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FISCAL FEDERALISM IN LATIN AMERICA
The impact of subnational borrowing can be of critical importance, both for macroeconomic stability and for the effectiveness of the decentralization process itself. According to Bird (2000), since subnational governments cannot print money, a systemic problem can only arise if the central government validates subnational deficits by expanding the national deficit to finance them; if the central government explicitly or implicitly subsidizes subnational borrowing (for example, by guaranteeing it); or if subnational governments borrow abroad and spend the money in ways that do not add to the country's capacity to service foreign debt. The problem is that central governments end up bailing out subnational governments, as happened recently in several countries in Latin America. Some would even argue that multilateral banks might unwittingly be supporting bailouts in Bolivia, Colombia and Ecuador.9 This is not an easy matter to resolve. Despite the potential for subnational fiscal indiscipline, there are some instances when borrowing is largely uncontroversial, such as for investment purposes. What to do? How can one find the right balance between jurisdictions that use their borrowing powers carefully and those that bet on future bailouts? There is no clear-cut answer. According to Bird (2000), "inappropriate borrowing by subnational governments should be viewed not as a problem of decentralization but as a symptom of more basic underlying inadequacies with the intergovernmental fiscal system in general." This is a key policy point, but the question remains: How then to correct those inadequacies of the intergovernmental fiscal system as a whole? Mexico's 2000 subnational borrowing regime comprises a varied mix of incentives and regulations embedded in its Pacto Fiscal (fiscal pact). Only the future will tell if this is a model to follow.10 Institutional Development It is now widely accepted that institutions and collective rules matter in fundamental ways in explaining long-term economic and social development in countries with different factor endowments.11 Institutions comprise both for9
For Colombia, see Renteria, Echavarria and Steiner (2002). See also Dillinger and Webb (1999a, p. 20).
10 11
For a full discussion of this model, see Giugale, Hernandez Trillo and Oliveira (2000).
As argued by several Nobel prize winners in economics. See Coase (1960), Buchanan (1991) and North (1981,1990,1993).
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Subnational Level Borrowing and Bailouts