Welfare State: Norway Jørn Rattsø
4.6 Reform
gic behavior is risky in relation to the local political process. Political leaders that create a local crisis to get a bailout by central government and are not successful will have a hard time explaining their actions to the voters. Open information about local government behavior and performance and an open local political system are essential to secure hard budget constraints under centralized financing.
distorts incentives for efficiency. Public sector efficiency is hard to achieve anyway, especially when service quality is closely linked to costs and monitoring is difficult. Interjurisdictional competition has been limited by low mobility, and local governments have refrained from market orientation, partly because of well-organized producer interests. The complicated decision-making system, the combination of local democracy and role as agency for the central government, influ- ences the ability to hold costs down and restructure services to meet changing demands. In the public debate, local governments are typi- cally seen as rigid and with weak cost controls.
Administrative federalism in Norway is characterized by frustration at both the local and the central levels. National politicians are blamed for welfare problems across the country, even when local governments are actually responsible for providing services. Local politicians are frustrated by the limited room to maneuver and a local democracy with little content. It may be, however, that the system of unclear responsi- bilities is favorable from the politicians’ point of view. Local politicians can blame those above, since funding is determined at the center.
National politicians can let local politicians take some of the heat of the permanent pressure for more welfare spending. This design creates the impression of fuzzy institutions and may threaten the legitimacy of the system over time.
Strong demands for reform in local government finance are expressed in the public debate, but there is no universal agreement on where to go. Further centralization is argued to give full responsibility of the services at the center and to get full control of the money. At the extreme, all revenues are distributed as grants, and ministries are given the power to regulate the supply of welfare services in each locality.
It is seen as unacceptable that children shall have different quality and quantity of schooling across the country or that health care shall depend on each locality’s financial situation and priorities. The recent decision to nationalize the hospitals, until now a county responsibility, is a step in this direction. But there are also attempts at further decen- tralization as a way of reducing the problem of unclear responsibilities.
Decentralization also will increase local accountability and strengthen local democracy and local self-rule. The recent consolidation of block grants and a revision of the Local Government Act to give more freedom of organization at the local level are such attempts. A govern- ment commission has proposed a set of reforms, mainly in the direc- tion of more decentralization (see Borge and Rattsø 1998). The main
proposal involves local tax discretion for all municipalities in setting a broad property tax. As always, taxes seen as productive from an economic viewpoint are seldom popular. This reform process may end because of the unpopularity of the property tax.
There is a third way out. The deeper issue is the handling of the welfare services, which will determine the role of the local public sector in the future. Competition and choice, and possibly privatization, will change the financing and control of the welfare services. Then maybe local governments can concentrate on local public goods and operate closer to prescriptions in standard fiscal federalism theory.
Acknowledgments
Financing was received from the Norwegian Research Council and the World Bank. I have enjoyed discussions with Lars-Erik Borge, Fredrik Carlsen, Terje P. Hagen, Jørgen Lotz, Lars Søderstrøm, and Rune Sørensen and draw on joint work with some them. I appreciate com- ments on the first draft of this chapter from Gunnar Eskeland, Jonathan Rodden, and a reviewer.
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Jonathan Rodden
At first glance, the Federal Republic of Germany appears to have one of the most decentralized public sectors in the world. Together, the Länder (federal states) and the Gemeinden (local communities) are responsible for over 60 percent of total government spending. Yet the German public sector is not a paragon of the virtues of fiscal decen- tralization. On the contrary, the rising cost of German-style fiscal fed- eralism has become a critical impediment to improved efficiency in the German public sector. Although the German federal government is famous for its prudent monetary and fiscal policies, the fiscal per- formance of the subnational sector has been far less admirable. Schol- arly criticism of Germany’s unique style of fiscal federalism has a long history, but the costs of German unification and implications of recent Constitutional Court decisions have pushed debates about the future of fiscal federalism into the arena of electoral politics. In spite of in- creasing scholarly and public attention, however, serious reform has been elusive.
The most obvious manifestation of the problem with fiscal federal- ism in Germany is the persistence of subnational deficits and public debt. Figure 5.1 provides a recent snapshot comparing the aggregate fiscal outcomes of the central, state, and local governments.
Most of the borrowing in the German federation—and most of the costs of unification—have been borne by the federal government, but the Länder, and to a lesser extent the Gemeinden, regularly run deficits and undertake significant short- and long-term borrowing. While stop- ping well short of the disastrous experiences with provincial borrow- ing in Brazil and Argentina, the borrowing activities of the German states have created a nagging problem. This chapter seeks to explain the institutional and political causes of soft budget constraints and bailouts among the German Länder in the 1990s. In contrast to many
of the other stories of soft budget constraints and bailouts described in the book, incentives for fiscal indiscipline in Germany have been con- centrated in a minority of the federated states. Prior to unification, the problem was limited to two small states that were faced with rapidly declining macroeconomic circumstances: Bremen and Saarland. These states have consistently run large deficits in recent decades, refusing to cut spending despite unsustainable debt levels (see figures 5.2 and 5.3).
Following a controversial court decision, the federal government may have exacerbated the moral hazard problem for other jurisdictions by extending large debt relief bailouts to Bremen and Saarland. The prob- lems of perverse incentives, persistent deficits, and dangerous debt burdens are now serious in the new eastern Länder as well.1
Starting from zero debt in 1990, by 1998 the per capita debts of the eastern Länder have surpassed those of their western counterparts (Seitz 1999). As this volume goes to press, a fiscal crisis in the city-state of Berlin appears to be heading down a now-familiar path toward federal bailouts (Seitz 2001). Soft budget constraints at the Landlevel could threaten Germany’s ability to stay within the general govern- ment deficit limit imposed under the terms of the Stability and Growth Pact of EMU. If the Länder run excessive deficits under present condi- tions, the Bund(federal government) would have to bear the fines for noncompliance under EU regulations (OECD 1998).
0 0.2
0.1
Deficit as percentage of revenue
Western local governments Federal
government
Eastern Länder
Western Länder
Eastern local governments
Figure 5.1
Deficit as percent of revenue at each level of government, Germany 1996. Source: Sachver- ständigenrat (1997, 120) and author’s calculations.
0 0.1 0.2 0.3 Hesse
Bremen Thuringia Saxony-Anhalt Saxony Mecklenburg-West Pomerania Brandenburg Saarland
Hamburg Bavaria Baden-Württemberg Rhineland-Palatinate
North Rhine-Westphalia Lower Saxony Schleswig-Holstein
Average deficit as percentage of revenue
Figure 5.2
Average deficit as share of revenue in the German Länder, selected years. Note: 1975–
1995 for the western Länder; 1992–1995 for the eastern Länder. Source: Statistisches Bundesamt and author’s calculations.
10,174 6,539
4,857
16,387 9,347
9,974 10,183
11,395
24,545 15,448
14,046 9,995
7,912 6,149
9,641 9,078
0 10,000 20,000
Hesse Bremen Thuringia Saxony-Anhalt Saxony Mecklenburg-West Pomerania Brandenburg Berlin Saarland
Hamburg Bavaria Baden-Württemberg Federal Government North-Rhine Westphalia Lower Saxony Schleswig-Holstein
Debt per capita in deutsche marks as of December 31, 1996
Figure 5.3
Per capita debt, German fereral government and Länder, 1996. Source:
Sachverständigenrat (1997, 195).
Undoubtedly some of the fiscal problems of Saarland and Bremen are related to the challenges of governing small states with high per- sonnel costs and high levels of unemployment, and deficits in Berlin and the eastern Länder reflect to some extent the need to combat massive unemployment and invest heavily in infrastructure. Never- theless, this chapter argues that the recent crisis of fiscal federalism in Germany is best understood as a manifestation of underlying struc- tural weaknesses in the German federal system that have been present throughout the postwar period. Specifically, the collaborative inter- governmental system of revenue legislation, collection, and distribu- tion breaks the link between taxing and spending decisions that is critical for effective government provision of goods and services.
While the Länder have wide-ranging expenditure responsibilities, they possess very little autonomy over the tax base or rates. While most spending and policy implementation occurs at the Land or Gemeinde level, most revenue decisions are made at the Bund level. As a result, voters cannot identify which level of government taxes or spends for which goods and services, and they have neither the ability nor the incentives to monitor or discipline the fiscal decisions of state or local governments. The leitmotiv of this chapter is that Germany’s complex, interdependent, collaborative style of federalism tends to dilute fiscal accountability and soften budget constraints.
The basic constitutional structure of German federalism undermines the hierarchical oversight mechanism as well. Often called administra- tive federalism, the German system is characterized in most policy areas by central legislation and state implementation. The Grundgesetz (Constitution) requires that the “equivalence of living conditions” be maintained throughout the federation through a complex system of fiscal equalization. As explained below, aspects of the equalization system create perverse incentives in some of the states by rewarding fiscal profligacy. Most recently, in response to debt servicing crises in Bremen and Saarland, the Federal Constitutional Court has ruled that the “equivalence of living conditions” clause obligates the federal gov- ernment to provide these Länder with special bailout transfers.
The remainder of this chapter examines the strengths and weak- nesses of the German Länder in maintaining fiscal discipline through each of the channels discussed in chapter 1. First, it describes in greater detail the basic architecture of the German federal system and assesses the institutional incentive structures faced by Land-level politicians.
Section 5.2 then considers additional political incentive structures.
Section 5.3 explains the role of the capital market and its regulation.
The penultimate section discusses the bailout episodes in Bremen and Saarland and the growing difficulties of the new Länder. The final section concludes and discusses the prospects for reform.
5.1 Hierarchical Structure and Intergovernmental Fiscal Relations