Federalism and Regional Inequality

Emily Griffith

Federalism in all its forms is designed to increase regional autonomy. In theory, devolving power from the central government, whether administrative, fiscal, or political, can be empower regions to invest more productively and responsively, while also increasing political education, leadership and participation through all levels of civil society. Although these are desirable outcomes, they are by no means guaranteed. Federalism can have the adverse effect, and rather, exacerbate regional inequalities. Federal systems divide power in ways the make it difficult for central governments to reduce regional inequality, due to disparities in resource and income distribution, limited technical and administrative capacity, the practice of corruption and state-capture, and ethnic marginalization.

In every country, resource distribution is geographically varied and inherently unequal. Urban localities tend to have more expansive infrastructure, larger populations, and higher incomes relative to their rural counterparts. As Bardhan argues, “income is often geographically concentrated, both because of agglomeration economies and initial endowments of natural resources and infrastructural facilities.” (Bardhan, 2002) The federal distinctions between such provinces entrench a system of regional inequality. Within the same vein, in a federal country with fiscal decentralization, public investment—a prime arena for the reduction of regional inequality—is only as strong as it’s tax base. Tax revenues in urban centres will inevitably be higher than in rural localities, as the number of individuals and businesses present, the level of employment, and the rate of consumption is much higher than in less populous agricultural regions. The strong tax base associated with urban regions increases the potential for public investment in infrastructure and social services, allowing urban and economically productive regions to develop faster than others. Souza articulates this problem exactly, arguing that “…in Brazil, federalism has always been a way of accommodating and assuaging deep-rooted regional disparities…Despite the inequitable distribution of resources across regions, subnational governments recently have become the main providers of social services as a result of demands for decentralization and the adoption of an agenda of economic reform. However the country’s deep regional inequalities imply that the capabilities of subnational governments to respond to these demands and agendas are highly uneven.”  (Souza, 2002) Fiscal decentralization and the subnational collection and redistribution of tax revenues have the potential to perpetuate regional economic disparities.

The relationship between decentralization, resource endowment and taxation has a significant impact on public spending and interregional competition. There is a large body of research on the economic efficiency of interregional competition, where—much the same as market competition—local governments compete to offer the best public tax-expenditure structures with the aim of attracting mobile capital and individuals. However, interregional competition has the potential to produce and exacerbate regional inequality through the mismanagement of public spending. Daniel Treisman argues, “if governments divide revenues between business-attracting infrastructure and other valuable public goods, the latter may be underprovided because of the need to appeal to investors.” (Treisman, 2007) This idea echoes the concept of a “race to the bottom,” where “competition to attract mobile capital encourages states to lower taxation and expenditure leading to the under-provision of public goods.” (Bedi and Tillin, 2015) This can create regional inequality, as wealthier regions are able to attract mobile capital without necessarily diverting resources from social services, as the initial tax base and economic infrastructure is established and self-reinforcing. Poorer regions in competition for investment may resort to providing artificial tax breaks to businesses and protection from national taxation. While the attraction of new investment may have a positive long-term economic impact, in an immediate sense it can weaken a regions tax base and jeopardize the provision of public services, thus fuelling regional inequality.

Another inherent regional disparity that feeds and exacerbates regional inequalities is variation in technical and administrative capacity. Bardhan argues that with every country, but particularly developing countries, the quality of staff in local bureaucracies may be lower than in the central government, as “central bureaucracies attract better talent.” (Bardhan, 2002) Local officials and administrators may be less capable of achieving the level of efficiency required for productive subnational governance, especially regarding fiscal management. This disparity stems from lower access to technical infrastructure, less education and training, minimal interaction with other professionals, and geographic isolation. (Treisman, 2007) Centralized government administration would allow such regions to benefit from the superior technical capacity of the central bureaucracy.

Administrative deficiencies can enable local corruption and state-capture, both of which have a detrimental impact on regional development and equality. Regional governments may pursue protectionist, rent-seeking policies in order to bolster their own regional economies. Bardhan argues that “Decentralization may result in growing interregional inequality and low provision of national public goods. To avoid these problems, market-preserving federalism requires a strong central government to rein in the uncoordinated self-seeking tendencies of local governments.” (Bardhan, 2002) Bardhan’s research on post-Soviet Russia provides and example on the economic pitfalls of interregional competition and local government capture, arguing that “high-powered fiscal incentives can compound interjurisdictional externalities: local governments attract investors by colluding with them to protect them from federal taxes and regulations and impose barriers on interregional trade. These actions promote regional growth at the expense of other regions, and lower growth in the country as a whole.” (Bardhan, 2002) He bolsters this idea with another example of how “fiscal decentralization in China in the 1980s led to growing inequality across provinces, regional protectionism, a fiscal crisis for both the central and (most) local governments, and a decline in redistributive power of the central governments, eventually inducing a fiscal recentralization in 1994.” (Bardhan, 2002) Limited technological and administrative capacities in regional governments can give way to corruption, collusion, and state-capture, all of which severely limit the central governments ability to reduce regional inequalities.

Another product of decentralization that can institutionally produce and aggravate regional inequality is ethno-federalism. A frequently cited disqualifier of ethno-federalism is that ethnic minorities are, by and large, not geographically concentrated; and so the federal transfer of power along ethnic lines creates and isolates certain minority groups in lieu of others. Roeder articulates this processes as follows: “Ethnofederal and autonomy arrangements in ethnically divided societies structure politics inside ethnic communities, among ethnic communities and between those ethnic communities and the central government in ways that bring political instability. These institutions privilege some identities and interests and distribute coercive and defensive capabilities in a way that increases the likelihood of escalation of conflict into acute nation-state crises.” (Roeder, 2009) This political instability that Roeder addresses is born out of aggregate dissatisfaction with representation and unequal resource distribution. However, institutionalized ethnic prejudice is not only born out of federal distinction on ethnic grounds, but also out of discrimination by local governments dominated by elites. Suberu writes on this problem in Nigeria, and argues that states and local governments are guilty of “…discriminatory practices that exclude so-called non-indigenes (Nigerians resident in a constituent state that does not incorporate their presumed historic ancestral or indigenous communities) from opportunities (educational admissions, bureaucratic placement, political offices, land and other economic resources, federal projects) available in such states.” (Suberu, 2010) Decentralization can exacerbate regional inequalities through the division, isolation, and marginalization of ethnic communities, whether by state-capture or ethno-federalism. A centralized political system has the capacity to distribute resources and political power equitably and proportionally, and is more likely to do so as a result of thorough and pressing national and international visibility and accountability.

Mookherjee and Bardhan very succinctly summarized the potential negative trajectory of decentralization, arguing that “increasing decentralization and competition for capital can reduce tax revenues, increase regulatory violations, reduce central government enforcement effort and reduce welfare. Federalism is then ‘state corroding’ rather than ‘market preserving’.” (Mookherjee and Bardhan, 2011) Especially in developing countries where high economic disparities already exist, decentralization is even more likely to increase such inequalities. Numerous studies on the challenges of decentralization point towards an increased role of the central government in regional affairs as the solution, rather than policy changes at the regional level. Bardhan argues that because “…decentralization is likely to be accompanied by increasing inequality in quality of governance between better-off and less-well-off regions” the central government should adopt “a watchdog role…with regard to monitoring the performance of local governments and guaranteeing minimal service provisions through targeted interventions in lagging areas.” (Bardhan, 2002) Decentralization is not conducive to regional equality. The primary role of the state in developing, and all, countries should be to foster and promote equality as a method of pursuing national growth.