Federalism and the Decentralized Politics of Macroeconomic Policy and Performance
Model 1: Model 2: Model 3
Variable Fiscal Balance Inflation Debt
FEDERAL −1.408∗∗ .057∗ .012
(.034) (.030) (.009)
MEAST NAFRICA −2.212 −.294∗∗ −.023
(2.040) (.124) (.034)
S ASIA −5.757∗ −.384∗∗∗ −.077∗
(3.055) (.147) (.045)
E ASIA −.130 −.344∗∗∗ −.006
(1.888) (.121) (.035)
SUB AFRICA −1.367 −.246∗∗ −.039
(2.030) (.119) (.039)
LATINAM .668 −.173∗ .078∗∗∗
(1.743) (.103) (.032)
ELECT YEAR −.696 .064 .009
(1.576) (.079) (.027)
PARTYFRAC 1.278 .017 −.013
(2.085) (.087) (.045)
DEMOCRACY −.109 .011 −.009∗∗∗
(.175) (.008) .004
TRADE 4.449∗∗ −.097 .218∗∗∗
(1.892) (.096) (.018)
lnGDP Per Capita 1.657∗∗∗ −.046 −.070∗∗∗
(.653) (.037) (.023)
GDP GROWTH .367∗∗∗ −.028∗∗∗ −.010∗∗∗
(.108) (.005) (.002)
WORLD −.122∗∗∗ .008
GROWTH (.041) (.008)
WORLD INFLAT −.004∗∗
(.002)
TREND .700∗∗∗ −.005 −.001
(.151) (.006) (.002)
LAGGED LEVEL −.350∗∗∗ −.228∗∗∗ .140∗∗
(.034) (.029) (.066)
ADJUSTED R2 .20 .15 .12
N= 841 1016 1208
Note:Volatility measured in first differences. Analysis conducted using OLS with panel- corrected standard errors. Entries are OLS regression coefficients; panel-corrected stan- dard errors in parentheses.
∗p=.10;∗∗p=.05;∗∗∗p=.01.
table 3.4. Determinants of Economic Crises, 1978–2000
Independent Model 1: Model 2: Model 3:
Variable Budget Balance Inflation Debt
FEDERAL 1.610∗∗∗ .781∗∗∗ .249∗
(.307) (.242) (.147)
MEAST NAFRICA −5.498∗∗∗ 1.283∗∗∗
(.888) (.421)
S ASIA −11.987∗∗∗ −.405
(2.202) (.431)
E ASIA .453 −6.560∗∗∗ .403
(.548) (1.314) (.415)
SUB AFRICA 2.340∗∗∗ −4.721∗∗∗ −.683
(.683) (.952) (.515)
LATINAM .982∗ −2.389∗∗∗ 1.252∗∗∗
(.532) (.662) (.352)
ELECT YEAR .205 −.077 −.106
(.334) (.289) (.278)
PARTYFRAC −1.517∗∗∗ 2.146∗∗∗ −.995∗
(.596) (.656) (.487)
DEMOCRACY .088∗∗ −.061 −.532∗
(.043) (.045) (.304)
TRADE −2.107∗∗∗ 1.136∗ −.003
(.567) (.681) (.002)
GDP Per Capita −.508 −2.053∗∗∗ 1.243∗∗∗
(.371) (.373) (.153)
GDP GROWTH −.075∗∗∗ −.139∗∗∗ −.024
(.023) (.024) (.019)
WORLD −.100 −.004
GROWTH (.089) (.023)
WORLD INFLAT −.043∗∗∗
(.010)
TREND −.167∗∗∗ .113 −.053∗∗∗
(.023) (.032) (.021)
log likelihood −357.929 −382.260 −324.887
N= 903 1081 1259
Note:Analysis conducted using logistic regression. Entries are logit estimates derived via maximum likelihood; standard errors in parentheses. A nation is in crisis when its inflation, governmental deficit, or indebtedness is greater than one standard deviation above the global average.
∗p=.10;∗∗p=.05;∗∗∗p=.01.
respect to macroeconomic performance, the controls for global eco- nomic context contribute relatively little, with increased world growth decreasing the likelihood only of deficit crises. The dummies for the Middle East and North Africa, sub-Saharan Africa, and Latin America regions contribute explanatory leverage, with Latin America again pro- viding the surprising result that all else considered, those nations are less likely to have inflationary crises, though predictably more likely to experience debt crises. Middle East and North African nations be- have similarly to those of Latin America, while South and East Asian nations are also less likely to experience inflationary crises. Election years do not have a consistent effect on the likelihood of crises. By contrast, party fractionalization and democracies do have important (if somewhat contradictory) effects on crises. Contrary to expectations, but consistent with recent evidence on democratic consolidation, in- creased party fractionalization decreases the likelihood of budgetary and debt crises.31Democracies have an increased propensity to fiscal crises but a lower likelihood of experiencing debt crises.
Returning, in summary, to the central explanatory variable under consideration, whether the indicator is of adjustment, volatility, or crisis, federalism has a pronounced tendency to exacerbate economic problems in the developing world. The findings are strongest with re- spect to fiscal and monetary policy, but federal governments are also more prone to debt crises. In no case does the coefficient’s direction contradict the theorized relationship; indeed, in most cases the impact of federalism is quite powerful and statistically significant.
Discussion
These findings point to five important conclusions. First and foremost, it suggests that federal institutions do matter for macroeconomic pol- icy and performance – they negatively affect the capacity of national governments to implement macroeconomic reforms. The result is a ten- dency toward macroeconomic fragility, volatility, and crisis. To date, the literatures on the political economy of market reform, federalism,
31 See Power and Gasiorowski (1997) for evidence on the finding that multipartism does not lessen the likelihood of democratic consolidations as Haggard and Kaufman (1995) have theorized.
fiscal decentralization, and macroeconomic policy have for the most part ignored the role of political federalism in the making (and break- ing) of macroeconomic policy in developing nations. In the case of the market reform literature, emphasis has been placed almost strictly on the national and international levels of analysis. Independent bureau- cracies, insulated executives, international economic pressures, and unified national party systems are the ingredients for successful reform efforts. The political federalism literature has focused overwhelmingly on a small number of cases where macroeconomic policy is not subject to coordination problems and concluded wrongly that those cases are generalizable to the universe of federations. In the burgeoning litera- ture on fiscal decentralization, the theorized relationship between fiscal federalism and macroeconomic outcomes overlooks the importance of subnational electoral incentives as a mediator between decentralized fiscal policy and economic performance. Finally, research on macro- economic outcomes, whereas increasingly engaged with the important effects of national level political fragmentation on policy, has under- appreciated the role of federalism in geographically fracturing control over macroeconomics. In all four cases, the political economy of sub- national politics is absent from the analytical story.
Second, given the contrary findings with respect to federations in the developed world, these results suggest there are important differences between federations in the developing and developed worlds. Although there is some evidence of occasional fiscal policy inconsistency across levels of government in the OECD federations, it is considerably more marked in many developing federations. Although the developed fed- eral systems appear largely to have overcome the coordination prob- lems inherent in federalism to achieve extended periods of economic stability and growth, the same cannot be said of their counterparts in the developing world. A number of factors might contribute to the greater degree of policy fragmentation in lesser developed federations:
weak subnational revenue collection and dependence on central trans- fers, widespread clientelism and a lack of electoral competition at the regional level, less regional bureaucratic capacity, more intense pro- cesses of market reform by national governments, deeper economic crises, and intergovernmental institutions that reward overspending are all features of developing federations that developed nations have, at least in part, managed to avoid or overcome.
As a result, this research raises significant questions about the widespread movement toward fiscal decentralization in the developing federations of the world. Although the supposed advantages of decen- tralization may be significant, the benefits must be weighed against the economic costs in a global context characterized by a close relationship between macroeconomic stability and growth, on the one hand, and disciplined public finances, on the other. In unitary systems, central governments intent on macroeconomic discipline have the capacity to control finances at decentralized levels of government, and so decen- tralization need not threaten reform efforts; that is not true of many federal systems in which central governments can do little more than cajole their subnational counterparts. As such, the price of ongoing decentralization in the federal systems of the developing world can be quite high if policy makers and researchers pay insufficient attention to the potential for divergent intergovernmental political incentives.
One clear implication of these findings is that national governments in federal systems may be forced into extensive processes of macro- economic overadjustment as regional governments avoid adjustment efforts. Even in nations such as Mexico and Argentina, where mar- ket reforms have been firmly established at the national level, solid macroeconomic indicators mask fragilities at the state level. The re- sulting incessant national budget cuts and tax increases are likely to be at least partly responsible for the recent political polarization, high unemployment, and electoral defeats of governing parties in Mexico, and Argentina, as well as India, Venezuela, and Brazil.
Finally, to the extent that these findings point to the significance of intergovernmental politics in shaping market reforms, they also sug- gest the need for comparative analysis of how variations in federal institutions shape economic adjustment policies. Clearly, tremendous variations exist in the nature of federal institutions across the develop- ing world. Differences in the degree of fiscal decentralization, political representation of subnational political units, the competitiveness of subnational politics, and intergovernmental fiscal systems are all likely to affect the capacity of federations to coordinate policies. This varia- tion appears to be reflected in the diverse macroeconomic experiences of nations such as Malaysia and Brazil. Precisely because federal institu- tions vary considerably, researchers and policy makers would benefit from a broader perspective on the effect of federal arrangements on
macroeconomic policy and performance. To the extent that the nine federal nations in this study include some of the largest, most important developing nations in the world, the interaction between their federal systems and economic policies has implications beyond their borders.
It is to this issue that I now turn in a first cut at testing the model of intergovernmental conflict presented in Chapter2.