Provincial autonomy sans fiscal devolution
By Shahid Javed Burki
Monday, 12 Apr, 2010
THERE cannot be any doubt that the 18th Amendment to the constitution will have a profound impact on the way the economy is managed. The federating units will receive additional powers as a result of the abolition of the concurrent list put into the 1973 constitution by its framers.
This will mean transferring large amounts of economic authority to the provinces. They will, for instance, have the right to manage labour laws, environmental impact of development in both the public and the private sectors of the economy, generation of much larger amounts of electricity than currently permitted, development of infrastructure etc.
This will happen only if the provinces find a way of financing these activities. If they remain dependent on the central government for funds, the autonomy promised by the amendment will remain illusory. What is the meaning of the 18th Amendment for economic decentralisation? While Pakistan may be on the way towards establishing not only a fully democratic system with political authority vesting in a directly elected parliament, it may also be moving towards the creation of a truly federal system in which there is sharing of power between governments at different levels – between the federal and provincial governments and between provincial and local governments. If this happens what will be the impact on the economy and on delivering services to the people?
The answer to this question has been provided by many theoretical and empirical studies done over the years by scholars from both developed and developing countries.
While many benefits have been claimed for federalism, it is “paradoxical that that we observe so few countries in the world which posses all the attributes of a strong federalist structure”, writes Dennis C. Mueller of University of Vienna. “There are two possible explanations for this paradox. First, there may also be several disadvantages associated with federalism, so many that for most countries the disadvantages outweigh the advantages. Thus full-blown federalism may be rare, because in fact it is undesirable. The second possible explanation for federalism’s rarity is that it is somehow inherently unstable. When it is chosen, it fails to survive, not because of any fundamental difficulty in the outcome it produces, but because of the existence of forces in a democracy which undermine it.”
To explain the case for federalism we should perhaps start with the reason why the state is involved in economic matters in the first place. The main reason for this is made in the public choice literature according to which markets fail in many situations particularly when public goods such as defence of the borders or police protection or a bridge connecting two places across a river are to be provided or where what economists call externalities become important. There are positive and negative externalities. Markets are less efficient providers in both cases; the governments, at least in theory, do a better job. But what type of government? There are three possibilities: a unitary state, a federalist system, or a confederation. I will concern myself with the first two.
A unitary system need not be distant from the people especially when the state is decentralised with government departments organised to reach people where they are located. This was the system used by the British during their long rule of India and was the one that Pakistan inherited when it became an independent state.
But it was not a federalist system in the sense that elected representatives of the people were not responsible for providing public goods to the people. That responsibility rested with the officials appointed by a highly centralised state.
In a unitary system, responsibility to the people is only at the central level. In a federal system people through elections have control over those who serve them. That in theory is the system that Pakistan attempted to establish following the adoption of the 1973 constitution.
Once the decision is made to establish a federal system the next question concerns its optimal design. How many levels of government should there be is one of these questions? What should be the division of responsibility among them? How should the governments at various levels finance their activities? The 1973 constitution established two tiers of government, one at the central and the other at the provincial level.
The 17th Amendment introduced into the constitution by President Pervez Musharraf effectively introduced a third tier into the structure. This was done by devolving various sate responsibilities to an elaborate system of local government. A new position was created to assign responsibility for delivering public services to an elected official called the “nazim”. This official was to be elected by the people and the bureaucracy at the local level was made responsible to him (or her).
The 1973 constitution – even when amended by President Musharraf – did not provide many resource generation responsibilities to the governments at the sub-national levels. They were mostly dependent on the central government for financing their activities. The provincial governments were given some say in the amount of resources they obtained from the centre by their representation in the National Finance Commission. The NFC was to be convened every five years and decide on the formula to be followed for allocating the resources available in what was called the divisible pool.
However, this provision, like so many other in the constitution, was largely ignored. For instance, the most recent NFC award was signed in 2009, almost 13 years after the one it replaced. Whatever shares were agreed upon were provided to the provinces in the form of grants. According to many economists, this way of providing resources to the federating units introduces serious distortions.
More than a 100 years ago, the economist Knut Wicksell established what has come to be called the Wicksellian connection. According to this each public expenditure should be coupled with a tax to finance it so that the voting public knows how much it is paying for the services being provided. Some experts go a step further. They suggest that the people receiving services from the state no matter where the state is located should be charged for the services they are being provided.
This approach serves several purposes. It forces the state to be efficient in the business in which it is involved. It also makes it possible for the people to bypass the state and go to the private sector if they are not happy with the services being made available by the state. This is what has happened in the case of education and health for the more well-to-do segments of the society. The people who can afford to go to the private sector have largely abandoned the state in these areas.
There is a virtual consensus among economists that intergovernmental grants lead to an expansion of the public sector – there is empirical evidence to suggest that a local government generally spends a far larger fraction of an unconditional grant from a higher level of government than its citizens would consider to be optimal. Applying this finding to Pakistan where financing for the provinces will come mostly from the NFC awards, 18th Amendment induced autonomy will not necessarily lead to economic efficiency. The provinces must be given a way to finance most of their own development.
The main conclusion from this discussion should be clear. While the 18th amendment has taken a major step forward in moving towards a federal system, the real test of efficiency will come once a system of providing services which the provinces will have the responsibility is decided upon. The amendment has largely left this as an open question. That is a mistake. It is only when the devolution of responsibility is coupled with the responsibility of raising resources that the real test of the new system will be in place.