MUNICIPAL FINANCE

 

Municipal Finance: Why should USAID get involved?

Municipal finance has an impact on development in several different ways, so it is natural that USAID missions may want to provide assistance to improve the way that municipal finance functions. Municipal finance can affect the development of democratic governance through its impact on the ability of elected municipal leaders to meet the expectations of the local citizenry. Municipal finance affects economic development through its impact on the quality of local services and infrastructure required for expanding commerce and industry as well as its impact on the deepening of financial markets. Municipal finance affects the quality of the natural environment through its impact on municipal services such as water supply, sewage treatment, solid waste management, and public transportation. Municipal finance even affects poverty reduction through its impact on the ability of municipal governments to undertake effective pro-poor programs of social, economic, health, education, and community development.

Local government programs are often an important component of a mission’s democracy and governance strategy. When this is the case, it is important to assess whether municipal finance is functioning well enough to provide the level of resources that local leaders need to meet the expectations of the citizens in their communities. Local leaders may not be viewed as credible, perhaps not even legitimate, if they cannot provide a minimally acceptable level of service in the areas for which they are responsible. When local government leaders fail some or all of their citizens, the door may be open to intervention by radical groups pursuing an anti-democratic agenda.  Given the worldwide trend toward the decentralization of responsibility for basic services, local government leaders are facing growing pressure to make municipal services work more effectively. This can only be done if local governments have sufficient resources to employ adequate numbers of trained personnel, buy needed supplies, maintain equipment, and expand infrastructure to keep up with growing demand. Unless municipal finance is working, local government leaders will fail in their most basic responsibilities.

Economic growth and private sector programs are another part of a mission’s portfolio where municipal finance can have an influence. Business depends on local government services, such as a healthy and educated workforce, good local transportation, and good infrastructure. If there is inadequate water supply, transportation gridlock, or shortage of power, business is less productive. If the local workforce is poorly educated or unhealthy, business is less efficient. For businesses to compete in the global marketplace, their bases of operations need to be in localities providing the services that support efficient production in the short and the long run. For this reason it may be helpful to economic growth and private sector programs to assess the condition of municipal finance in key cities to determine if targeted assistance could improve the business climate, at least insofar as municipalities are tasked with providing services that are supportive of business.

It also may be appropriate for economic growth and private sector programs to consider assistance that supports greater involvement of financial market institutions in municipal finance. Here the opportunity is to deepen financial intermediation by bringing long term private capital to municipal infrastructure investments. In many developing countries, the emergence of private institutional investors such as life insurance companies, pension funds, and mutual funds is resulting in increased demand for secure long term investment opportunities. At the same time, municipalities and their utilities are looking for long term financing for infrastructure projects. Putting these two sides of the equation together can help develop more robust and diversified capital markets. In addition, U.S. models of municipal finance can be adapted to a developing country context in ways that create opportunities for expansion of U.S. companies that provide financial services, when that is a mission’s priority.

Environment and natural resources programs is another place where municipal finance can have an influence The operation of water supply, wastewater treatment, solid waste management, and public transportation has an important impact on the natural environment. If these services are well managed by local government, the impact can be positive. If not, pollution and resource depletion may result. For a mission’s environment and natural resources program it is important to know if local government environmental services are adequately funded because this is likely to be the most important factor affecting the quality of service management. Targeted assistance to improve specific aspects of municipal finance can be an important part of an Environment and Natural Resources program, e.g. water tariff reform to reduce wastage, support for debt financing of municipal wastewater treatment projects, or introduction of user charges for solid waste collection and disposal (polluter pays).

Poverty reduction is a common theme in most mission programs. As the level of government closest to the people, local government can play a key role in poverty reduction. The ability of local governments to implement pro-poor policies and programs will be particularly dependent on municipal finance. In most developing countries, the poor are the last people to gain access to essential services and facilities such as potable water, sewer, solid waste collection, schools, and clinics. Unless local governments have the financial resources to expand their services beyond their current clientele, the poor will continue to be marginalized. For many local governments, expanding services to the poor will require investment in new infrastructure. This can only be done if the local government can access long term loans to finance infrastructure projects. In turn, local government borrowing requires the local government to have its financial house in order to be able to qualify for loans. So, improving municipal finance can be an important part of mission efforts toward poverty reduction.

For the purpose of this assessment toolkit, municipal finance refers to the flow of financial resources that local governments use to fund the delivery of services at the municipal level. Local government refers to municipalities (or their equivalent in the local government system of the country) as well as any local government owned utility organizations (e.g., for services such as water, wastewater, power, transportation, etc.)  Broadly speaking municipal resources can be classified into three categories: revenues from taxes, user fees, and tariffs; intergovernmental fiscal transfers; and borrowings.

In order for local governments to provide adequate levels of services to their citizens, they usually need to mobilize resources from all three categories in amounts sufficient to operate, maintain, and expand their operations. The following assessment toolkit provides guidance to missions on how to determine whether to undertake assistance designed to improve municipal finance, and if so, what kinds of problems need to be addressed.