FISCAL FEDERALISM AND MACROECONOMIC PERFORMANCE IN NIGERIA

FISCAL FEDERALISM AND MACROECONOMIC PERFORMANCE IN NIGERIA

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Background to the Study

Fiscal decentralization, which mirrors the amount of fiscal autonomy and responsibility accorded to subnational governments has been an important subject in the policy equation of many developing and developed countries. Fiscal federalism is essentially about the allocation of government resources and spending to the various tiers of government (Oates, 1972; Tanzi 1995).  In general the intensification of clamour for greater decentralization is informed by a combination of people desiring to get more involved in government, and the inability of the central government to deliver quality services (Chete, 1998). Fiscal decentralization serves as a constraint on the behavior of revenue-maximizung central government, while it serves as a booster on behalf of underdeveloped subnational governments. Since 1990s there has been a resurgence of interest in the macroeconomic performance of developing countries. A prominent element in the policy advice given to developing countries to enhance growth and development potentials is the fundamental need to restructure the public sector to make it more responsive to efficient and equitable provision of public services for the public sector’s contribution to a stable macroeconomic performance (Aigbokhan, 1999). A trend that has emerged from this public sector restructuring is the devolution of spending and revenue-raising responsibilities to lower levels of government not only in federal systems, but also in many unitary countries. This trend is a reflection of the movement towards participatory democracy and the need to provide public goods and services that meet the preferences of people in each locality.

 

Federalism is essentially about multilevel government structure, rather than within a level structure of government, for the performance of government functions and service delivery to the people. Each level of government can be viewed as an institution with definite functions to perform (Rivlin, 1991). The conventional wisdom in economics is that all functions allocated to government should be those that the market is not able to perform in the efficient allocation of resources, equitable distribution of income, and economic stability and growth (Varian, 1990; Layard and Walters, 1978).

 

There are different forms of federalism. The prominent ones are fiscal, political and administrative. Decentralized systems of government give rise to a set of fiscal exigencies referred to as fiscal federalism also known as fiscal decentralization. It refers to the scope and structure of the tiers of governmental responsibilities and functions, and the allocation of resources among the tiers of government to cope with respective functions. Decentralization encompasses a wide range of distinct processes. The main ones are administrative deconcentration, or the transfer of state functions from higher to lower levels of government while retaining central control over budgets and policy making; fiscal deconcentration, or the ceding of influence over budgets and financial decisions from higher to lower levels; and development or transfer of resources and political authority to lower-level authorities that are independent of higher levels of government.

 

The concepts of concentration and deconcentration are issues relating to decentralization. Deconcentration is often considered to be the weakest form of decentralization and is used most frequently in unitary states that redistribute decision making authority and financial management responsibilities among different levels of the central government. It merely shifts responsibilities from central government officials in the capital city to those working in states, regions, provinces or districts, creates strong field administration or local administrative capacity under the supervision of central government ministries.

 

Political federalism deals with the devolution of powers between tiers of government, where the tiers each, within a sphere, coordinate its partially independent tasks (Oates, 1972; Asobie, 1998; Taiwo 1999). It follows, therefore, that there would be constitutional or some legal provisions to protect the autonomy of the different tiers of government.

 

Administrative federalism, on the other hand, involves delegation of functions to lower-level governments, usually according to the guidelines or controls imposed by the higher level government and, therefore, without the autonomy which is characteristic of decentralization. Of the different forms of federalism the one of relevance in this study is fiscal federalism.

 

Recent interest in fiscal decentralization fueled the debate about public sector reforms in general, and the role of sub-national governments in macroeconomic policy-making process. In all countries, power is necessarily divided to some extent between the central and other levels of government. The extent of division of power has important implications for the functioning of the public sector and efficient provision of services. Division of policy-making powers influences not only delivery of services but also their financing that in turn determines macroeconomic performance of countries. Fiscal decentralization requires that sub-central units of the government must make decisions about provision of public services at the lower level (Yilmaz, 1999). The important question that remains to be answered is whether lower-level governments’ spending increases, for example, fiscal deficits at the central level and put macroeconomic stability into jeopardy. In general, macroeconomic variables such as prices, money supply, interest rate, unemployment, foreign exchange rate may be subjected to violent fluctuations which may compromise the growth of the national economy and promote an unstable macroeconomic environment. This is of particular importance in the performance of the stabilization function, usually assigned to the central government, especially with respect to the issue and management of the national currency, on the basis of its spatial incidence which covers the entire country. Thus, it can be seen that issues of fiscal federalism affect national development and macroeconomic stability.

 

1.2     Statement of Research Problem.

The overall objective of this study is to examine the issue of fiscal federalism and effects on macroeconomic performance in Nigeria. Fiscal federalism is the product of the reciprocal and dynamic interaction between different tiers of government, and therefore poses questions as to how the nature and conditions of the financial relations in any federal system affect the production and distribution of the wealth of a nation. In particular it influences how political decisions and interests influence the location of economic activities and the distribution of the costs and benefits of these activities.

 

There has been a resurgence of interest, in many parts of the world, in problems of multi-level government finance. Recent and ongoing political and economic developments raise questions about the role of nation, subnational governments and supranational public authorities in the provision and financing of public sector programmes.

 

Problems of fiscal decentralization and intergovernmental fiscal relations are of wide-spread concern in developing countries. Much of the established literature of fiscal federalism has been explicitly or implicitly oriented toward the institutions and policy issues that arise within developed countries, particularly Canada and the United States (Wildasin, 1997; Artis, 2006; Austin 2006). There is hitherto no consensus in the literature on the effects of fiscal federalism on macroeconomic performance in developed and developing countries. The literature on the potential macroeconomic effects of fiscal federalism is quite vast but mixed. Decentralization may improve allocative efficiency, but it may also make stabilization policies more difficult to carry out (Prud’homme, 1994; Tanzi, 1995). While there are several reasons that fiscal decentralization has been adopted around the world the common motive of many is that fiscal decentralization is considered to have the potential to improve the performance of the public sector. The theory of fiscal federalism holds that for certain public goods, the decision to provide these goods in a decentralized fashion can increase efficiency and accountability in resource allocation (Bird and Vaillancourt, 1998 as cited in Kwom, 2003; Oates, 1999).

 

However recent studies have held that the conventional argument that decentralized provision of public goods will increase efficiency in resource allocation may not be applicable in developing countries (Bahi and Linn, 1994; Prud’homme, 1995). Recent experience with fiscal decentralization in numerous developing and transition economies has led many observers to question whether fiscal decentralization undermines macroeconomic stability. In several countries, central government transfers to lower-level governments have increased fiscal deficits at the central level, creating pressures on central banks to monetize additional debt and thus jeopardizing stability. In other countries, central governments attempting to control their deficits have reduced transfers to lower-level governments, creating fiscal distress at lower levels (Wellisch and Wildasin, 1996).

 

Most developing countries do not meet implicit or explicit assumptions posed by the fiscal federalism theory. In developing countries, for example, local voter preferences may not be as readily reflected in local budget outcomes as in developed countries. Local governments have weak administrative capacities to carry out their own fiscal decisions. Without an independent decision-making capacity to determine the quantity and quality of public goods provided and sources of finance that internalize the costs, decentralized provision of local public goods may not increase efficiency (Kwon, 2008).

 

Several studies in developed countries regarding decentralization have found that the stage of economic development in a country measured by income, urbanization and the Gross Domestic Product (GDP) is associated with a significantly greater subnational share of expenditures (Kee, 1977; Bahi and Nath, 1986; Waisylenko, 1987; Panizza, 1999).

 

Despite the controversy concerning the effects of fiscal decentralization in developing countries, fiscal decentralization continues to take place in developing countries as well as in developed ones. There has been a growing body of literature that deals with fiscal decentralization in developing and transition economies. The emerging literature clearly departs from the broad principles and practices of fiscal federalism to the quality of macroeconomic governance because it perceives the federal system as possessing high potentials for macroeconomic mismanagement and instability (Prud’homme, 1994). As Oates (1994) puts it, “fiscal federalism has much to offer, but it is a complicated enterprise”. The common conclusion which seems to arise from such views is that a decentralized governance structure is incompatible with prudent fiscal management (Tanzi, 1996).

 

Many of the empirical literature on Nigeria have been concerned with explaining the pattern of intergovernmental relations (Mbanefor, 1993; Sarah et al, 2003) or providing an impressionistic view within the context of political economy of possible consequences of such relationships (Ekpo, 1994). A notable exception is the work of Aigbokhan (1999) and Chete (1998) which investigate the relationship between fiscal federalism and economic growth. Missing from the empirical literature on Nigeria is an empirical analysis of the impact of fiscal decentralization on macroeconomic performance. In an attempt to fill this void, this study is therefore an extension of previous studies that are based on one macroeconomic variable, as the thesis is more comprehensive in its scope.

Fiscal federalism in Nigeria dates back to 1954 when the country, which had until then been governed as a unitary state by the British, adopted a federal constitution. However, despite over fifty years of experience with fiscal federalism, the country is still beset with the challenges of macroeconomic management, poor output growth rate, high inflation rate, and weak balance of payment position. The absence of good macroeconomic governance has also raised the problematic issue of credibility in public policy. Relevant question central to this thesis is could fiscal federalism challenges be responsible for poor macroeconomic performance in Nigeria? Another question is: What are the current issues promoting or inhibiting the principles and practice of fiscal federalism in Nigeria? In Nigeria, fiscal federalism has generated intense debate and controversy in recent years. Debates about fiscal management within federal system are not peculiar to Nigeria. From independence in 1960 till date (2011) Nigeria’s fiscal management system has neither been efficient nor equitable (Ike, 1981). Indeed it manifested a wide spectrum of vulnerability, ethnicity, language, region and religion interactively forming Nigeria’s matrix of cultural pluralism (Ike, 1981). The Federal Government has, for more than four decades assumed certain responsibilities which rightly belonged to the lower tiers of government and, in the process, had compromised efficiency in public expenditure management, resulting in high levels of unsustainable overall deficits, high inflation, slow economic growth and poor external sector balance (Ike, 1981; Anyanwu, 1995; Aigbokhan 1999; Chete, 1998).

 

There is the problem of how to allocate revenue vertically to the different tiers of government in relation to the constitutionally assigned functions. The discordance between fiscal capacity of the various levels of government and their expenditure responsibilities, and the non-correspondence problem, is a striking feature of the Nigeria federal finance. There is also the problem of how revenue should be shared horizontally among the states and among the local councils. All these put together have far-reaching implications for the harmonious co-existence of the component units and hence of the system as a geo-political entity (Elaigwu, 1994). The success of a federal system depends on an acceptable distribution of resources and functions among the different tiers of government so that efficiency in the use of scarce resources is encouraged towards achieving macroeconomic stability. All these are the issues of concern in this study.

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