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Friday, 7 November 2008

Fiscal decentralisation and economic growth

A regular issue that crops up on this blog is fiscal decentralisation - that is local autonomy on tax revenues and expenditure. See for example MrK's Manifesto for Economic Transformation, and to a lesser extent Henry Kyambalesa's Agenda for the next government? (Guest Blog - HK). Fiscal decentralisation aims to encourage efficiency and better realignment of local preferences with development priorities, ultimately leading to "economic growth". But can fiscal decentralisation deliver superior economic performance?

Well according to this latest paper, the answer is a little more complicated. In short, it probably would not be able to deliver growth if all you do is transfer resources to the local level, but it probably can work if it also comes with some "local tax" raising powers - or rather if the authorities raise what they spend. The problem with that solution, is that is it leaves the local system open to exploitation by "local elites", or other corrupt entities, unless fiscal decentralisation is accompanied with changes to local "power structures". As we have discussed many times, this in itself is fraught with political and cultural challenges, not to mention informational ones (for example, there's no point allowing people to vote on the budget if they are illiterate and are not able to read the details of the budget or have no access to information - one of the challenges of "participatory budgeting"). Excerpt from the paper :

This study has tested for the effect of fiscal decentralization on the rate of economic growth across a sample of 16 Central and Eastern European (CEE) countries for the years 1990-2004. Our findings suggest that fiscal decentralization is operating in the opposite direction than what is predicted by the ‘economic growth through fiscal decentralization’ hypothesis. The results conclude that expenditure at, and transfers to, the subnational level have had negative correlation to national growth rates in CEE, while locally imposed taxation has achieved some mildly positive economic benefits over time.

In terms of subnational expenditure and transfers, our results are in line with the findings of other empirical studies on fiscal decentralization and economic growth, such as Zhang and Zou (2001), Rodden (2002), Thießen (2003), and Rodríguez-Pose and Bwire (2004). Although decentralization is often associated with increased degrees of policy innovation, greater transparency, and better capacity of governments to adapt policies to local needs, it can be difficult to connect these factors with increased economic performance. Especially in countries lacking the appropriate institutions, legal systems, and human capital, economic growth rates are unlikely to rise as a direct result of fiscal decentralization. Indeed the opposite case is more likely to happen with decentralization having a detrimental effect on the overall economy of a country.

However, while subnational expenditure assignments and dependence on transfers have negative implications for economic growth, locally imposed taxes have, in the medium term, the opposite effect. This supports the claims that when subnational governments have a greater share of own revenues and are more responsible and accountable for their expenditures, there is a greater likelihood of achieving the economic efficiency predicted by the majority of the literature on fiscal decentralization. The ability for local governments to generate their own revenues promotes fiscal responsibility and incentivizes them to meet expenditure obligations in a transparent manner. Although subject to local competencies, an important challenge and implication for fiscal decentralization reforms therefore is to adjust locally generated revenues to local expenditure responsibilities.

The positive correlation between local tax and economic growth at the national level shows, however, a more nuanced picture of fiscal decentralization in CEE. Namely, the ability for local governments to create their own revenue, fiscal responsibility and incentives to meet their expenditure responsibilities can bring about medium-term economic benefits, and are hence important implications for the design of fiscal decentralization. This is a very relevant outcome in the case of CEE, as most of the countries are still in the early stages of extensive programmes aimed at restructuring government which began in the 1990s. In many regions, local accountability is not in place and local governments are often at the mercy of power elites who use local and regional government as a further opportunity to promote their own private, rather than collective interests. This means not only that fiscal decentralization has, in order to be economically effective, to be accompanied by serious attempts to change the existing structures of power within communities (Shah, 2000; Bardhan, 2002), but also that the potential benefits from further reforms, both in terms of strengthening institutions and promoting fiscal decentralization can, in time, have better implications for economic growth. Hence for fiscal decentralization to yield the benefits touted in the literature, the fiscal architecture must be appropriately designed: local governments must have a significant degree of real autonomy, adequate accountability to local populations whose preferences local officials are supposed to be responding to, and sufficient capacity to respond to local demands.

National fiscal and tax reforms have taken place in a weak macroeconomic context, and the lack of experience and capacity in raising local own-source revenue has hindered the necessary exercise of local fiscal discretion that is called for in fiscal decentralization. As most countries in the region have only just completed the process of transition, the idea of rapid transition to fiscal decentralization may be over-ambitious. In terms of economic growth, the CEE countries are attempting to fast-track what has been a relatively slow process elsewhere in Europe and North America (Gooptu, 2005). The list of problems that CEE countries have faced to date with fiscal decentralization seems to lend weight to arguments for slowing the process, at least until there is greater demand from below for decentralization and laws and enforcement mechanisms are fortified through stronger institutions.

Overall, fiscal decentralization is a multifaceted process and the inverse relationship between growth and subnational expenditure assignment and fiscal transfers, and the, in time, positive correlation between growth and subnational taxation, as implied in this study, is just one facet to consider. Within the fiscal sphere, all the fiscal decentralization indicators examined in this study are intertwined. Meaning that if one of these elements is poorly designed, the entire fiscal structure may be compromised. As indicated by Bird (2000), the design of each pillar of the intergovernmental system must be very well linked to broader decentralization reform goals and intergovernmental fiscal policy objectives. The importance of this study is therefore not only to isolate the significant influence of any individual fiscal decentralization indicator, but also to underline the complex nature of the interaction between different indicators and the importance of understanding this interaction when undertaking further reforms towards fiscal decentralization.

13 comments:

  1. Cho,

    Thanks for mentioning my Manifesto. I am flexible on the decentralisation to the Municipal government level, but I think the rest stands up pretty well even after a couple of years.

    Hence for fiscal decentralization to yield the benefits touted in the literature, the fiscal architecture must be appropriately designed: local governments must have a significant degree of real autonomy, adequate accountability to local populations whose preferences local officials are supposed to be responding to, and sufficient capacity to respond to local demands.

    I would like to add that through my Manifesto, local government would receive it's share of central government revenues, distributed by an independent government (ZRA) agency. They would not have to depend on extra income from bicycle or dog tax or any other local taxes and levies. As we know, Levy Mwanawasa was on record of being against any decentralization of budgets.

    But I think the overall thrust of the article is that local accountability and transparancy leads to more responsive government.

    As an interesting link, more about decentralization at the Provincial government level, in The Sudan:

    The imperative of decentralization
    Daniel Awet Akot (2006)

    On decentralisation to the District level in Zambia:

    Districts now road authorites
    By KANYANTA KATONGO

    THE Road Development Agency (RDA) has appointed all the 72 district councils in the country as Road Authorities. Minister of Works and Supply, Kapembwa Simbao, said in a statement yesterday that the appointments were effective February 12, 2007.
    More...

    Here is a previous article on decentralisation in Zambia:

    (ALLAFRICA, TIMES) On Decentralisation

    The Times of Zambia (Ndola)
    5 December 2007
    Posted to the web 5 December 2007
    Ndola

    The drive by Government for a fully decentralised and democratically elected governance system as one way of enhancing transparency and accountability is a noble pursuit. Whichever way one looks at it, there is no denying the importance of a strong local government system based on open, predictable and transparent procedures tailored towards enhanced service delivery to the people. The Government decentralisation vision envisages enhanced and effective community participation in the decision-making process relating to the development and administration of local affairs while at the same time maintaining strong linkages with the centre.


    More...

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  2. MrK,

    I agree that your Manifesto has withstood critical scrutiny with considerable success for years. I am glad to hear that you remain flexible with regard to methodology of decentralization to the local level, since, if I read this paper correctly, the findings here would indicate a re-evaluation is in order.

    Your current method is stated as, "local government would receive it's share of central government revenues, distributed by an independent government (ZRA) agency. They would not have to depend on extra income from bicycle or dog tax or any other local taxes and levies." This particular study seems to conclude that such a structure is unlikely to fulfill its potential for growth, as indicated by this paragraph:

    "However, while subnational expenditure assignments and dependence on transfers have negative implications for economic growth, locally imposed taxes have, in the medium term, the opposite effect. This supports the claims that when subnational governments have a greater share of own revenues and are more responsible and accountable for their expenditures, there is a greater likelihood of achieving the economic efficiency predicted by the majority of the literature on fiscal decentralization. The ability for local governments to generate their own revenues promotes fiscal responsibility and incentivizes them to meet expenditure obligations in a transparent manner. Although subject to local competencies, an important challenge and implication for fiscal decentralization reforms therefore is to adjust locally generated revenues to local expenditure responsibilities."

    In other words, when local governments are simply handed a share of national revenues by a central tax collection agency, they do not apparently spend it as effectively than if they are given access to a taxation revenue stream of their own and forced to collect and budget accordingly. This is akin to the classic "Tragedy of the Commons" economic scenario, where access to a limited amount of pasture is available to all farmers without limitations, the result is to reward those who act most selfishly in the short run and ultimately ruin the pasture itself in the longer run.

    It is encouraging however that where local government is given both resource and responsibility, they appear to perform with comparable effectiveness to their national counterparts with regard to overall national economic growth, and (arguably) better with regard to innovation, flexibility and responsiveness.

    The implications would also seem to suggest that any redistributive efforts by central government authorities aimed at balancing regional inequities are better delivered in the form of tangible infrastructure projects and regulatory flexibility rather than direct budget support. This would also seem to be supported by the experience of EU member states such as Ireland, Portugal and Spain.

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  3. Yakima,

    " The ability for local governments to generate their own revenues promotes fiscal responsibility and incentivizes them to meet expenditure obligations in a transparent manner. "

    In my opinion, the source of the funding doesn't have anything to do with the level of accountability.

    If the ZRA was an independent organisation, and there was a depoliticized civil service, it could both collect taxes nationally and disperse them to government, including local government. If any council would have problems with it's finances, the council could be put under all kinds of supervision or restrictions. Councils could be forced to show receipts before money was released. Every council would have a ZRA account, with an account manager who would be rotated to a different council every 3 years (for instance).

    You could practically eliminate corruption.

    The ZRA would be the only central government agency that I would expand. :)

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  4. MrK,

    While I cannot personally vouch for the veracity of this particular study, either its methodology or conclusions, I feel compelled to again state that this particular study is, apparently as its primary practical application, declaring that it does indeed matter how local governments collect the revenues that they spend. What is being asserted is that there is a profound difference between the attitude of a local government with an independent source of revenue versus one with a fully dependent source, with regard to functional investment in measurable development.

    Now I will be among the first to claim that those aspects this study does not or cannot measure with regard to local development are just as, if not more, important than what they can and/or do measure. That said, I still find it useful to evaluate any and all data relevant to development planning which might better inform those directing Zambia's development policy.

    I will also admit that one of the reasons which I have chosen to take this study seriously is precisely because as a long time advocate of fiscal decentralization, I feel compelled to examine most closely that evidence which might indicate that I am mistaken and may do harm with good intent.

    I will repeat that I am encouraged by the fact that this study does not find that decentralization is in itself undesirable (with regard to encouraging classic economic development), rather that the tactics used to achieve the goal have variable effectiveness. With that in mind, I feel that while your conception of ZRA as final arbiter over councils would work after a fashion, I find that the concept shown to be effective within the interpretation of the data by the model presented in this paper to be superior.

    While it is fully conceivable that an "independent" ZRA could be established, it begs the question of exactly what independence means in practice over time. For example as a restaurant owner in the US state of Oregon, I am subject to the whims of the Oregon Liquor Control Commission, which was established in the 1930's as an independent agency to oversee the sale and distribution of alcohol within the state following the abolition of prohibition laws. While I don't doubt that the politicians here had good reasons for wanting an "independent agency" to regulate this particular part of public life at the time that they established its legal authority, in practice it is now, generations later, an unelected, unaccountable, largely hereditary agency which is completely out of step with the rest of the US on regulation and prevention, and has only begun to relent to popular opinion in the wake of their own top executive being arrested for driving while intoxicated.

    My point is that independence is something that can only be maintained for a clearly defined period and task within a bureaucracy. Special prosecutors or investigative task forces with clear boundaries and goals can be safely cut loose from control by elected officials. To establish agencies without democratic checks that have constitutional mandates to run for generations is very dangerous even at the local level, to do so at the heart of government revenue collection and distribution seems to tempt fate in the extreme.

    Assuming however that ZRA manages to maintain its integrity and esprit de corps, and does an exemplary job in all aspects of revenue collection and distribution without corruption, we have yet to deal with the implications in this particular study with regard to how local governments will spend the money disbursed to them by ZRA. Unfortunately, the paper does not include extensive appendices of raw data, and so I am forced to assume that if the authors were able to detect a significant factor reducing overall development directly attributable to the misallocation of funds by central government otherwise destined for localities, that they would have included it (however privately I maintain suspicions that they may not have looked, or been permitted to look, all that thoroughly).

    Given all that, we still have to contend with the difference in incentives between a localized tax base and a national distribution network with regard to achievement of development goals. What is being contended in the study, and which I am contending also makes common sense, is that if the amount of money a local government gets to play with is dependent on the size and profitability of local businesses and taxable (ie middle class) citizenry, then it will have immediate incentives to increase those factors which are not as present or as strong under a central distribution and expenditure regulation model such as you are currently advocating as your path to fiscal decentralization.

    Another way of putting the conclusions of this paper is to say there is no halfway to decentralization, either local authorities have control over the resources and legislative responsibility for disbursing them, or they don't. Apparently they cannot be trusted to do one without the other, but in the process of doing both they become more responsive, more innovative, and more accountable.

    If these conclusions can be borne out beyond the confines of this study alone, then I think it behooves you to take advantage of the apparent symbiosis between decentralization of revenue and expenditure in your model. If not, best we debunk this definitively, lest it contribute to error on a massive scale.

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  5. MrK,

    My understanding is similar to Yakima's.

    The paper's conclusions, if accepted, provides little scope for a "half-way house".

    The problem with the "full house" is that you then have to worry about the local corrupt elements..and how "power is equalised" so to speak....

    On that front new research seems to suggest that the most efficient way to prevent corruption is through efficient legal systems...if true then, if we can fix that..we need not worry too much about creating complex systems of local accountability e.g. participatory budgeting...

    Unfortunately as this chief highlights our local legal system is broken..

    http://zambian-economist.blogspot.com/2008/03/insights-from-chiefs-chief-chisunka.html

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  6. Cho, Yakima,

    I've finally managed to get to this.

    1) This is about Eastern Europe

    Even though they are etnically diverse, and have moved from a strongly centralized government to more decentralized government, there are also differences with African governments. The main would be the long history of settlement that preceded centralization with the arrival of communism in 1945. In Eastern Europe, there is no formal role in government envisioned for former traditional authorities - the aristocracy and the Church, as offical parts of government.

    2) Interesting example

    If you look at the level of development, it is relevant to look at the former Czechoslovakia, which was unified into one country. Now, they are the Czech Republic and Slovakia again. Slovakia was always the less developed and more rural of the two.

    It is interesting to see their respective decentralisation, because they used to be the same country.

    Figure 1 Subnational Shares of General Government Expenditures

    Czech Rep 23.0%
    Slovak Rep 6.3%

    Now it doesn't say what the cause is and what the consequence - whether decentralisation improved on development, or whether previous development made it easier to decentralize government. Or even whether there was already a greater level of prior decentralization, before the fall of communism. Remember that the closer the countries were to the West, the less strict communist rule was. East Germans were very much influenced about what they saw on West German television, even when the 'Iron Curtain' was already up. Hungary was always very much oriented towards Austria in their outlook and historical memory - communism lasted only 44 years, so there were many people alive who remembered the time before it's institution. There were many degrees of totalitarianism and statism, which to a great degree coincided with who ruled that part of the country before communism. Even within a country like Poland, there was a clear distinction between parts of the country that were once ruled by the aristocracy (greater poverty and inequality) and the church (greater level of social involvement).

    GDP (PPP) in US$ versus % of Subnational Shares of General Government Expenditures

    Czech Republic: $19,272.24 23%
    Hungary: $16,746.68 25.9%
    Slovakia: $14,410.24 6.3%
    Poland: $12,955.78 35%
    Russia: $9,821.52 33%
    Belarus: $6,592.43 41.7%

    Sources:

    Fiscal decentralization and economic
    growth in Central and Eastern Europe


    Nation Master - Statistical resource

    The per capita GDP does not take into account income inequality within the economy and society.

    You could conclude from this list, that higher the per capita income, the lower the share of local government expenditures is of all government expenditures. Or vice versa. It is unclear if A causes B, B causes A, A and B are caused by C, or whether this is pure coincidence. Certainly this list is not exhaustive, but a comparison between the Czech Republic and the Slovak Republic can be useful as they used to be the same country of Czechoslovakia.

    I came across this very interesting and relevant file from the year 2000:

    THE EFFECTIVENESS OF DECENTRALIZATION IN HUNGARY AND SLOVAKIA
    Jean-Jacques Dethier
    The World Bank, Washington, D.C. 1

    About decentralization in Hungary:

    To replace the local councils, citizens were granted the right to create autonomous self governments (önkormany). This process was driven in large part by an understandable political imperative to get rid of the old system but led to excessive fragmentation. As a result, there are now some 3,200 local governments of which about 1,670 have less than 1,000 inhabitants.

    To which I say - WOW. I my manifesto I only suggested 350 local councils with a population of 30,000 people each. But at least we now have a measuring stick of what 'excessive fragentation' means. :)

    Here are the tasks assigned to local government:

    Local governments are obliged to provide primary education, basic health and social welfare provisions, waste disposal, safe drinking water, public lighting, and to maintain local public roads and cemeteries. They are also obligated to enforce the observance of rights of national and ethnic minorities. Other tasks—not all mandatory—include providing local mass transport, settlement development, snow removal, fire protection, and public security and the explicitly voluntary provision of cultural and sports facilities, housing, and public safety.

    I had only listed education, healthcare, policing/enforcement and utilities as mandatory, to make sure that basic services are met as well as limit government expenditures, with the finances from what is left over or specifically set aside, to be determined by local people and councils themselves.

    On the source of funds:

    Local government expenditures in Hungary have accounted for roughly 20 percent of public sector expenditures and 35 percent of public sector investment. Locally raised tax revenues over which localities have control have amounted to only 20 percent of total revenues, or roughly 3 percent of GDP. Local governments also receive a share of the personal income tax, based on the amount collected within their jurisdiction, and 50 percent of the motor vehicle tax; but these two revenue sources yield only 11 percent of total local revenues. As a result, local governments depend heavily on transfers from other parts of the public sector to finance their expenditures. Transfers include a series of normative and earmarked transfers to cover current expenditures, as well as a system of specific grants to finance investment.

    In other words, in Hungary, only 20% of local government revenues come from local and personal taxes - leaving 80% to come from central government.

    In Zambia, I think local government revenues must be closer to 100% coming from local taxes, because famously, the Ministry of Local Government receives more national funds than all local governments combined. I think this is the reason for the absence of local services - too much money sticks at the ministerial level.

    About Slovakia:

    While Hungary is one of the most decentralized countries in Central and Eastern Europe,
    Slovakia is one of the least decentralized.


    And also much poorer than the Czech Republic. Not saying there is a direct connection, because Hungary was part of the Austro-Hungarian empire, and Slovakia was always the Czech Republic's poorer twin.

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  7. Yakima,

    Your current method is stated as, "local government would receive it's share of central government revenues, distributed by an independent government (ZRA) agency. They would not have to depend on extra income from bicycle or dog tax or any other local taxes and levies." This particular study seems to conclude that such a structure is unlikely to fulfill its potential for growth, as indicated by this paragraph:

    "However, while subnational expenditure assignments and dependence on transfers have negative implications for economic growth, locally imposed taxes have, in the medium term, the opposite effect. This supports the claims that when subnational governments have a greater share of own revenues and are more responsible and accountable for their expenditures, there is a greater likelihood of achieving the economic efficiency predicted by the majority of the literature on fiscal decentralization. The ability for local governments to generate their own revenues promotes fiscal responsibility and incentivizes them to meet expenditure obligations in a transparent manner. Although subject to local competencies, an important challenge and implication for fiscal decentralization reforms therefore is to adjust locally generated revenues to local expenditure responsibilities."

    There seems to be an inverse relationship between relative wealth of the population, and national funding for local government.

    I think what is going on is that with poor populations, there is the need to fund local government from national revenues, because there is simply no way to raise enough revenues locally. If the people are poor, local governments can't rely on taxes from real estate, luxury cars, golfclub membership and the like, and have to resort to taxing dogs and bikes.

    Considering most people in Zambia earn considerably less than people in Eastern Europe, and the lowest income countries have more of national revenues go to local government, it would make sense in this regard to make the mines pay for it. Also, perhaps local governments could get into the mining business themselves to provide income and jobs. They could exploit small mines - even if it gave them $1mn per year extra income, it would more than double their present budgets where many cities are concerned.

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  8. MrK,

    Interesting assessment, and you make an important point about the absolute amount of revenue available being in the Zambian case, overly dependent on excise, income and other taxes on a few large companies, and therefore not directly accessible by (most) local governments. I do think that strengthens your case for wholesale redistribution of a large percentage of national revenues evenly across all local authorities. I am not certain however that such transfers will not be accompanied by the type of increased potential for fraud by local authorities themselves described in the reference, nor by improved rates of investment in economic development by them once they have control over funds.

    The question occurs to me, is it possible to structure incentives for local authorities in such a way that national transfers will be invested in ways which increase local tax bases over time? Similar to the road inspection dilemma, what sorts of checks and balances on how local authorities spend are available and effective?

    Direct investment by local authorities in specialized productive activities such as mining, manufacturing or agriculture can be fraught with unnecessary difficulties due primarily to the fact that politicians are not always as well informed about specific industries than their private sector counterparts, which is one argument for why they tend to get out-competed (more so for small scale operations) over the long term. Vertical integration of value-added processing that provides for export of finished goods processed from sustainable sources of local raw materials, as in the Warm Springs model, can significantly overcome some disadvantages to direct investment. Achieving efficient vertical integration however requires sustained commitment to high rates of investment long before the full benefits can be realized.

    On the other hand, as we often discuss, improved public infrastructure is often a pre-requisite for stimulating growth of profitable local enterprises. In discussions about Tribal corporations, I have touched on the potential of relatively passive electrical generation technologies as a flexible means of localized investment, in that the power produced can be either used to reduce the overhead costs of existing operations, sold to national or regional power grids to increase cash flow, or employed as raw material for further value addition and vertical integration of local production.

    To draw the somewhat strained parallel between electrical power and the thesis in the reference paper, the supposition is that giving local authorities direct control over the production and use of 10MWh of electricity, as opposed to providing them with 10MWh of "free" electricity from the national grid, will result in local authorities using more of their resources to generate even more of their own electricity. Perhaps if local authorities are given the ability to tax local production (which admittedly doesn't much exist at present), as well as the 50% share of national revenues, along with a set schedule of decline of that national revenue share over time, they might be better incentivized to make investments in local development at a higher rate?

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  9. MrK,

    I came across this on the attra.ncat.org website, and I found it to be a rather startlingly clear illustration of how much localizing ownership can speed up development in local economies.

    "Farmer-owned renewable energy facilities enable farmers to pool their resources to meet startup capital requirements and other costs, while producing an energy source that is largely non-polluting and thus less damaging to the environment. Cooperatively owned biodiesel and ethanol plants offer other benefits too: They tend to increase local prices for soybeans (in the case of biodiesel) and corn (in the case of ethanol). Grower-owners can sell their own commodities to the plant, and are eligible to receive annual dividends. Moreover, biofuel plants provide a hedge against volatile commodity prices. When corn or soy prices drop, so do the production costs of ethanol or biodiesel, increasing the potential profits from biofuel production. This is not to deny, of course, that there are very substantial financial risks for farmers investing in bioenergy production facilities. Energy markets are volatile and unpredictable.

    "A locally owned renewable energy facility can generate economic benefits to a community that are as much as 56 percent higher than facilities owned by absentee companies. The biggest component of this 56-percent increase is the multiplier effect—a term that refers to the way that money circulates within a community. Increased local income encourages spending on local goods and services. Similarly, when locally owned businesses spend money in the community for payroll, member dividends, operations, supplies, etc., those dollars have a multiplier effect because they are re-circulated within the community several times.

    "In general, direct labor needs in renewable energy projects are comparable, regardless of whether the facility is locally or remotely owned. However, locally owned facilities can create more indirect jobs in local communities. A September 2004 U.S. Government Accountability Office report studied the relative economic impacts of locally owned and remotely owned wind systems. The study found that locally owned wind systems generated an average of 2.3 times more jobs and 3.1 times more local dollar impact than wind systems financed by non-local interests. This increase in jobs results from accumulation of wealth within the local economy—the multiplier effect.

    "A July 2006 report from Iowa State University found that an ethanol plant in Iowa would create—either directly or indirectly—133 jobs in the regional economy with no local ownership. For each 25-percent increase in local ownership, 29 more jobs are created."

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  10. Yakima,

    The question occurs to me, is it possible to structure incentives for local authorities in such a way that national transfers will be invested in ways which increase local tax bases over time?

    In my manifesto I mentioned education, healthcare, policing, and utilities as the core tasks of local government, but I could have added roads/local infrastructure to that - as required as it could also be funded from a road tax.

    All of which would elevate a future tax base. Education will create more educated workers and the jobs to go with that. Hong Kong always advertises about how educated their workforce is. Healthcare would reduce the number of sick days, policing would decrease the cost of doing business by reducing vandalism and theft, and utilities (electricity, water, sewage disposal) are a requirement for doing business. These are all indirect ways of facilitating commerce in a community.

    However I think it are the roads which have the greatest potential to open up remote areas for agriculture and other sectors.

    Similar to the road inspection dilemma, what sorts of checks and balances on how local authorities spend are available and effective?

    I think the ZRA would have a comptroller in every local council. These comptrollers would be periodically rotated from one council to the next.

    Also, expenditures could be all electronic only. The council's employees and suppliers would have to have bank accounts where money would be transferred to. This would cut down on ghost employees and at least leave an electronic paper trail.

    Lastly, extra attention could be given to problem councils, as most in the end would be run honestly.

    The question occurs to me, is it possible to structure incentives for local authorities in such a way that national transfers will be invested in ways which increase local tax bases over time? Similar to the road inspection dilemma, what sorts of checks and balances on how local authorities spend are available and effective?

    One way I can think of, is to reward them for the number of successful startups in their council.

    For instance, a council could get slightly more money from central government, for instance a percentage of taxes collected.

    The measure of success could be the number of startups registered in their council, which still pay taxes 3 years after they first become profitable.

    Let's say startups have a flat tax of 6% of either income or turnover, 1% could go to the local council where they first registered.

    New startups could have to deposit 10% of shares with the council, and if they are successful, receive back 8% of their shares, with 1% remaining in possession of the council and 1% going to the council leader him/herself.

    I think that because they become worth more as the business becomes more successful, shares could be used as an incentive that generates goodwill toward the company and business creation. As it is difficult to predict which startup will be the next Microsoft, there is an incentive to start as many new businesses as possible and have as many of the succeed as possible.

    And I agree completely that inbuilt incentives need to be thought out very carefully to get the intended results.

    The study found that locally owned wind systems generated an average of 2.3 times more jobs and 3.1 times more local dollar impact than wind systems financed by non-local interests. This increase in jobs results from accumulation of wealth within the local economy—the multiplier effect.

    The idea of local accumulation of wealth goes directly against the theory of neoliberalism and it's reliance on free markets and the unhindered repatriation of funds.

    This is also why the boom in copper prices had a minimal impact on the Zambian economy. Because the mines were not taxed, because they were not required to reinvest any of their profits locally, they only created jobs - which were not effectively monitored for terms of employment. I suspect the creation of these MFEZ special economic zones is just another attempt to sidestep local and national legislation on worker conditions and environmental pollution (a kind of economic Gitmo's).

    Neoliberalism's incentives were all wrong, if the objective was to foster local development through foreign investment. (And of course it wasn't - the objective of neoliberalism was to create a one world corporate economy.)

    "A July 2006 report from Iowa State University found that an ethanol plant in Iowa would create—either directly or indirectly—133 jobs in the regional economy with no local ownership. For each 25-percent increase in local ownership, 29 more jobs are created."

    Are you familiar with the works of Claud Anderson, and local economics theory (LETs)?

    There are a lot of interesting articles and links on Local Economics Theory on this page, including to the Henry George Institute and the Institute for Community Economics.

    On local money, as an alternative to scarce official currency:

    The LETS Design Manual and on Transaction.net and a page on Complementary Community Local Exchange Systems in Asia, Africa and Latin America.

    These systems basically exist to keep economic activity going in the absence of official currency, where people exchange services and goods outside of the official economy. They could provide some comfort to communities during times of hyperinflation.

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  11. MrK,

    Thanks for the links to LETs, I am only somewhat familiar with localized currencies, primarily from the US perspective. Most such systems I have encountered, such as Ithaca NY's broad-based parallel currency for local barter transactions, Wash. DC's public employee child sitting trade coupons, and my local Portland OR effort, tend toward the Marxist conception of equivalent value per hour of labour regardless, and often seem to unintentionally discourage skill acquisition and/or quality products. Something similar happened to Soviet systems, if a masters in engineering provides no greater reward than pushing a broom, then why bother with all the classes and lectures and effort? I don't think that this is an inherent problem with localized currencies per se, but rather some fuzzy thinking on the part of some on the American Left with regard to Tragedy of Commons dilemmas.

    For example, I recall trying to explain to my local time-trading organization that their policy of attracting new entrants to their system by offering them 2 hours of someone else's time without requirement to reimburse was inherently inflationary to consumers, and that in fact the time being spent on administration by the organizers themselves was likewise watering down their supposedly fixed currency. I tried for several hours (it was a friendly conversation, not a debate), but the idea that they would have little choice but to apply some sort of tax on the system in order to account for administration and expansion of their base just wouldn't penetrate. I concluded, perhaps out of personal frustration more than proper science, that they simply wished for it not to be true, especially that their own "selfless" actions to free their fellow citizens from the tyranny of the dollar in fact required someone else's labour to pay for them.

    The result over the past several years has been a steady decline in the number of requests for hours being actually filled by a person with the appropriate skills, while the total requested hours has continued to grow. In simple terms, people are relatively uninterested in earning more coupons until they can be confident of receiving value for the coupons they already have. The opposite case occurred in DC with the public employee child sitting coupons (again, simple trade of hour for hour, only this time hours were closer to actual equivalence of invested value), when they didn't issue enough of them and ran head on into the "desired savings rate" of their client base. In other words, parents were hoarding coupons against the day when they would really need them, and were reluctant to spend what they had, which in turn made it impossible for the next family to accumulate enough coupons to make them comfortable spending some, and so on. The problem was solved by a large inflation of the number of coupons in circulation.

    I agree that there is potential for such localized currencies to cushion against certain types of macroeconomic distress, however I caution that it appears to be all too easy to simply create a microcosm of failed national currencies.

    Oh, and I forgot to mention in the last post that the truly surprising thing about the advice from attra.ncat.org was that it was being paid for by the US Dept. of Agriculture, which goes to show how the internal culture of a large specialized bureaucracy can act in the interests of a relatively narrow constituency like farmers, contrary to the ideological goals of the politically elected national leadership. I think you are working a potentially very productive seam with this concept, thanks for allowing my concerns about shoring up the roof as you go to slow your pace, hopefully only in the short term.

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  12. Thanks for the links to LETs, I am only somewhat familiar with localized currencies, primarily from the US perspective. Most such systems I have encountered, such as Ithaca NY's broad-based parallel currency for local barter transactions, Wash. DC's public employee child sitting trade coupons, and my local Portland OR effort, tend toward the Marxist conception of equivalent value per hour of labour regardless, and often seem to unintentionally discourage skill acquisition and/or quality products. Something similar happened to Soviet systems, if a masters in engineering provides no greater reward than pushing a broom, then why bother with all the classes and lectures and effort? I don't think that this is an inherent problem with localized currencies per se, but rather some fuzzy thinking on the part of some on the American Left with regard to Tragedy of Commons dilemmas.

    Wouldn't it be relatively easy though to price the local currency as a dollar equivalent of the service that is provided? One $100 doctor's treatment would be the equivalent of X amount of groceries?

    Also, local currencies would have the potential of the exchange of services with the currency set at a pre-inflationary level. If there hyperinflation started 5 years ago, the local currency could be set at that level, and some commerce could continue.

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  13. MrK,

    I didn't mean to imply that local currencies can't work, they certainly can, and do. I just get frustrated in the face of insistence by some advocates of such systems that somehow they are tapping into something mystical rather than historical, "Newage", to use a term I learned from members of the Anishnabai Tribe of Ontario and Quebec, rhymes with "sewage" and masquerades as "New Age" applications of traditional methods or values.

    For example, in the material provided on the Complementary Community Local Exchange Systems site, I find the claims that somehow such systems are inherently more fair than national currencies or bank credit to be both false and unnecessary. The principle evidence I can find for this is the assertion that interest is unfair, while user fees are fair.

    The most stable and flexible systems described are the ones which are pegged to a more widely accepted currency, usually the national currency, or as in your hyperinflation example, another nation's currency. However, systems employing strict credit limits and user fees rather than interest on short term borrowed capital, are for practical purposes identical to the original American Express Card terms and conditions.

    This is a good way to get local people to extend microcredit to each other, however like any enterprise it has overhead costs and efficiencies, and in my more cynical moments I suspect that the operators of many LES choose to hide behind the mystical assertion that they have tapped into something ancient yet unknown to modern finance in order to disguise the fact that they are making a living off "administrating" the new currency.

    To quote from the CES pdf,
    Type 1: Mutual Credit Currency
    Advantages
    • Simple to manage, transparent, sound way of issuing money.
    • Easy to audit, impossible to steal from.
    • Gives access to money to everyone, not just those who are already wealthy.
    • Individual and community responsibility for maintaining the currency.
    Disadvantages
    • Requires some administrative ability and dedication.
    • Requires some overhead to ensure transparency and accountability.

    Type 2: Fiat Currency
    Advantages
    • As long as the money supply is less than the value of goods and services available, no
    problems. Over-issuance can cause inflation in prices and collapse of the system.
    • Ensures each person receives an equal amount of money.
    • Requires little overhead to maintain.
    Disadvantages
    • Lack of transparency can lead to abuses, over-issuance of money.
    • Problems of over-issuance are difficult to solve, often lead to collapse.
    • No individual responsibility for maintaining the currency.


    The mutual credit systems are good, but not really currency, just lending or triangular barter. The assertions about fiat currency are more troubling to me, because it becomes hard to see how they cover their overhead if not by supply inflation or by taxing transactions or holdings, which is what governments do. I also suspect that rather than ensuring that each person receives an equal amount of money (a phrase which could have come straight out of some little red book), they in fact issue each person an equal amount of credit, which if not properly managed can leave them not only as impoverished as before, but also in debt. Four out of the six bullet items cited make reference to over-issuance and/or responsibility, accompanied by words like lack of transparency, abuses, problems, difficult and of course, collapse. Not unlike every other currency I have heard of.

    So I guess I would say that such systems should be deployed where a lack of liquid capital or transferable collateral for traditional credit is restraining trade, certainly, however should be pegged to a larger currency with a view toward eventually entirely replacing credit/trade in local currency with the larger currency. That's because, all things being equal, the economy of scale will cause the more widely circulated currency to be administrated at a lower cost. This becomes more pronounced with regular savings, presumably a sign of increased prosperity in part due to access to credit, when a currency user wishes to convert surpluses of local units into national ones. Since users are less likely to wish to convert in the other direction, this puts exchange rate pressure on the local currency unless the supply is deflated to match the conversion rate.

    Sure it makes sense if you are in a very isolated village where the total supply of national currency is tiny, and what comes in from underpriced exports goes right back out to buy too few overpriced imports because the shippers are making you pay the traffic in both directions, but everyone keeps exporting their entire surplus because it is the only source of cash. Then a local currency unit can encourage diversification away from export production and toward import substitution, with subsequent potential to exploit the difference between the advantage of external economies of scale versus reduced transport costs.

    It also makes sense to absorb the costs and inefficiencies of local currencies in circumstances like Zimbabwe, where the national currency is no longer reflective of any real value for more than a few seconds at a time, and supplies of foreign currency are short. Of course it is hard to do worse at imposing overhead costs on currency holders than Harare has done in recent years. However, I believe that such local currencies are illegal under present Zimbabwean law, and efforts to replace the national currency with a new one would still require an overhaul of central bank and government policy to prevent the hyperinflation from simply jumping to the new currency.

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