Consequences of Decentralization

What are the ideas of political decentralization? How can decentralization attract enterprises to the regions? What are the consequences for firms? These and other questions are answered by Professor of Political Science in University of California, Los Angeles Daniel Treisman.

Political decentralization has been a very topical subject for the last few decades. People have lots of ideas about political decentralization. Especially in the US people tend to think that political decentralization is really good: it improves the quality of government, it can even be good for the economy, if a lot of power is held by politicians at the local level, regional lever, perhaps state lever. Many problems emerge because you have too much power in the center. So there is very strong demand in the US and in various other countries for more political decentralization.

One could come up with the reason why political decentralization might help in some way. But very often there was another logic that could lead to exactly the opposite consequences. Fir instance, competition for businesses to locate within a municipality sounds very good. The classical argument that governments will provide better services to businesses and that’ll be more efficient and less corrupt to attract businesses to locate there because of the competition between localities. That sounds like a good thing. But how else could these local governments compete? One possibility is that the would compete by giving generous tax breaks for the businesses. And this would have the effect of forcing all the municipalities to lower tax rates on business and they would have to make up for that raising taxes on the population. So it could lead to an excessive support for businesses from the point of view of the citizens.

Another way that local governments could compete to get these big firms to come and set up their headquarters in their locality would be to try and fight the central government on the firms’ behalf. An example of this was noticed in Russia. In the 1990s a lot of regional governments would illegally and covertly set up deals with enterprises in the region under which the regional governor would try to protect the enterprise from paying all the tax that it was supposed to pay to the central government. So if you remember, in the middle of 1990s Russia had terrible budget problems. It was unable to raise as much taxes as it needed to pay for public spending. In part that was because the regional governments were not remitting as much of the tax revenue as was supposed to go to the central government. And also they were helping the enterprises in essence evade taxes because that made it attractive for the enterprise to stay in that region.