkonen and Meagher (2000) surveyhouseholds and government officials at municipal and provincial levels in thePhilippines with respect to the stated public investment priorities in a given locality.Stated priorities of officials at the municipal level turned out to match weakly thoseof local residents, while those of officials at the provincial level did not, suggestingthat decentralization may improve the quality of information officials use in publicinvestment decisions. There is also some evidence in the survey of more perceivedcorruption at the central level than at the local level. A similar survey was carried

Pranab Bardhan 199

out by Azfar, Kahkonen and Meagher in Uganda with qualitatively similar results.They also find in Uganda a greater reliance on community leaders for newsconcerning local corruption and local elections than for national news, which theyinterpret as evidence of greater potential for local capture.

In the 1990s, Nicaragua started a program of transferring key managementtasks in public schools from central authorities to local councils involving parents.An evaluation of this program by King and Ozler (1998) on the basis of school andhousehold surveys and student achievement tests suggests that de facto autonomyhas not yet been given to many of the councils, but where it has been, there is asignificant positive effect on student performance.

The World Development Report 1994 on Infrastructure cited several cases ofquality improvement and cost savings in infrastructure projects after local commu-nities were given part of the responsibility in management. A review of World Bankdata for 42 developing countries found that where road maintenance was decen-tralized, backlogs were lower and the condition of roads better. Data for a group ofdeveloping countries revealed that per capita costs of water in World Bank–fundedwater projects were four times higher in centralized than in fully decentralizedsystems. A study of 121 completed rural water supply projects, financed by variousagencies, showed that projects with high participation in project selection anddesign were much more likely to have the water supply maintained in goodcondition than would be the case with more centralized decision-making.

Wade’s (1997) contrasting account of the operations of irrigation bureaucracyin South Korea and in south India brings out the importance of local accountabilityin delivery of infrastructural services. The Indian canal systems are large, central-ized hierarchies in charge of all functions, operations and maintenance as well asdesign and construction. Their ways of operation—including the promotion andtransfer rules for officials, rules designed to minimize identification between theirrigation patrollers and the local farmers, and the frequent use of low-trustmanagement and supervision methods—and source of finance (most of the irriga-tion department’s budget comes in the form of a grant from the state treasury) areinsensitive to the need for developing local trust and cooperation. In Korea, on theother hand, there are, according to this account, functionally separate organiza-tions in the canal systems. The implementation and routine maintenance tasks (asopposed to policymaking and technical design work) are delegated to the Farm-land Improvement Associations, one per catchment area, which are staffed by localpart-time farmers selected by the village chiefs, knowledgeable about changinglocal conditions, dependent for their salary and operational budget largely on theuser fees paid by the farmers and continually drawing upon local trust relation-ships. Korea at the time of the study did not have a democratic political regime ora free press, but farmers were better informed about and had better access to thelocal irrigation organization. This example shows that there is no one-to-onerelationship between the strength of democracy at the national political level andthat of institutions of accountability at the local level.

A similar story on accountability can be told in the field of education and

200 Journal of Economic Perspectives

health, comparing north India with some authoritarian countries. Institutions oflocal accountability are rather weak in large parts of north India, and it is commonto observe, for example, the serious problem of absenteeism of salaried teachers invillage public schools and of doctors in rural public health clinics.8 The villagers areusually aware of the problem but do not have the institutional means of correctingit, as the state-funded teachers and doctors are not answerable to the villagers in theinsufficiently decentralized system. On the other hand, in nondemocratic China,the local Communist Party officials have sometimes been quite responsive to localneeds (at least as long as they are not conflicting with the party’s program), as thecomparative study of two villages in China and India by Dreze and Saran (1995)show in the context of China’s far better performance in the provision of primaryeducation at the local level. Similar accounts are available of more effective publicpressure in rural basic education and health services in Cuba compared with someof the more democratic regimes in Latin America. There are, of course, manyauthoritarian countries where local accountability is completely absent and thesituation is much worse than in north India.

Taken as a group, these studies suggest generally positive effects of decentral-ization, but it is hard to draw conclusive lessons. Many of the studies are largelydescriptive, not analytical, and often suggest correlations rather than causal pro-cesses. Most of them are not based on household survey data, making the compar-ative impact of centralized versus decentralized programs on different socioeco-nomic groups of households difficult to assess.

Decentralization and Local Business Development

Most of the cases of decentralization in developing countries examined in thetheoretical and empirical literature relate to delivery of social services. But in recentyears, there has been an extension of the traditional literature on federalism to thecase of the role of local government in promoting local business development,particularly in the context of transition economies, especially China, and this haspotential implications for developing countries where so far public delivery issueshave been more prominent.

In Qian and Weingast (1997) and Qian and Roland (1998), for example,decentralization of information and authority and interjurisdictional competitionin China have been considered as commitment devices on the part of the centralor provincial government to provide market incentives, both the “positive” incen-tive rewarding economic success at the local level and the “negative” incentive interms of punishing economic failure. The local government-run township andvillage enterprises that served as the engine of growth in China in the last twodecades have been cited as a major example of the outcome of a successful

8 See, for example, PROBE (1999) on the basis of an intensive survey of 234 randomly selected villagesin north India carried out in 1996.

Decentralization of Governance and Development 201

“market-preserving federalism.” In terms of positive market incentives, the town-ship and village enterprises had full control over their assets and were largely leftalone (as a residual claimant) to “get rich gloriously,” and the limited knowledge ofthe upper-tier governments about the extra-budget and off-budget accounts of localgovernments acted as check on the upper-tier interventionism. In contrast, aneconometric study of the fiscal relations between local and regional governments inRussia by Zhuravskaya (2000) on the basis of a panel dataset for 35 large cities showsthat local governments could retain only about 10 percent of their revenues at themargin, thus providing only weak incentives to foster local business developmentand thus to increase their tax base. In terms of the “negative” incentive, Chineseupper-tier governments, by denying bailout to many failing township and villageenterprises, enforced a dynamic commitment. Having no access to state banks andfacing mobility of capital across jurisdictions raised the opportunity costs of localgovernments for rescuing inefficient firms, thus leading to the endogenous emer-gence of a hard budget constraint.

Without denying the importance of these market incentives, it is possible toargue, however, that the case of market-preserving federalism is institutionallyunderspecified in these studies. Depending on the political-institutional complexin different countries, the same market incentives may have different efficacy. AsRodden and Rose-Ackerman (1997) have pointed out in a critique of market-preserving federalism, whether political leaders of a local government respond tohighly mobile investors or instead pay more attention to the demands of strongdistributive coalitions dominated by owners of less mobile factors depends on theinstitutional milieu. Owners of capital vary widely in the specificity of their assets,and institutional incentives facing political leaders may vary even for the samejurisdictional competitive pressure. Even in a democracy, not to speak of authori-tarian systems, electoral competition does not necessarily punish local leaders whofail to respond to exit threats of mobile asset owners and are instead moreresponsive to coalition building and the voice of well-organized lobbies. We havepointed out earlier the problem of local capture by the oligarchic owners ofimmobile factors of production, like land in rural India, and how in the Chinesecase, the lack of such strong rural lobbies (owing largely to the egalitarian landdistribution) may have made a difference in the local governments’ vigorouspursuit of rural industrialization.9 In Russia, many have pointed out that over muchof the 1990s, local governments have shown features of being captured by erstwhilerent-holders and old firms, which sometimes blocked the rise of new firms thatcould compete away their rents.10 Of course, even in China by some accounts (for

9 Even in India, in areas where land distribution is relatively egalitarian and local democracy is moresolidaristic, as in Kerala, there are now some instances of municipal governments taking a leading role,in collaboration with bankers and social groups, in local business development. For some examples, seeDas (2000).

10 The explanation of China’s relative success attributed to political centralization in Blanchard andShleifer (2000) does not seem very plausible. A strong central political authority can punish local

202 Journal of Economic Perspectives

example, Shirk, 1993), local officials have often used their financial authority underdecentralization to build political machines, collecting rents in exchange of selec-tive benefits and patronage distribution, and federalism may not always have beenthat market preserving.

It seems jurisdictional competition is not enough to explain the emergence ofendogenous hard budget constraints for local governments without a lot morespecification of the local political process. Even ignoring the lobbies of landoligarchies, if a local business fails, threatening the livelihood of thousands of poorpeople, the local government (or if the latter is bankrupt, upper-tier governments)will have difficulty ignoring the political pressure that will be generated in favor ofbailing them out. Wildasin (1997) has rightly pointed out that federal grants tolocal governments may be less “soft” in the small jurisdictions as opposed to thelarge (which are “too big to fail”), but even small jurisdictions may have keypoliticians representing (or lobbying for) them—and in any case, it is cheaper tocome to their rescue.

Conclusion

It is quite plausible to argue that in the matter of service deliveries as well as inlocal business development, control rights in governance structures should beassigned to people who have the requisite information and incentives and at thesame time will bear responsibility for the (political and economic) consequences oftheir decisions. In many situations, this insight calls for more devolution of powerto local authorities and communities.

But at the same time, it is important to keep in mind that structures of localaccountability are not in place in many developing countries, and local govern-ments are often at the mercy of local power elites who may frustrate the goal ofachieving public delivery to the general populace of social services, infrastructuralfacilities and conditions conducive to local business development. This means thatdecentralization, to be really effective, has to accompany serious attempts to changethe existing structures of power within communities and to improve the opportu-nities for participation and voice and engaging the hitherto disadvantaged ordisenfranchised in the political process. After all, the logic behind decentralizationis not just about weakening the central authority, nor is it about preferring localelites to central authority, but it is fundamentally about making governance at thelocal level more responsive to the felt needs of the large majority of the population.To facilitate this, the state, far from retreating into the minimalist role of classicalliberalism, may sometimes have to play certain activist roles: enabling (if only as acatalyst) mobilization of people in local participatory development; neutralizing

governments (reducing the risk of their capture and the scope of their rent seeking), but one needs aplausible story of a benevolent nonrentier central authority to go with it.

Pranab Bardhan 203

the power of local oligarchs; providing supralocal support in the form of pump-priming local finance; supplying technical and professional services toward build-ing local capacity; acting as a watchdog for service quality standards, evaluation andauditing; investing in larger infrastructure; and providing some coordination in theface of externalities across localities.

The literature on decentralization in the context of development is still in itsinfancy. On the theoretical side, perhaps the key challenge is to find better ways tomodel the complex organizational and incentive problems that are involved, in asituation with pervasive problems of monitoring and enforcement. On the empir-ical side, there is a great deal of scope for rigorous work in evaluating the impactof ongoing decentralization initiatives, using detailed household and communitysurveys, comparing it with the experience with centralization or some other coun-terfactual. In such empirical work, one has to be particularly wary of severaleconometric problems. One issue is that some of the data involved in evaluatingcommunity participation and project performance may be subjective. For instance,some investigators start with the prior belief that participation is good, whichcreates a “halo effect” in their observations. A second problem is one of simulta-neity: better beneficiary participation may cause improved project performance,but improved project performance often also encourages higher participation.11

Finally, there is the commonly encountered endogeneity problem. Before beingtoo quick to claim that decentralization brought about certain outcomes, it is worthconsidering that decentralization may have resulted from ongoing political andeconomic changes that also affected these same outcomes. Separating decentral-ization from its political and economic causes, so that decentralization is not just aproxy for an ill-defined broad package of social and economic reforms, is a delicatetask.

y I am grateful to Brad De Long, Timothy Taylor and Michael Waldman for editorialsuggestions and to Dilip Mookherjee for substantive discussion (and joint research) on issuesrelating to this paper.

11 For an attempt to take this latter set of econometric problems into account in an evaluation of 121rural water projects, see Isham, Narayan and Pritchett (1995).

204 Journal of Economic Perspectives

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