Shifting fiscal responsibilities downstream

Fiscal decentralisation and economic growth in South Africa

Fiscal decentralisation, or the shifting of some responsibilities for expenditures and/or revenues to lower levels or other spheres of government, has been identified as a vehicle for stimulating economic growth at the provincial or regional level in developing countries. Margaret Chitiga and colleagues examined the case for South Africa and found a weak but positive relationship between fiscal decentralisation and provincial-level economic growth.

Fiscal decentralisation, including delegating responsibilities such as revenue mobilisation, expenditure or borrowing to lower levels of government, has the potential to facilitate greater efficiencies within government and overall, better governance.

The delegation of such responsibility to sub-national levels of government can also ensure more efficient allocation of resources and service delivery. This happens through two key avenues: through the information advantage local governments have over the national government concerning the types of goods and services that match local needs; and the accountability argument, in which local government officials are thought to be under closer scrutiny by their constituencies, leading to a greater incentive to manage fiscal resources in the best interest of the public.

At the same time, contrary views have challenged these supposed advantages. There are three arguments: the first is that the central government can gain the same level of information by assigning its representatives to local offices. The second is that central government can involve local officials in decision-making processes. And the third is that in most developing countries, local officials may not be directly elected but indirectly elected or appointed, weakening the accountability argument, as the local officials in this case might not have the incentive to act in the best interest of the local public.

South Africa’s system of decentralisation has recently been categorised as a form of co-operative governance in a unitary state where intergovernmental fiscal relations are determined by its constitution. The system has been subjected to several important reforms since the adoption of the 1996 constitution and the Intergovernmental Fiscal Relations Act (1997).

These reforms have increased the quality of the fiscus and improved budgetary planning and control at all levels of government. However, some challenges remain.

The constitution sets out the broad guidelines of the Intergovernmental Fiscal Relations (IGFR), but there is no implementation manual that guides the modus operandi of the three spheres of government, the interrelationship between them and the boundaries of their authority.
This has sometimes resulted in inefficient outcomes at lower tiers of government. As a result, South Africa’s National Development Plan (NDP) further stipulates five main pillars by which its decentralised system of governance can be made more effective:

•    improve clarity in the differentiated system of governance;
•    address capacity contraints at lower tiers of government;
•    ensure a more coherent set of powers for metropolitan municipalities;
•    outline a more focused role for provinces; and
•    ensure a proactive approach to identifying and resolving problems within the vertical and horizontal linkages of the IGFR mechanism.
Tensions in SA’s fiscal systems

Despite the significant fiscal reforms, there are divergent views as to whether South Africa’s fiscal system is more decentralised or whether there is a greater tendency to return to more centralisation of fiscal policy. The tension arises as a result of the country’s need to balance the redistributive requirement in chapter 13 of the bill of rights to provide mandated basic services as a right, and the other constitutional obligation to ensure equitable and efficient allocations for provinces and municipalities to meet economic development objectives.

This paradox is driven by the need to ensure inclusive and sustainable growth at all levels of society on the one hand, and the efficient distribution of the gains of growth on the other hand.

If fiscal reforms undertaken by South Africa are conducive to efficient allocation of resources and consequently, economic growth, as argued by proponents of fiscal decentralisation, then measures must be taken to enhance the efficiency of intergovernmental fiscal relation systems. On the contrary, if fiscal decentralisation does not improve economic growth, then South Africa would need to evaluate its intergovernmental fiscal relations and implement appropriate measures to mitigate inhibiting factors and enhance its impact on growth.

This study looked into the impact of fiscal decentralisation on economic growth at the provincial level in South Africa. The aim was to further contribute to the policy debate on the fiscal stance in an emerging economy like South Africa, which is grappling with low economic growth, averaging just 3% over the past five years, compared to the African average of 5.3%.

Fiscal decentralisation and economic growth in South Africa

The results of this study showed fiscal decentralisation had a positive but weak impact on provincial-level economic growth (measured as GDP per capita of each province) in South Africa. This was explained by the fact that resource allocation at provincial level was more heavily skewed towards operating expenditure than towards growth-inducing capital expenditure. Consequently, capital expenditure at provincial level was found to have no impact on provincial economic growth.

Evidence shows that industrialisation usually leads to higher levels of economic growth. However, if it is driven by capital-intensive production as opposed to labour-intensive production, it results in high levels of unemployment, which could translate into more social welfare expenditure for the government. This state of affairs places a huge burden on government resources and also has the ability to reduce economic growth.

The study also found the more literate or skilled the working population was, the more likely it was the economy would grow. A skilled working population should translate into higher levels of productivity, which has a positive impact on economic growth. An additional finding was that if South Africa’s population grew more than its economy, the quality of social welfare and living standards would decline.

Where to from here?

The positive but weak relationship between fiscal decentralisation and provincial-level economic growth is attributable to a number of causes. South Africa’s fiscal decentralisation measures have not really been targeted at achieving economic growth. To date, they have been more focused on ensuring an equitable distribution of growth, bridging income inequality and poverty reduction. Consequently, resource allocation at provincial level in South Africa has been heavily skewed towards operating expenses as opposed to growth-inducing capital expenditure.

On average, operating expenses are five times higher than capital expenditure in the provinces. In addition, restrictions on revenue mobilisation (which is still largely centralised in South Africa) and borrowing further inhibit the ability of provincial governments to raise additional revenue for growth inducing investments.

There is also the perennial challenge of the lack of the requisite capacity at the lower tiers of government in South Africa for effective revenue mobilisation, attracting foreign direct investment and implementing the needed growth enhancing initiatives. The clear regional disparities cannot be ignored either in any policy reform. Indeed, several issues emerged from this study that should inform policy-makers’ efforts to improve the growth-enhancing potential of South Africa’s IGFR.

Authors: Professor Margaret Chitiga, executive director, Economic Performance and Development (EPD) research programme, HSRC; Dr Emmanuel Owusu-Sekyere, senior research specialist, EPD, HSRC; Dr Nicholas Ngepah, Oxfam senior regional research adviser, Southern Africa; Dr Jaya Josie, Head, BRICS Research Centre, HSRC.