FISCAL FEDERALISM IN LATIN AMERICA
dered a double cost: macroeconomic instability and no gains in sectoral decentralization. In some cases it even resulted in a deepening of sectoral centralization. Overall, the initial institutional frameworks in Latin America have been largely inflexible. Officials adopted them without adequate information and without incorporating significant independent performance evaluations or incentives to reward results. Although in principle the transfer of responsibilities and resources to other jurisdictions should have been fiscally neutral, the net effect, in most cases, was an increase in total expenditures and a weakening of fiscal balances. In fact, most decentralization initiatives were put in place with little regard to overall macroeconomic policy consistency and without tight budget constraint.12 But all this may be beginning to change. The fact that the fiscal performance of some subnational levels is growing relative to national levels augurs well for the second-generation decentralization process in Latin America. "Second-Generation" Decentralization In certain countries, including Brazil, Chile and, to some extent, Mexico, a new approach to structuring and implementing decentralization policies seems to be evolving. This second-generation approach is characterized by tighter macroeconomic budget constraint, a strong intergovernmental regulatory framework, and more intensive use of incentives at the sectoral level. In Brazil, the 2000 Fiscal Responsibility Law provided a de facto strong regulatory institutional framework for intergovernmental fiscal and financial relationships. In Chile, which followed a tight macroeconomic approach well before other countries adopted such a course, the emphasis is on the use of incentives at the regional and sectoral levels. In Mexico, a reform agenda is being developed that emphasizes a stronger subnational taxing autonomy and a rationalization of the transfer system, and it may also involve a new federalstate commission on fiscal federalism and a code of fiscal conduct.13 Although it would be premature to affirm that most other countries will follow a more market-based approach to decentralization, it is safe to say that countries like Argentina and Colombia are being forced to revise their existing decentralization frameworks. Such a policy change can come about from 12
According to Bird (2000, p. 35), "macroeconomic problems arising as a result of increased transfers must then occur because the central government has not reduced its spending proportionally." 13
See Courchene and Diaz-Cayeros (2000).
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