Department of Political Science
Penn State University, University Park, PA 16802, USA
(Professor of political science, earned her Ph.D. from the University of Illinois at Urbana-Champaign in 1977. Prior to joining Penn State, Donna was a professor of political science at Vanderbilt University. Donna specializes in politics and public policy in the USSR and Post-Soviet States. She has written extensively on issues concerning elections, public opinion, politics, and economic reform in Russia. The National Science Foundation has often supported Donna's research and involvement on USSR policies.)
The Two Faces of Federalism
In the past 15 years, research on newly democratic countries has come to reflect two increasingly divergent views of federalism. For one school, the division of powers among two or more levels of government provides a critical anchor for developing democracy and markets. For the other school, federalism creates yet another set of problems that new democracies must somehow overcome. My aim here is to evaluate these two views, and to provide an overview of recent evidence on this debate.
Federalism as a Cornerstone of Democracy and Markets
For its proponents, federalism provides a number of political advantages that help to strengthen democratic governance. One is responsiveness. Where regional governments possess substantial authority, they can react more quickly and effectively than central governments to satisfy the preferences of the local citizenry. Central governments, in this view, are simply too large and too slow to identify and respond to all of the diverse demands of citizens in different regions.
A second advantage is that federations provide more opportunities for meaningful citizen participation in public decision-making below the central level Public participation, in turn, should increase the accountability of regional and local officials. Citizens have more opportunities and more incentive to choose their representatives and to monitor their work.
With expanded participation comes a third advantage – increased political competition. Regional- or state-level elections multiply the potential “entry points” for new candidates and parties, and thus provide additional opportunities for representation of diverse groups and interests. In newly democratizing countries, the opportunities are especially important for opposition groups. As a result, increased participation and competition make it less likely that new democracies will revert to old authoritarian modes of rule.
Advocates of federalism also see important economic advantages as well. One advantage is that regional/state governments compete among themselves to attract business, investment and skilled labor. Such competition typically makes it costly for any government – central or regional – to impose excessive regulations or taxes. And the less the government regulation, the more effectively the economy can develop.
In other words, economic competition across regions helps to limit the role of government in the economy. If one regional government imposes higher taxes or excessive regulations, businesses and investors will seek another region with less burdensome restrictions. And if a regional government is ineffective in providing public services – such as education or public safety – then residents with the most valuable skills will move to regions that perform more effectively. In this sense, citizens, businesses and investors all “vote with their feet,” i.e., they move to regions with more effective public services and less burdensome government involvement in business.
These presumed political and economic benefits of federalism led international lending organizations to make a special effort early in the Third Wave of democracy to promote devolution. As Willis, Garman and Haggard (1999) note, lending agencies came to view devolution as an antidote to the accumulated problems of overcentralization under old authoritarian regimes. Large central governments were seen as inefficient, while regional and local ones were viewed as more efficient in providing public services. Regional and local governments were believed to have more and better information about local needs and preferences, and to have more ability to respond to them effectively.
Globalization provided added pressure to decentralize. Increasingly open trade and investment flows demanded smaller and more flexible organizations that could adapt readily to changing market conditions – in government as well as in business. For regional governments, dependence on the center thus became a serious economic disadvantage.
Pro-democracy groups and parties pushed for decentralization, too. From their perspective, devolution would provide more opportunities for political competition below the central level. It would also help to prevent backsliding toward authoritarianism.
In sum, federalism and devolution came to be key elements of international prescriptions for new democracies during the Third Wave. Shifting power away from central governments seemed to be a critical step in helping to consolidate both democratic government and market economies.
Federalism as an Obstacle to Reform
However, experiences with “real-world” federalism and devolution in new democracies led to a more pessimistic view in the past few years. Many scholars, policy-makers, and advisers to international lending agencies thus came to emphasize the problems associated with federalism (Prud’homme, 1995; Breton, 2000; Shah, n.d.; Tanzi, 2001; Treisman, 2000; Cai and Treisman, 2004).
One key problem, in this view, is that regional/state governments have undermined central government efforts to promote economic reform in newly established democracies. Central governments, under pressure to improve economic performance, have attempted to limit inflation, hold down budgetary expenditures, manage trade balances and privatize state enterprises. And much of their agenda of economic reform involves difficult decisions that can impose painful costs on various groups of citizens, from unemployment to devaluation. Regional governments face the same problems. But the opportunities and costs of economic reform are somewhat different for regional than for central governments. Any region that pursues economic reform by itself is unlikely to solve economic problems that are essentially national in scope. And many regions face concentrated costs – for example, the closing of a major factory has far more impact at the regional than at the national level. As a result, many regional governments have appeared unwilling to support needed but painful economic reforms.
In some cases, regional governments have pursued policies directly at odds with the center’s. Thus federal governments seeking to limit government spending and maintain monetary discipline have faced regions with expanding government payrolls and rising budget deficits. The problems have been even greater where subnational governments have had the power to borrow money to finance government spending. They could spend with impunity, while leaving the federal government to rescue them from default.
The implication, for many authors, is that federalism itself undermines the prospects for economic growth and stability. Regions may pursue policies that are popular locally – such as providing government jobs, overspending and the like – but at the expense of effective management of the economy as a whole.
Critics of federalism and devolution also point to a variety of related economic problems. Since regions typically have few tax sources of their own, they may end up relying on a “quasi-fiscal” strategy to raise revenues (Tanzi, 2001). Such regions impose a variety of regulations, licensing requirements and other devices as a way of raising revenue indirectly. But the various fees raise the fiscal burden on businesses and citizens, and make government finances less transparent. The end result is to undermine economic development.
Critics note as well the problems that arise when regional governments impose barriers to cross-regional trade. Regions that require residency permits, for example, or impose other similar rules, limit mobility of labor. Regions that require government purchasing to be limited only to internal suppliers may end up spending far more, or compromising on quality or fit. Regions may also adopt protectionist strategies that shield local enterprises from central taxes and regulations (Cai and Treisman, 2004). Thus regions may compete with each other, but in ways that undermine rather than enhance the country’s overall economic performance.
Critics have argued, too, that federalism and devolution lead to higher levels of corruption (Treisman, 2000; Tanzi, 2001; Prud’homme, 1995), though the reasons are controversial. One view holds that lower pay and limited opportunities for advancement at the regional level breed more corruption (Tanzi, 2001). Another view suggests that federalism simply multiplies the number of governments – and number of government officials – with the power to demand bribes, kickbacks, or other forms of payment. A third view suggests that regional governments face more problems in promoting transparency of governmental activity. Given their limited resources, regional governments often find it difficult to publish full and timely information about their activities on a regular basis. As Albert Breton (n.d.) notes, it is typically far easier to find information on government policies and performance for countries as a whole than for individual regions. And if information is lacking about state/regional government activity, then there are fewer opportunities for citizens to hold their government accountable.
All told, critics thus see federalism and devolution as major obstacles to economic well-being in new democracies. In fact, some authors have come to view them as the key reason for financial problems and failure of economic reforms in many Third-Wave countries, from Brazil and Argentina to Russia. In Brazil, for example, the transition to democracy in the 1980s devolved substantial authority to state governments. And as a number of authors argue, the states adopted policies that contradicted much of the central government’s economic reform plan. State governments added more employees to their payrolls, ran substantial budget deficits, and borrowed with impunity – leaving the federal government to bail them out. Central government efforts to control inflation and promote sound fiscal policies were thus impaired by the inability to constrain regional governments (Saiegh and Tommasi, 1999; Dillinger and Webb, n.d.). According to one assessment (Mainwaring and Samuels, 1999), devolution in Brazil’s transition to democracy had created “predatory federalism” that undermined federal government economic policies.
Argentina’s transition brought similar problems. The shift from military to civilian rule in the 1980s also brought decentralization of authority from the center to the provinces. And newly empowered provinces expanded the number of the people on state government payrolls, overspent, and borrowed at will (Remmer and Wibbels, 2000). As in Brazil, the federal government thus found it difficult to rein in inflation and limit provincial borrowing.
In Mexico, federal efforts to privatize state firms were offset by provincial efforts to re-nationalize them (Snyder, 1999). Mexican state governments imposed their own regulations on newly private sectors.
Many assessments of Russia’s economic reforms have also focused on the negative role of regions and republics. Shleifer and Treisman write, for example, that many of Russia’s economic problems in the 1990s could be traced to the intergovernmental division of power and property (2001: 113). Stoner-Weiss (n.d.) argues that regional divergences in policy undermined the federal government’s efforts to complete successful market reforms. And Desai and Goldberg (2001) contend that the inability to restructure many enterprises stemmed in large part from the close connections between the enterprises and regional or local governments. Russia’s republics and regions thus came to be identified as a major obstacle to effective economic reform (Slider, 1997).
Along with these various economic problems, critics also contend that “real-world” federalism did not necessarily promote democracy in the Third Wave. Thus, for example, the presumed benefits of political competition often did not materialize uniformly below the national level (O’Donnell 1993). Many new democracies established more or less free and fair, competitive elections for central government executives and legislatures, but had large pockets of less democratic rule at the regional level. As Frances Hagopian (1996) argued in her study of Brazil, regional politics in some areas remained “traditional,” with a narrow concentration of political power, restricted access to decision-making, hierarchical channels of political representation, and limited political competition.
In sum, the experience of Third Wave countries suggested that federalism and devolution did not promote either participation, responsiveness or accountability in new democracies. Critics argued that if anything, federalism had undermined these essential aspects of the transition. And that prompted a reversal in attitudes toward federalism: now the prescription for reform emphasized a combination of more centralized government and privatization of public services. Newly democratic federations have attempted to follow suit, by imposing more fiscal discipline, as in Argentina and Brazil, or by mounting a more concerted policy to roll back regional prerogatives, as in Russia (Bahry, forthcoming).
Reassessing the Debate
There is no doubt that some newly democratic federal states have experienced serious problems of economic management – far more serious than in other, more established federations. And there is no doubt that both political and economic changes spread unevenly within newly democratic federations. But recent research now traces these problems to the organization of federalism in particular countries, rather than to the principle of federalism itself. In other words, the benefits of a federal system depend on how it is structured (World Bank, 2001). Many of the federal states in democracy’s Third Wave had built-in imbalances or distortions that made it difficult for either central governments or states and regions to conduct effective reforms.
“Devolution” of power from the center often meant passing down more responsibility for public services and programs to state/regional governments, but without corresponding power to raise revenues. States and regions thus acquired more authority to manage local economic development, environmental policy, health, education and welfare, but they were still dependent on the center to finance such programs, When central governments did pass down revenues, they tended to rely on transfers rather than allowing state/regional governments to define their own tax policies. The size of the transfers, in turn, often depended heavily on political relations between federal and regional governments. Thus subnational revenues could be highly unpredictable. The reliance on revenue transfers meant that subnational governments could spend money without having to develop local sources; they did not need to be accountable to the local citizenry. Where regions/states had the power to borrow, fiscal responsibility was even lower. Deficits and defaults could be passed on to the central government.
Many of the intergovernmental economic problems in newly democratic federations in the 1980s and 1990s could thus be traced to imbalances in the structure of federal responsibilities. For example, some new federal democracies “offloaded” central government programs and expenditure responsibilities to regions and localities, as a way of trimming the federal budget. But revenues seldom followed suit. As a result, subnational governments found themselves with substantial unfunded mandates – federal requirements to provide services to local citizens, without federal financing to cover the costs. This, in turn, created serious vertical fiscal imbalances: regions had too many expenditure responsibilities and too little authority to raise revenues themselves. And the more they depended on the center for revenues, the fewer their incentives to limit their own government spending or deficits. When they could count on federal bailouts, there was little penalty for overspending.
“Problem” federations in democracy’s Third Wave thus faced perverse incentives created by misaligned revenue, expenditures, and borrowing authority. In Brazil and Argentina, for example, federal governments had to bail out deficit-ridden regions several times. Regional state banks were under political pressure to lend to regional governments, and central government banks were under political pressure to bail them out when they defaulted on their debts (Shah, n.d).
As Shah (n.d.) notes, the particular structure of budgetary and revenue-sharing systems added to the problems. “Problem” federations tended to be the ones where most taxes were shared between levels of government, via non-transparent or “pork-barrel” style formulas. Lack of predictability, and lack of firm criteria for allocating federal funds, made it especially difficult to plan regional services.
Broader comparative research provides even stronger evidence on how the particular organization of federalism influences economic performance. Rodden (2001a) and Rodden and Wibbels (2002) demonstrate, for example, that federal systems relying heavily on transfers of revenues to lower levels of government experience larger budget deficits overall and higher rates of inflation. Where regions and localities are more responsible for raising their own revenues, fiscal resources are used more effectively. Thus as Rodden and Wibbels (2002) conclude, “fiscal decentralization [is] associated with smaller overall deficits and lower inflation rates, especially when the states have wide-ranging autonomy over taxation.”
The economic difficulties of “fractured” federalism may also have contributed to some of the political problems of uneven democratization. Regional governments that depended more on the federal government than on local citizens would be less responsive and accountable to their local constituents. And incumbents relying on expanding public payrolls (patronage) and continued control of the local economy would have substantial opportunities to limit political competition.
All told, then, some newly democratic federations did have a variety of economic and political problems in the 1980s and 1990s. But the difficulties could be traced to what might be called “fractured” federalism – where regions had too little control over revenues, compared to the new responsibilities they acquired for expenditures. Regions with the authority to borrow coped by accumulating debt, leaving the federal government to pick up the costs. Where federal systems aligned revenue and expenditure responsibilities more closely, and where they provided autonomy to regions, the overall results were far more positive – as earlier theories of federalism had predicted.
Alexseev, Mikhail, 2001. “Decentralization versus State Collapse: Explaining Russia’s Endurance,” Journal of Peace Research 38:1, pp. 101-6.
Bahry, Donna. Forthcoming. “Russia’s New Federalism and the Paradoxes of Sovereignty,” Comparative Politics.
Benton, Allyson Lucinda. 2000. “Federalism and the Stability of Provincial Party Systems in Argentina: Regional Development Policies, Fiscal Resources, and Provincial Politics During Economic Reform,” American Political Science Association Annual Meeting, Washington, D.C.
Berkowitz, Daniel and David DeJong. 1999. “Russia’s Internal Border,” Regional Science & Urban Economics 29, pp. 633-649.
Bermeo, Nancy. 2002. “The Import of Institutions,” Journal of Democracy 13:2, pp. 96-110.
Breton, Albert. 2000. “An Introduction to Decentralization Failure,” Conference on Fiscal Federalism, International Monetary Fund, Washington, D.C.
Cai, Hingbin, and Treisman, Daniel. 2004. “State Corroding Federalism,” Journal of Public Economics 88:3-4, pp. 819-43.
Desai, Raj M. and Itzhak Goldberg, 2001. “The Politics of Russian Enterprise Reform: Insiders, Local Governments, and the Obstacles to Restructuring,” The World Bank Research Observer 16:2, pp. 219-40.
Dillinger, William and Steven B. Webb, “Fiscal Management in Federal Democracies: Argentina and Brazil,” http://www.worldbank.org/html/dec/Publications/Workpapers/wps2000series/wps2121/wps2121.pdf
Filippov, Mikhail and Ol’ga Shvetsova, 1999. “Asymmetric Bilateral Bargaining in the New Russian Federation: A Path-Dependence Explanation,” Communist and Post-Communist Studies 32, pp. 61-76.
Garman, Christopher da C. B.; Haggard, Stephan; and Willis, Eliza, 2001. “Fiscal Decentralization: A Political Theory with Latin American Cases,” World Politics 53:2, pp. 205-36.
Garrett, Geoffrey, and Jonathan Rodden, 2000. “Globalization and Decentralization,” paper presented at the Midwest Political Science Association, Chicago.
Hagopian, Frances. Traditional Politics and Regime Change in Brazil. (New York, Cambridge University Press, 1996);
Jensen, Nathan, and McGillivray, Fiona. 2000. “Political Determinants of Foreign Direct Investment,” American Political Science Association, Washington, D.C.
Mainwaring, Scott, and David Samuels, “Federalism, Constraints on the Central Government and Economic Reform in Democratic Brazil,” Kellogg Center Working paper #271, November 1999
O’Donnell, Guillermo. 1993. “On the State, Democratization and Some Conceptual Problems: A Latin American View with Glances at Some Postcommunist Countries,” World Development 21:8, pp. 1355-69.
Prud’homme, Remy. 1995. “The Dangers of Decentralization,” World Bank Research Observer 10:2, pp. 201-20.
Rodden, Jonathan. 2001a. “The Dilemma of Fiscal Federalism: Grants and Fiscal Performance Around the World,” http://web.mit.edu/polisci/faculty/J.Rodden.html
Rodden, Jonathan. 2001b. “Reviving Leviathan: Fiscal Federalism and the Growth of Government,” http://web.mit.edu/polisci/faculty/J.Rodden.html
Rodden, Jonathan, and Erik Wibbels, 2001. “Federalism and Macroeconomic Management” http://web.mit.edu/polisci/faculty/J.Rodden.html
Rodden, Jonathan, and Erik Wibbels, 2002. “Beyond the Fiction of Federalism: Macroeconomic Management in Multitiered Systems,” World Politics 54:4, pp. 494-531.
Saiegh, Sebastian, and Mariano Tommasi, “Why Is Argentina’s Fiscal Federalism So Inefficient?” 1999, http://www.isr.umich.edu/cps/pewpa/archive/archive_99/19990003.pdf
Shah, Anwar. N.d. “Fiscal Federalism and Macroeconomic Governance: For Better or For Worse?” mimeo.
Shleifer, Andrei and Daniel Treisman, 2001. Without a Map: Political Tactics and Economic Reform in Russia. (Cambridge, Mass. and London: MIT Press).
Snyder, Richard. “After Neoliberalism: The Politics of Reregulation in Mexico,” World Politics, 51 (1999), 173-204
Shleifer, Andrei and Daniel Treisman, Without a Map: Political Tactics and Economic Reform in Russia. (Cambridge, Mass. and London: MIT Press, 2001).
Stepan, Alfred. 1999. “Federalism and Democracy: Beyond the U.S. Model,” Journal of Democracy 10:4, pp. 19-34.
Stepan, Alfred. 2000. “Brazil’s Decentralized Federalism: Bringing Government Closer to the Citizens?” Daedalus 129:2, pp. 145-69.
Stoner-Weiss, Kathryn. “W(h)ither the Central State? The Regional Sources of Russia’s Stalled Reforms,” http://www.princeton.edu/~kesw/Whither%20the%20State%208sub2.pdf
Tanzi, Vito. 2000. “On Fiscal Federalism: Issues to Worry About,” Conference on Fiscal Federalism, International Monetary Fund, Washington, D.C.
Tanzi, Vito. 2001. “Pitfalls on the Road to Fiscal Decentralization,” Working Paper no. 19, Economic Reform Project, Global Policy Program, Carnegie Endowment for International Peace.
Treisman, Daniel. 2000. “Decentralization and the Quality of Government,” Conference on Fiscal Federalism, International Monetary Fund, Washington, D.C.
Willis, Eliza; Garman, Christopher da C. B., and Haggard, Stephan. 1999. “The Politics of Decentralization in Latin America,” Latin American Research Review 34:1, pp. 7-56.
World Bank, 2001. “Decentralization and Governance: Does Decentralization Improve Public Service Delivery?” PREM Notes (Poverty Reduction and Economic management Network), number 55.
 Note, however, that other authors took a more positive view of Russian federalism in the 1990s. See, for example, Alekseev (2001) and Filippov and Shvetsova (1999).