Fiscal Decentralization and Economic Growth in Pakistan

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FISCAL DECENTRALIZATION AND ECONOMIC GROWTH IN PAKITAN

A Thesis Submitted to the Faculty of Institute of Management Sciences, Peshawar In Partial Fulfilment of the Requirements for the Degree of

MBA (Finance) (2009-2011)

Institute of Management Sciences, Peshawar

Chapter 1:
Introduction

According to James Edwin Kee, Fiscal decentralization is the devolution of certain administrative and fiscal powers and functions to the sub-national governments. It also means the shifting of responsibility to the low-level governments with concomitant accountability. The extent of Fiscal devolution can be measured in terms of the powers of low-level governments to raise revenue or to incur expenditures. Fiscal devolution in the public sector has received great attention during the last two decades for many reasons. The implications of financial autonomy on the performance of sub level government and economic growth has been studied widely both for the developing and the developed world. In transition countries, with the disintegration of centralized system, fiscal federalism emerged; and in many developing countries, like India, Brazil and Argentina, financial decentralization was debated regarding its effects on economic stabilization. Some studies have, however, suggested that the relationship between the two has not been conclusive.

[Financial devolution] is reckoned as a key policy tool that ensures economic efficiency and good governance through financial autonomy of the [federating units]. It leads to the integration of provinces and enhances their participatory role in the economic development of a country. It relieves the central government from paying attention to the details of financial matters, thereby enabling it to undertake the tasks at national level in a more effective and efficient manner. Also, if the central government for some reasons becomes inefficient, then devolution can be a possible solution. It accelerates growth and empowers the low-level governments through financial autonomy and administrative empowerment. The devolution makes the federating units more responsible as it brings the government closer to the people.

Decentralization policy has a positive effect on economic growth as it helps implement social policies in a better manner. In decentralized set ups, the lower tiers of governments know more about the necessities and developmental needs of the people, which leads to economic efficiency in service delivery, thereby accelerating the growth rate at national and regional levels. This is also called the “Oats Decentralization Theorem”. It says that if the people in one municipality are not provided with adequate public services, they may opt for shifting to other municipalities having more facilities.

Financial autonomy reduces the wasteful utilization of resources by the central government. According to Bird and Smart (2002), for effective service delivery it is important that the recipient of funds has clear mandate, sufficient resources and powers to make decisions. Through decentralization, responsibilities as well as resources are devolved to the lower level governments (Rondinelli,1981). In this way , the federating units are empowered which enable them to use the resources to good effect , raise living standard of the people and distribute the work load (Gordin, 2004).

In Pakistan’s case, the significance of Fiscal devolution cannot be overemphasized. Pakistan is a federation having a centralized taxation system. The major chunk of revenue is collected by the central government, which is then distributed among the provinces to remove...
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