When finance doesn’t follow function: unfunded mandates and their impact on economic growth

Power without resources can be a curse rather than a blessing. When governments decentralise, both matter.

Over the last five decades, the Regional Authority Index shows that 52 of 81 countries boosted regional powers and responsibilities. Regional and local government expenditures have also risen in recent decades to reach 40% of total government expenditure across the OECD. It is hard to overestimate the importance of subnational governments in delivering key public services and infrastructure.   

More or better decentralisation?

In theory, decentralisation can, among other things, increase the efficiency of public service delivery, spur policy innovation and promote local democracy and accountability. All of these elements lead to higher rates of growth. Yet decentralising may not yield better economic performance. Existing research has shown mixed results. While some studies find that more decentralisation leads to higher economic growth, other research concludes the opposite, while the rest finds no relationship at all. This suggests that context and design are all important.

Capturing the quality of decentralisation

Measuring decentralisation is complex. Our latest paper takes a novel approach and finds that in many cases new powers for subnational governments have not been accompanied by the resources to deliver. This situation is referred to as an “unfunded mandate”.

Like a tennis player cannot play without a suitable racket, subnational governments cannot fulfil their responsibilities or functions if they are not accompanied with the sufficient and adequate funding.

Andrés Rodríguez-Pose and Miquel Vidal-Bover

Does “finance follow function” in the OECD?

Using a dataset covering 518 OECD regions over the 1997-2018 period, we compare fiscal decentralisation at the regional level and political decentralisation and calculate the mismatch between the two as a proxy for unfunded mandates.

The map below shows no clear geographical pattern, but a greater tendency towards unfunded mandates at the regional level in centralised countries (e.g. France, the Netherlands, New Zealand, Poland, Slovakia), despite their existence in some regions in highly decentralised ones (e.g. Germany, Spain). Second, unfunded mandates are more prevalent in regions with relatively lower GDP per capita (e.g., Colombia, Poland), apart from Germany. Finally, unfunded mandates seem to be more widespread in OECD European and Latin American countries than in Northern American and Australasian ones.

Unfunded mandates in regions around the world

Unfunded mandates lie behind lower economic growth

We can also show that unfunded mandates have a negative, robust, and statistically significant impact on economic growth. It also shows that these losses may exceed any benefits from devolving powers to lower tiers of government.

We must therefore be cautious in calling for more decentralisation as a route to growth. This study, the first to offer a quantitative measure of unfunded mandates, indicates that in countries that seek to decentralise, it is better –not more– decentralisation that should be pursued. This is in line with OECD guidelines on how to make decentralisation work.

Towards better decentralisation frameworks

Recent reforms have aimed to empower subnational governments to drive growth, but have also granted them leading roles in education, health, and digital and climate transition. As OECD/UCLG work shows, between 2019 and 2020, subsidies and transfers from the central government jumped by 24% in 56 countries to ensure the necessary funding for subnational governments to respond to the COVID-19 pandemic.

With fiscal space tightening, countries will need to revise their decentralisation frameworks and boost their fiscal resilience so that they guarantee adequate service delivery and infrastructure.

In all cases, finance should follow function: devolving responsibilities to subnational governments without the appropriate resources is not decentralising powers, but problems. When finance does not follow function, decentralisation frameworks engender dysfunctionalities that may put a serious drag on economic growth and project a negative image of decentralisation generally.

When decentralising any further, policy makers would be well-advised to ensure, among other things, that subnational governments are equipped with the necessary resources to fulfil their newly acquired responsibilities. After all, no tennis player can win if they have to play with a holed racket – or with no racket at all.

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Read more on the OECD work on finance on Subnational Public Finance and Investment.