We live in an era when finance, commodities, and labor have reached an unprecedented
international mobility. The average daily turnover in foreign exchange increased from about $200
billion in the mid-1980s to approximately $1.2 trillion in 1996, equivalent to approximately 85
percent of all countries foreign exchange reserves. By 1992, the net stock of international bank
lending reached $3.6 trillion, seven times the level of international lending just fifteen years before.
Net capital flows to developing countries grew from an annual average of $44 billion for the period
1983-88 to $196.9 in 1996 while foreign direct investment increased from $10 billion to $91 billion.
Since 1950, the ratio of international trade to global output has doubled with trade growing at twice
the rate of world GDP since the mid-1980s. By 1995, world trade reached the five trillion dollar
mark as production was internationalized through the proliferation of joint ventures, strategic
alliances and subcontracting networks among firms located in different countries.
The advance of economic globalization has reinvigorated concerns that globalized finance,
international trade, and multinational corporations curtail state sovereignty. Other analysts contend
that while internationalization increases the “opportunity costs” of autarky and enhances the
incentives for participating in the globalized economy, countries still retain scope for delimiting their
involvement and developing strategies to exploit their opportunities. This paper will not address
this important debate. Rather it will highlight developments usually neglected by its participants.
It will contend that globalization has altered the challenges of governance by changing the
distribution of power and authority within state institutions. In particular, I will argue that
globalization promotes decentralization. I will begin by using examples from the United States,
India, and China to illustrate how globalization promotes decentralization. Next, I will “deconstruct”
decentralization by demonstrating that there are different ways to decentralize and that these
different approaches, or even similar approaches in different socio-economic contexts, are likely to
produce divergent outcomes. In view of the diverse possibilities, the section will argue that it is
important to develop decentralization strategies which maximize the prospects for desirable
outcomes. Drawing on delegation theory, I contend that successful decentralization strategies are
likely to require a combination of three types of mechanisms — “police patrols,” “fire alarms,” and
“pocketbooks” to ensure that local government will pursue the broader public purpose. Finally, the
paper contends that decentralization in a globalizing world will produce regional disparities within
countries. It will contend that resolving the political and economic problems that arise as a
consequence will require new and creative solutions.
Globalization and Decentralization
It is more than a coincidence that countries as different as the United States, India and China
have taken major initiatives to decentralize authority over public policy since the 1980s. While there
is a diverse range of explanations for decentralization in each country, globalization has provided
an impetus for decentralization in two manners. It has created pressures to redefine the role of
central government by curtailing many of its economic and social interventions. This has produced
de facto decentralization as the diminishing role of the central government increases the relative
importance of the roles of state and local governments. Second, increased capital mobility and
changing patterns of international investment and trade have enhanced the importance of state and
local government policy in attracting investment and promoting economic development.
The age of globalization coincides with an era of rolling back central government economic
intervention. Although susceptibility to the pressures of global finance and capital flows varies,
India, China and the U.S. have attempted to enhance the efficiency of their economies by reducing
central government intervention. Some argue globalization of financial markets has obliged states
to curtail their economic intervention by obliging them to demonstrate greater fiscal responsibility.
For advanced industrial countries this has not been the case. Financial globalization has meant
access to foreign capital which financed increased budget deficits both in the United States
beginning in the 1980s, and in Western Europe beginning in the late 1970s. Similarly, financial
globalization during the 1970s led to governmental expansion in many developing countries. It
wasn’t until the 1982 debt crisis international finance exerted pressures for fiscal austerity.
The roll back of central governments around the world is less a result of the imperatives of
international finance than it is a response to international competition pressuring states to find ways
to improve the competitiveness of their economies. The United States, provides a clear example.
While running up historically unprecedented deficits — a large part of which were financed by
international capital — it deregulated its aviation and banking industries. It has curtailed the federal
government’s role many other public policy including welfare and education. Similarly in India,
more progress has been made in reducing government regulation than in bringing down the fiscal
deficit. India has virtually abolished the central government’s investment licensing regime, and with
the creation of agencies like the Stock Exchange of Bureau of India (SEBI), the Government of India
has embarked on a transition from direct intervention in the economy to procedural regulation of
markets in order to improve economic efficiency by lowering transaction costs. The transformation
of the role of the central government in China has been even more dramatic given its starting point
as a command economy. The transition from plan to market in China has dismantled the controls
of central planning and greatly enhanced the autonomy of provincial and local governments. Yet
as Barry Naughton has pointed out, while central planning institutions have been weakened, the
reforms have enhanced the capacity and authority of central government institutions, like the
People’s Bank of China, which exercise control over macroeconomic policy levers. We might
summarize these developments by saying that each state has attempted to move in the direction of
what Barry Weingast has termed “market-preserving federalism” in which central government
intervention in markets is limited to promoting market efficiency and minimizing undesirable
While central governments have curtailed their economic intervention, the salience and
importance of local government economic policy has increased. As the roll back of central
government economic intervention increases the exposure of state governments to the consequences
of their own policies, the increased mobility of industrial capital pits localities across the nation and
around the world in a competition to attract investment. This competition is more acute at the local
than national level since the impact of capital investment and flight in terms of jobs and revenues
is more palpable there. Local governments often compete with one another to attract investment
by extending tax concessions or subsidies. However, the competition for investment also increases
the importance of the policies that local governments can implement to create investment climates
that will attract capital. In most countries of the world, state governments have primary
responsibility for the provision of transportation, energy, and communications infrastructure, the
education, training, and health of their work force. Those states that implement their responsibilities
more effectively will be more successful in attracting capital.
The technological change that has accompanied globalization also increases the importance
of local government policies. Michael Piore and Charles Sabel contend that the application of new
information processing technologies to industrial production has created a new era in which mass
production by specialized machinery will be displaced by technologies enabling “flexible
specialization.” As production technologies become more flexible and less asset specific, it
becomes less efficient to locate them in large corporate governance structures and more efficient to
place them in more decentralized governance structures based on cooperative network linkages
between firms. The increasing importance of competition through technological innovation also
makes economic networks more attractive because network structure allows each firm to concentrate
on a limited range of technological expertise and accelerate their innovation in that area. Local
governments can provide services that are essential to the success of business networks by
collaborating with local business organizations to formulate and implement supportive policies.
Since the 1970’s, innovations in productive and managerial technologies have fashioned a
new economic geography. Improvements in transportation, information processing, and
communications technology have transformed the organization of economic activity creating new
configurations that span national boundaries. Global trade and production is increasingly organized
through international networks of firms designed to minimize costs and maximize flexibility and
innovation. These “global commodity chains,” as Gary Gereffi has called them, take different
forms. Some are “producer-driven” commodity chains organized by multinational corporations
which orchestrate the international production process and control commodity distribution.
Producer-driven commodity chains are usually organized by multinational corporations in capital
and technology-intensive industries. Other networks are organized by large retailers, brand-named
merchandisers, and trading companies. These “buyer-driven” commodity chains are most frequently
found in labor-intensive, consumer-goods industries such as garments, foot-wear, toys, consumer
electronics, etc. where retailers and brand-name merchandisers set up decentralized production
networks in developing countries with low labor costs.
Global commodity chains reorganize economic space creating new regional disparities in the
process. Bangalore — India’s Silicon Valley — epitomizes how changing patterns of production and
trade links have spurred regional development. The metropolis that Jawaharlal Nehru called
“India’s city of the future” with its three universities, 14 engineering colleges, and 47 polytechnic
schools has been targeted as a center of Indian science since the days of the British raj. While it is
home to modern industrial giants like Hindustan Aeronautics and Bharat Electronics, its most
dynamic sector is software. Bangalore’s “Sultans of Software” include firms with technological
expertise matching the world’s most sophisticated software firms. Their satellite links with software
developers around the world lead American economist John Stremlau to observe, “In cyberspace,
Bangalore and Boston are practically in the same space.” Many of Bangalore’s software firms are
located in one of the city’s dozen “technology parks.” These self-contained communities usually
have their own satellite communication system, power, sewage, and often their own stores, schools,
and health care facilities. Life in these communities is increasing detached from the rest of
Bangalore, not to mention India’s rural hinterland.
Tiruppur is another recently created island of prosperity. Usage of computerized embroidery
machines along with incorporation into multinational marketing networks has enabled the dusty
provincial city to increase exports from $25 million in 1986 to an estimated $1 billion in 1995,
making it one of the few places in India where there is a labor shortage. Even greater dynamism
can be found in China’s special economic zones in Guangdong and Fujian or in the United States’
Silicon Valley and North Carolina Research Triangle. In each case, the dimension of economic
space has been transformed, as the distance between these localities and lucrative foreign markets
diminishes while the distance between dynamic regions and economic backwaters like Bihar,
Shaanxi, and West Virginia increases.
This reorganization of global production enhances the importance of state and local
government policy. Dynamic regions require good infrastructure in order attract foreign investment
and enable local firms to become internationally competitive. Good public education systems and
vocational training, usually the responsibility of local governments, also increases in importance.
In China and India, as in the United States, state and local governments develop industrial policies
to attract investment and promote economic development even while central governments are
curtailing their intervention in the economy. The Enron controversy in India, involving a $2.8
billion dollar investment project, epitomizes the growing importance of state and local governments.
India’s central government was relegated to the status of spectator as the state government of
Maharashtra negotiated, canceled and then renegotiated the largest foreign investment project in
The Need for Strategizing Decentralization
The increase in the relative importance of local government that has accompanied economic
globalization, makes the need for developing effective strategies for decentralization more urgent.
Important measures to enhance the power of state and local governments are being implemented in
China as part of the economic reform process. With the passage of the 73rd and 74th amendments
at the end of 1992, India is also taking important steps to decentralize power to municipal and local
panchayat governments. As the contrast between southern and northern states throughout American
history prior to the civil rights movement illustrates, decentralized state power can produce very
different results for local governance including the democratic rights of minorities. Most Indians
would acknowledge that decentralizing state authority to areas such as Western Maharashtra, where
civil society is highly mobilized, and rural Bihar, where crime bosses exert considerable political
influence, is likely to produce very different outcomes. Furthermore, India’s state governments
must make a difficult transition from the populism. The inability to ensure that all local officials are
interested in optimizing economic development and protecting political rights, heightens the
importance of devising strategies to motivate local authorities to enhance social welfare.
Political scientists have theorized that there are two methods of attempting to ensure that
officials can be motivated to achieve policy objectives — “police patrols” and “fire alarms.” “Police
patrols” are when central authorities monitor the actions of their agents to investigate whether they
have used the power delegated to them to achieve policy objectives. “Fire alarms,” are established
when central authorities establish rules and informal practices that enable interested citizens to
monitor the actions of officials to whom authority has been delegated.
In contrast to China where officials as far down as the village and township level have played
an active role in promoting economic growth and generating millions of jobs, India, until very
recently, has never had effective levels of government below the district level. Due to the colonial
genealogy of the Indian state, Indian has relied almost exclusively on the “police patrol” approach
to ensure that government officials below the state level implement public policy objectives. Efforts
to ensure accountability through bureaucratic controls have broken down as the bureaucracy has
been placed under the authority of unscrupulous politicians. As the Indian state became more
extensively involved with promoting Indian development the opportunities and spoils of corruption
have increased while the risk of getting caught in the act and the penalties to be paid have declined.
Simultaneously, reliance on the police patrol approach contributed to India’s bureaucratic labyrinth
which has hamstrung Indian public policy in red tape.
Although India’s panchayat and municipal governments existed throughout India prior to
the 73rd and 74th amendments, they were generally ineffective because they lacked adequate funding.
What funding they did control was often used ineffectively since the failure to hold regular
competitive elections silenced most “fire alarms.” The constitutional amendments promise to
invigorate local government in India by ordering each state government to set up a finance
commission to transfer adequate revenues to local governments and by requiring members of
panchayat and municipal governments be elected every five years.
The proceedings of state finance commissions are vital to the effectiveness of municipal and
panchayat governments. They present the opportunity to overcome the historical reluctance of state
governments to devolve adequate funding to municipal and panchayat governments. Traditionally,
India’s finance commissions have occupied themselves with determining equitable distributions of
funding among different levels of government. In addition to arriving at equitably distributions, state
finance commissions should take advantage of the opportunity to create other mechanisms for
promoting the accountability of local government — mechanisms that we will call “pocketbooks.”
“Pocketbook” mechanisms promote the accountability of local government by linking their revenues
to the achievement of broader social objectives. Fiscal policy offers one type of pocketbook
mechanism. It has been central to the dynamic promotion of economic growth by local government
Throughout China’s reform period, the profits of enterprises have been an important source
of revenues for local and provincial governments. This links the economic performance of
enterprises with economic well-being of local and provincial governments. China’s fiscal reforms
tightened the budget constraints on provincial and local governments while transferring new policy
responsibilities to them. Simultaneously, local governments reached revenue sharing arrangements
with provincial governments and provincial governments negotiated revenue sharing agreements
with the central government. By apportioning fixed percentages of enterprise profits among local
and provincial governments and fixed shares of revenues among different levels of government,
China’s fiscal policy motivated provincial and local officials to expand their economies in order to
increase their revenues. In addition, economic growth motivated government and party officials
because it increased employment for workers and administrative positions for political supporters.
It thereby enabled them to build networks of support essential to advancing careers within China’s
political system. In fact, the incentives to promote economic growth were so strong that China’s
economy periodically overheated in the through the early 1990s, and one of the post formidable
challenges confronting national policy-makers was to find a way to limit growth to a manageable
Increased incentives to promote economic growth in countries like China have intensified
competition for investment in the global economy. Localities compete by offering various forms
of subsidies to investors or by providing better infrastructural physical and human infrastructure.
Localities are better off competing through infrastructure. The efficacy of granting tax concessions
and other subsidies to businesses as a means of attracting their investment is marginal at best.
Businesses are transients in today’s global economy, and they often threaten to leave for other
localities even when they are offered new concessions. Localities that attract investment through
infrastructure are less vulnerable to this pressure. While localities attracting investment through tax
concessions are left with little but unemployment when businesses depart, those that build up their
infrastructure can use their assets to attract other investment.
The American experience provides a lesson demonstrating that the development of bond
markets can provide local governments with access to funding for infrastructure while serving as
another pocketbook mechanism of accountability. For two centuries, state and local governments
in the United States have actively promoted economic development through the issue of bonds. In
fiscal year 1991-92 (the latest year of available data) state and local governments issued nearly $158
billion in long-term debt and had more than $950 billion in long-term debt outstanding. This debt
has been utilized for a very broad range of economic development activities, some of which may be
inappropriate for developing countries. Perhaps the most useful lesson from the American
experience for developing countries comes from the nineteenth century when in a matter of decades
state and local governments used bonds to build a range of infrastructure that before the end of the
century created infrastructure unequaled anywhere in the world.
As countries like India and China develop their capital markets, they should take measures
to develop markets for state and local government debt. Promoting bond markets for municipal and
rural local governments is especially attractive because of the immense need for infrastructure
investment. While state governments in India can already issue bonds, the underdevelopment of
bond markets restricts their use. Large municipalities also issue debt, but only after having obtained
state government guarantees. This restriction limits the enterprise of state and local governments.
The American experience suggests that it can be eliminated as long as there is a well developed legal
system that holds the governments accountable for repaying their debt.
In view of failure of Indian state governments to provide local government’s with adequate
revenues, promoting bond markets for state and local governments offers a viable alternative for
making them autonomous agents for development. Encouraging state and local governments to issue
bonds raises the concern that they would not use this power in a fiscally responsible manner, but in
fact, as long as the judicial system holds the governments responsible for repaying their debt, the
bond market provides a mechanism that would hold local governments more accountable than they
are when the finance development through general revenues. And while capital markets over-represent wealthy economic interests, requiring government debt issues to be approved by public
referenda provides a mechanism to protect the public interest.
and a New Challenge for Democratic Governance
Globalization and decentralization present a new challenge for governance. By reorganizing
economic geography, foreign direct investment and global commodity chains promote islands of
economic dynamism in large developing countries like China and India with vast hinterlands that
threaten to become seas of economic backwardness. Decentralization, if it is effective, will
exacerbate regional differences. It provides the opportunity for local governments to adjust policies
to local circumstances in innovative ways. Some states will be more successful than others. Harder
budget constraints create incentives for state and local governments to compete for domestic and
foreign investment to promote economic growth and increase their revenue base. As in any
competition, there will be winners and losers. The outcome will exacerbate regional disparities.
These are already apparent in the political tensions between coastal and inland provinces in China.
They may pose even more formidable challenges for countries like India where provincial borders
coincide with boundaries between ethnic communities.
Regional disparities are not a new problem for developing countries like India and China,
but in the context of economic liberalization and administrative decentralization, they require new
solutions. Previous measures taken by central governments to reduce regional disparities — e.g.
allocating investment to “backward” areas — interfere with market dynamics and will be even more
counterproductive now than they were in the past. Effective governance is likely to require the
creation of a policy environment that encourages state and local governments to create institutional
innovations that solve their related problems through policy coordination promoting mutually
beneficial economic linkages. Developing inter-regional labor markets will be especially important.
One model in this regard might be the inter-state labor coordination center created by the China’s
thriving coastal province Guangdong, and the inland provinces of Hunan, Guangxi, and Sichuan.
This regional labor coordination center helps supply needed labor to Guangdong at times of
shortages, and it discourages flows when labor is not needed.
Globalization promotes decentralization by creating incentives to roll back central
government economic interventions and increasing the relative importance of local government
policy. This essay has “deconstructed” decentralization by demonstrating that decentralization is
likely to lead to diverse outcomes. In light of the range of possibilities, the paper has contended that
it is important to develop decentralization strategies which maximize the prospects for desirable
I have highlighted two issues that strategies for decentralization should address. First,
drawing on “delegation theory,” I have argued that decentralization strategies should create
incentives to accomplish broad social goals even while increasing local discretion. I have contended
that decentralization can achieve a proper balance between local innovativeness and social
responsibility through a combination of “police patrol,” “fire alarm,” and “pocketbook” mechanisms.
Second, I have demonstrated that decentralization, especially where it is effective, will present new
challenges to governance by contributing to growing regional disparities. Finding solutions to this
problem will require new and creative approaches that will protect the autonomy of local
governments while encouraging them to cooperate in fashioning solutions to the problems of