Monday, May 18, 2020

Counter-cyclical central powers with pro-cyclical sub-central ones, again

Rodden and Wibbels have an academic article where they analyze, in the context of the previous global financial crisis and before, the conflicto between counter-cyclical stablization policies of central governments, and pro-cyclical budgets of sub-central ones. Because of tax competition and borrowing constraints, the finances of regional powers have a very hard time in times of crisis, although in most federations and decentralized countries, they have very important expenditure powers that are more under demand in times of recession. This creates tensions that, among other things, may undermine the stabilization efforts of the central Powers, who in turn may have incentives not to transfer enough resources to the sub-central governments, in order to shift the blame for the crisis.
Although fiscal policies of central governments sometimes provide modest insurance against regional income shocks, the paper shows that procyclical fiscal policy among provincial governments can easily overwhelm these stabilizing effects. The authors examine the cyclicality of budget items among provincial governments in seven federations (it seems that Canada and Australia do it better than the others), showing that own-source taxes are generally highly procyclical, and contrary to common wisdom, revenue sharing and discretionary transfers are either acyclical or procyclical. Constituent governments are thus left alone to smooth their own shocks, and they document the extent to which various restraints on borrowing and saving undermine their ability to do so. The resulting procyclicality of provincial fiscal policy is likely to have important implications in a world where demands for countercyclical fiscal policy are increasing but considerable fiscal responsibilities are being devolved to subnational governments.
They do not develop a lot on the potential solutions, but they hint that specific institutions like ones existing in Australia and Canada may be useful to introduce an explicit mandate to counteract output shocks. Since similar tensions are emerging again in federal and decentralized countries in the context of the COVID-19 crisis, these ideas will be necessary again.

No comments:

Post a Comment