chapter  3
45 Pages

3 Trends and quality of decentralized public investment LORENA VIñUELA

Introduction Around the world state and local governments have an important and growing role in the provision of public infrastructure services. Subnational governments presently account for an average of 63 percent of public fixed capital formation in OECD countries and of approximately 40 percent in developing countries. However, to date, the subnational dimension of public investment has been largely overlooked and it is not as well documented as other aspects of service delivery. In order to contribute to a better understanding of public investment and capital formation in multi-tiered governments, this chapter reviews the relevant literature and empirically examines possible determinants of the quality of infrastructure and quantity of public investment, with particular attention to the effect of the overall level of fiscal decentralization. The following questions are explored using cross-sectional and time series analysis: (i) Has decentralization led to an increase or decrease of public investment?; (ii) Are more decentralized countries better off in terms of stock and quality of infrastructure?; and (iii) What are the factors that shape the distribution of public investment across levels of government? In addition, through two short cases I further analyze the impact of decentralization on the allocative efficiency of public investment and whether it is helping to better identify and meet infrastructure needs. The results support the expectation that fiscal decentralization is associated with lower amounts of fixed capital formation and better quality of public infrastructure. Estimates are provided for two different country samples, one including OECD members and the other comprising 58 developing countries. Comparing the two groups shows that the effects of decentralization are greater in developed countries. This suggests than the positive impact of decentralization is contingent on the efficiency of public investment management and overall level of institutional quality. The lower levels of public investment may be reflective of efficiency gains, but they also raise concerns about potentially insufficient access to financing and steady funding sources for subnational governments. Lower investment rates can also be symptomatic of the fact that states and municipalities may be prioritizing other types of social investments over infrastructure.