JACQUES MORISSET: This is how the state can better deliver services

The role of the state is to ensure macroeconomic stability and equity, while delivering quality public services to all citizens. SA authorities have struggled to meet the second aspect, despite significant public spending.

In 2021, the country was ranked 135th out of 173 on the World Bank’s human capital index, despite spending on education and health being among the world’s highest (almost 15% of GDP). SA’s level of crime insecurity is also higher than would be expected regarding the level of public spending on police, safety, and protection services. The quality of public infrastructure has also rapidly deteriorated in recent years. 

The public sector’s challenge with delivering high-quality public services to citizens is a major source of concern for the country’s economic, social and political future. Service delivery failures have generally been explained by the diminishing capabilities of public administration, which is itself rooted in limited co-ordination, weak technical and financial capacities, poor motivation, and corruption. But is it possible that other factors underlie the government’s poor performance?

One of the most important underlying factors has been the unbalanced allocation of responsibilities between spending and revenue across levels of government. Two of the most eminent economists in this field, R Musgrave and W Oates, have said that the structure of the state should follow the following principles:

• The subsidiarity principle indicates the responsibility of public service delivery should be allocated to the level of government the closest to beneficiaries, accounting for the capacity to deliver.
• There should be consistency in the degree of decentralisation of spending and revenue responsibilities.

To what extent has SA adhered to these principles? On the first principle, the country has performed relatively well as about 50% of public spending has been decentralised to the nine provinces (for health, education, housing, and public transport) and 257 municipalities (for water, sanitation services, municipal health and public transportation, energy distribution). This makes SA a fiscally decentralised country compared with Organisation for Economic Co-operation and Development (OECD) economies.

Discipline lacks

On the second principle, only 15%-18% of total public revenue is collected by local governments. This discrepancy between decentralised revenue and spending is measured in the economic literature by the so-called vertical fiscal imbalance, which is on average equal to 70% in SA, but with significant variations between big municipalities and provinces. By comparison, the vertical imbalance is only 13%-25% in fiscally decentralised countries such as Iceland, Sweden, Switzerland, and Canada.

The problems associated with a high vertical fiscal imbalance in SA are many, starting with a lack of fiscal discipline. Indeed, local governments are likely to continue to spend if the cost of collecting revenue is supported by the central authorities — the IMF estimates that a one percentage point increase in the vertical imbalance leads to a 0.1-0.2 percentage point increase in the ratio of fiscal deficit over GDP.

An additional problem is the limited motivation for local authorities to improve value for money in service delivery as they are weakly accountable for their financing.

Local governments also lack the flexibility to adjust the delivery of services to their citizen needs or willingness to pay, which may vary across locations.

Policymakers could explore a number of options to address these challenges. They could rethink the vertical structure of the state so the vertical fiscal imbalance can be reduced. This could be achieved by decreasing the spending responsibilities devolved to subnational government or by increasing their revenue responsibilities.

For example, there is an increasing debate in SA regarding whether some education or health services should not be (re)centralised at the national level given the limited delivery capacity of several subnational governments. However, whatever the direction of these changes (towards less or more decentralisation), it would require significant efforts in the current political economy context and would probably require amending the constitution.   

System adjusted

Two intermediary solutions can be considered, to reduce the vertical fiscal gap, which have the advantage of being more practical in the short term as they would not significantly change the current structure of the state. These options would however, incentivise the subnational governments to become more effective.

The current formula-based transfer system from the central to local governments could be adjusted to strengthen the link between revenue and spending responsibilities. So far, unearmarked transfers are mainly calculated by the equitable share formula, which only accounts for the needs and capacities of each local government, while they could also be determined by their efforts to deliver more and better services.

The National Treasury has recently initiated this process under the conditional debt relief offered to municipalities that have accumulated large arrears with Eskom. This could be further applied to social sectors under the responsibility of the provinces; for example, Brazil did it for the health sector with relatively good results.

The responsibilities of revenue collection (except for the income tax, which will require a constitutional amendment) could be further decentralised but only for good performers or subnational governments with proven capacity. The Vietnamese authorities used this approach to enhance the local authorities in Ho Chi Minh City to increase their collection performance.

As emphasised by Daron Acemoglu, a professor of economics at Massachusetts Institute of Technology, the performance of the state is largely determined by its capacity to adjust to the needs of its citizens. While intergovernmental relationships are complex, the authorities will send a strong signal to citizens by fixing the existing vertical fiscal imbalance — since SA is clearly an outlier, with pragmatic but decisive actions.

• Morisset is programme leader and lead economist for the World Bank in SA.