Macroeconomic Reform Beyond the Federal-Unitary Distinction
The previous chapter and a growing body of research suggest that federalism in the developing world does not conform to the market- preserving ideal. Consistent with the poor economic reputation of federalism in places such as Russia, Argentina, and Brazil, it seems that the political and economic institutions characteristic of fed- eralism have undermined the capacity of some developing nations to institute the lasting economic reforms that contribute to macro- economic stability (Tanzi 1995; Treisman 1999c; Jones, Sanguinetti, and Tommasi 2000; Remmer and Wibbels 2000). Even in cases in which national policy makers have succeeded in initiating reform, macroeconomic indicators have masked destabilizing economic fragili- ties at the subnational level that threaten to stall, prolong, or re- verse the gains achieved at the national level (Dillinger and Webb 1999; Remmer and Wibbels 2000). The prevalence of these com- mon characteristics is not to suggest that uniformly identical processes pervade each and every federal system under consideration. Indeed, the macroeconomic experiences of the federal nations in the devel- oping world have varied along a continuum ranging from relatively poor in Brazil throughout the1980s and much of the 1990s to im- pressive policy management in Malaysia. This variation in economic outcomes is more than matched in the heterogeneity of federal in- stitutions across nations in the developing world. As Stepan notes, there is “immense variation that exists within democratic federal
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systems.”1To date, little research has systematically compared the im- pact of variations in federal politics and institutions on macroeconomic policy making and performance. Indeed, as the previous chapters have explained, most research on macroeconomics and the politics of mar- ket reforms has uniformly ignored the significant role of subnational and federal institutions in economic reform efforts.
This chapter moves beyond the simple federal-unitary distinction to explain the tremendous diversity in the macroeconomic experiences of federations across the developing world. It does so by beginning to test the model of intergovernmental bargaining over economic policy developed in the introductory chapter. Remember that the model em- phasizes that the electoral considerations of regional leaders, the means by which regional interests are expressed at the national level, the par- tisan tools available to national leaders to foster regional reforms, and the incentives inherent in the intergovernmental fiscal system shape the dynamic federal bargaining context (see Figure2.2). Stated as individ- ual hypotheses, these factors predict that more competitive regional political environments, lower representation of deficit spending re- gions in national policy making, greater intergovernmental partisan harmony, and more fiscally autonomous regions will diminish the de- gree of intergovernmental conflict over macroeconomic policy. As these factors hold, regions are likely to have fewer incentives to overfish the common pool of national fiscal policy, and national governments are less likely to give in to the bailout requests of economically troubled regions. The net result should be improved macroeconomic perfor- mance. Given the challenges of measuring some of the crucial concepts central to the model, the test in this chapter is partial. I cannot, for instance, test cross-nationally the notion that regions with competitive politics conduct tighter fiscal policy and have a dampening effect on intergovernmental conflicts over fiscal policy. The necessary data on regional electoral contests across federations is simply not available at this time. As such, I leave the testing of this aspect of the theory for later chapters. Likewise, I can not distinguish between the centraliz- ing and coattails paths to intergovernmental partisan harmony. I do, however, measure partisan harmony across federations and test the
1Stepan (2000:146).
other two theoretical propositions regarding regional representation in national policy making and federal fiscal arrangements.2 As such, this chapter adds to both the market reform and federalism literatures by testing a model of macroeconomic reform that addresses variations across federal systems through time.
The chapter progresses in three stages. In the first, I briefly overview the diverse economic experiences of the federations in the developing world and the role that federal politics has played in those outcomes.
This discussion establishes the range of macroeconomic outcomes the model of intergovernmental bargaining will help explain. In the sec- ond section, I further develop the components of the theory explored in this chapter, with particular attention to their impact on macro- economic policy. I also discuss the measurement challenges associated with testing the theoretical argument and present some descriptive data on the nine cases. I subsequently test the model using a pooled time- series analysis of macroeconomic performance and reform between 1978and1996for the nine federal nations in the non-OECD world for which data is available: Argentina, Brazil, Colombia (since1991), India, Malaysia, Mexico, Nigeria, Pakistan, and Venezuela.3I then ex- plore the theoretical implications of the research for the market reform and federalism literatures, emphasizing the political challenges associ- ated with reforming federal institutions in a manner consistent with good macroeconomic outcomes.
The Macroeconomic Experiences of Nine Federal Nations
Historically, the political science literature on federalism developed largely with reference to the experiences of economically advanced and institutionally stable federal nations such as the United States, Canada, Australia, and Germany (Riker 1969, 1987; Chubb 1985;
Savoie1990; Brace1993; Peterson 1995). Where research has been done on nations such as India (Das and Choudhury1990; Tiwari1996;
2Note that the first such attempt in print is presented in Wibbels (2001), which is an early and preliminary version of this chapter. Also see Rodden and Wibbels (2002) for an extension.
3Russia is excluded because of the lack of data. Note that the time period here is shorter than in the previous chapter given the paucity of subnational data necessary to conduct tests of the model of intergovernmental bargaining.
Khemani2001), Nigeria (Adebayo1993), and Brazil (Souza1997), it has usually consisted of case studies of particular national experiences with federal institutions. Indeed, some have suggested that the decen- tralized institutions of federal systems in the developing world are so unique to their national contexts as to be all but incomparable (Bird 1996; Freire 1996). Yet, as Wildasin cogently argues, “. . .precisely because each country’s fiscal institutions are dependent on local cir- cumstances, analysts and policy makers can potentially benefit greatly from the broader perspective that can be obtained from study of the problems of intergovernmental fiscal relations encountered in other countries and regions.”4In other words, although nations may not be free to choose the set of federal institutions most conducive to flexible macroeconomic management, the role of diverse federal institutions in explaining divergent macroeconomic policies and reform experiences remains an important comparative question that research has only be- gun to address.
Table4.1provides a number of measures relevant to macroeconomic reform and stabilization for the nine federal systems under study. For each indicator, yearly values have been averaged since the onset of the 1982debt crisis. For ease of exposition, the nine nations are categorized as having generally poor, average, or good macroeconomic experiences.
A number of the nations, Brazil, Argentina, Mexico, and Venezuela most noticeably, have performed poorly by the standards of develop- ing nations. In all four cases, heterodox adjustment policies through- out the 1980s and early1990s resulted in periodic economic crises.
Although no fewer than nine distinct stabilization plans foundered in Argentina, Brazil struggled with periodic bouts of hyperinflation and profound economic contraction, Mexican reform crashed on the ef- fects of the Tequila Crisis, and Venezuela remains stuck in recurrent, but failed, stabilization policies. Of these four nations, researchers have implicated subnational politics in complicating reform in Argentina, Brazil, and, to a lesser degree, Mexico. In Argentina, provincial deficit spending has been a consistent and serious challenge to national fiscal policy (World Bank1996; Sanguinetti and Tommasi 1997; Remmer and Wibbels 2000), whereas in Brazil state debt to both the fed- eral government and state-owned banks has produced recurrent
4Wildasin (1997).
table 4.1. Average Macroeconomic Performance in Nine Federal Nations, 1982–1996
GDP Debt Service
Growth Inflation As % of Exports Poor Performers:
Argentina 2.04 448.47 46.03
Brazil 2.60 662.88 44.22
Mexico 1.59 46.17 39.37
Venezuela 1.75 32.35 25.08
Average Performers:
Colombia 4.12 23.64 35.95
India 5.65 8.98 22.51
Nigeria 3.04 28.71 19.00
Pakistan 5.63 8.55 22.91
Good Performer:
Malaysia 7.01 3.84 13.07
Source:Budget balance and inflation taken from IMF’sInternational Financial Statistics;debt service taken from World Bank,Global Development Finance.
bailouts from the central government (Bomfim and Shah 1994;
Souza 1997; Samuels 2000, 2002). In the case of Mexico, slow but steady economic reform began in1985and accelerated in the late1980s under the presidential leadership of Carlos Salinas. Although widely re- garded as a highly centralized federation, Mexico’s concerted and ongo- ing process of fiscal and political decentralization is making state-level politics increasingly relevant for discussions of reform, both economic and political (Ch ´avez1996; Giugale, Trillo, and Oliveira2000). At least one observer has noted that continued state borrowing could threaten Mexico’s macroeconomic stability (Amieva-Huerta1997:594–5).5To date, research has not established a connection between Venezuela’s failed reform process and its twenty-two state governments, although this is not particularly surprising, given the substantial degree of politi- cal and fiscal centralism in its federal arrangements until recent years.6 It is telling, however, that Venezuela’s attempt to rescue its moribund party system with an experiment in decentralization in the early1990s
5Similar considerations forced the Mexican central government to recentralize the col- lection of the value-added tax (VAT) from state governments in the early1980s. For a more optimistic view, see Giugale, Trillo, and Oliveira (2000).
6Most significant in this respect is the near total reliance of Venezuela’s state govern- ments on central oil revenues.
coincided with a deepening of its economic crisis (on the decentraliza- tion process, see Penfold-Becerra2000).
Even in Argentina and Brazil, where national leaders initiated pro- found economic reforms during the1990s, healthy macroeconomic in- dicators belied provincial governments in budgetary crisis. In the early 1990s under President Carlos Menem, Argentina implemented exten- sive economic reforms through widespread privatization, a currency board arrangement that effectively eliminated monetary policy flexi- bility, and extensive cutbacks in government services (Smith, Acu ˜na, and Gamarra1994; Gibson1997). These successes, however, do not have their parallel at the provincial level, where the worsening fiscal condition of provincial governments has drawn increasing attention in recent years as a contributor to that nation’s ongoing economic crisis. In 1996, many years after the onset of profound stabilization efforts at the national level, the World Bank warned that in Argentina,
“provincial fiscal adjustment is urgent” (1996: I, ix).7In recent years, the IMF has become equally concerned, conditioning a package of loans on a series of reforms in the intergovernmental financial system and the provinces themselves.8Likewise, Brazilian president Fernando Henrique Cardoso successfully tamed inflation with the Real Plan, but structural reform has not been extended to the subnational level where state politicians relatively unconcerned with macroeconomic manage- ment (Dillinger and Webb1999; Samuels2002) and Brazil’s exten- sive fiscal decentralization (Bomfim and Shah1994) have combined to stymie reform. Indeed, the mainstream media widely covered the key roles of state debt and federal/state conflict in sparking Brazil’sreal crisis of1999.9
Since the early1980s, Colombia, India, Nigeria, and Pakistan have experienced average macroeconomic performance. In Colombia, the nation reformed its Constitution in 1991 so as to qualify as fed- eral, while undergoing an extensive process of decentralization.10
7World Bank (1996: ix).
8SeeLa Naci ´on(11/20/00), “De la Ra confa en que el pacto fiscal se firmar ´a hoy” and The Economist(11/17/00), “Argentina’s New Struggle for Confidence and Growth.”
9See The Economist (10/23/99), “Comic Turns”; (7/24/99), “Cardoso’s Reform Puzzle”; (5/13/99) “Local Loot.”
10Colombia’s thirty-two departments have historically been quite important, but with the1991constitutional reform, departmental governors are elected popularly, a fact that in conjunction with fairly extensive decentralization pushes the nation from a fairly decentralized unitary system to a fairly centralized federal system.
Throughout this period, the nation has continued to experience rel- ative macroeconomic stability in conjunction with solid growth. As in Mexico, however, some have seen Colombia’s process of fiscal decen- tralization as macroeconomically threatening. In a move that echoes similar provincial bailouts elsewhere, the national government recently underwrote nearly $1billion of departmental (regional) debt in order to facilitate refinancing at lower interest rates.11Ahmad and Baer argue that “the dynamics of the decentralization process, with weak expen- diture management, inadequate incentives to raise own revenues, and easy access to debt finance do not bode well for macroeconomic stabil- ity in Colombia.”12The role of state politics in the historic performance and reform of the Nigerian, Pakistani, and Indian macroeconomies is far more prominent. The extensive deficit financing of Nigeria’s state governments, their overwhelming dependence on central government transfers for financing, and the significant controversies over the in- tergovernmental fiscal transfer system are tied to policy stickiness in that nation (Adebayo1993; Ekbo1994). In particular, the central gov- ernments control over oil revenues has made it an attractive target for fiscal poaching on the part of the states, each of which attempts to maximize its share (Suberu2001). In relatively centralized Pakistan, the weak fiscal base of the provinces and their consequent inability to generate revenues have generated fiscal pressures on the central gov- ernment to sustain rapidly expanding state expenditures through an extensive system of intergovernmental grants and loans (Sato1994).
Similar problems have characterized the Indian federation, where cen- tral government structural reforms have been constrained by the failure to coordinate reform policies with state governments. As explained by the World Bank, “Fiscal adjustment by the Central Government has been limited by the absence of corresponding adjustments by India’s 25states” (World Bank1996:17). Even more significantly, Chhibber and Eldersveld (2000) argue that popular support for reform processes are themselves conditional on support by local, not national, elites in India.
11Latin American Weekly Report,10July2001, p.318.
12Ahmad and Baer (1997:484). Note that the central government has recently revised the intergovernmental fiscal system in order to slow the devolution of resources to departmental governments for exactly this reason.
Only Malaysia, of the nine federal nations under study, has ex- perienced relatively stable and strong macroeconomic performance.
Malaysia’s rapid economic development over recent decades has been well documented (Gomez and Jomo1997). Because of its highly cen- tralized federal structure, however, researchers have focused little at- tention on the role of state governments and federal institutions in either its macroeconomic success, or its recent rise in deficits and in- debtedness associated with East Asia’s deep economic crisis.
Even this brief overview understates the degree of macroeconomic diversity across these federal nations. The obvious research challenge is to explore which characteristics of these federations influence this di- versity both across nations and through time. In thefollowing section, I detail the theoretical propositions outlined in Chapter1as to the fac- tors that are most likely to influence the degree of divergence between the economic policy making of national and regional politicians.
Parties, Regional Representation, Fiscal Systems, and Macroeconomic Policy
To briefly review from previous chapters, there are three reasons to expect that intergovernmental coordination problems in federal na- tions can stymie or delay economic reform efforts. First, provincial governments in many federal nations have extensive taxing and spend- ing responsibilities. Thus, each level of government must engage in simultaneous and concerted action for any attempt to balance public accounts, ensure price stability, and restructure the public sector to be sustainable. Second, subnational governments’ large budget shares in federal systems can complicate macroeconomic policy as politi- cally independent provincial officials can choose to ignore macroeco- nomic contexts for which they are not held accountable. Oates (1972), Prud’homme (1995), Wildasin (1997) and others explain that macro- economic stabilization has the characteristics of a collective good in the eyes of subnational governments. As a result, subnational govern- ments have few incentives to bear the political costs of reform mea- sures when the openness of regional economies ensures that many of the benefits of reform will leak to other jurisdictions. Third, Oates (1972,1977) notes that regional governments have a limited capacity to engage in macroeconomic stabilization. He explains that “in the
absence of monetary and exchange-rate prerogatives and with highly open economies that can not contain much of the expansionary im- pact of fiscal stimuli, provincial, state, and local governments simply have very limited means for traditional macroeconomic control of their economies” (1999: 1121). When combined with the aforementioned collective action problem, the result can be the failure to coordinate macroeconomic stabilization policies across levels of government.
Again, however, it is important to emphasize that federations are likely to vary in the degree to which provincial level politicians view their interests as inconsistent with fiscal stabilization. Because the mar- ket reform and macroeconomic literatures typically have underappre- ciated the importance of subnational politics, whereas the federalism literature has construed the effect of federations on economics quite statically, we are left with a number of crucial comparative questions:
What are the key characteristics of federal systems that influence macroeconomic policy, performance, and reform? And are some fed- eral arrangements more or less conducive to macroeconomic reform than others? What affects the interests and bargaining positions of national and regional leaders? The market-preserving federalism liter- ature has long recognized that federalism can provide the foundations for very good macroeconomic performance. If some federations such as Russia and Argentina have deviated significantly from that ideal, the challenge is to theorize the features of federations likely to account for the variance from market-preserving to market-distorting outcomes. As explained later, strong intergovernmental partisan ties and significant provincial taxing authority in a context of high fiscal decentralization are likely to foster a healthier subnational appreciation for national macroeconomic projects. Both factors generate more aligned incen- tives on the part of national and regional leaders. Conversely, when deficit spending regions as a group hold a strong position in national policy making, their capacity to obstruct fiscal retrenchment and fa- cilitate federal bailouts is likely to bode ill for macroeconomic policy.
All three factors vary significantly both across federations and within federations through time, thus providing a more dynamic and political account of the relationship between federalism and economic policy than one gets from alternative models.
As the introductory chapter makes clear, researchers of federalism have long recognized the importance of political parties in shaping
conflicts of interest across levels of government. More than thirty years ago, Riker (1964) suggested thatthecrucial determinant of intergov- ernmental policy inconsistency in federal systems is the centralization of a nation’s party system. Garman, Haggard, and Willis (2001), echo those sentiments more recently in arguing that “. . .if parties are more centralized, any bargaining over intergovernmental fiscal relations will favor the center and the fiscal structure of the state will be more cen- tralized. Conversely, if party control is less centralized, the state’s fiscal structure will also tend to be more decentralized, other things being equal.”13 Where national party leaders have substantial capacity to discipline party members at various levels of government, it becomes much easier to implement coherent, unified policies that transcend ju- risdictional divisions (Ordeshook and Shvetsova1997; Stepan2000).
This capacity to discipline has obvious implications for macroeconomic policies. Where national governments initiate painful fiscal adjustments at the behest of national electorates preoccupied with macroeconomic stability and an international financial community closely tuned to macroeconomic developments, success is more likely where party dis- cipline can ensure that regional economic policy is consistent with the reform project. In cases in which regional politicians have political in- centives to throw in their lot with national copartisans, they are far more likely to contribute to aggregate public sector fiscal adjustment.
They are also less likely to overspend and lobby for the kinds of bailouts that put pressure on national fiscal policy.
As suggested in Chapter 2, partisan harmony can occur via two mechanisms. In the first case, national partisans use their influence over the careers of subnational politicians to enforce fiscal discipline at the regional level. Regional copartisans have incentives to contribute to aggregate fiscal discipline to the degree that their national counterparts can provide incentives or inducements to do so. When regional fiscal discipline occurs in this manner, macroeconomic policy should im- prove with the ratio of regional governments governed by the national executive’s party and the centralization of the party system. In the sec- ond case, coattail effects whereby the electoral fate of regional partisans is tied to those of the national government encourage regional govern- ments to contribute to the kinds of economic policies (fiscal stability,
13Garman, Haggard, and Willis (2001:207).