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Strasbourg, 15 September 2009                                                          CDLR(2009)29

Item 5.2.1 of the agenda

                                                                                                                         

EUROPEAN COMMITTEE ON LOCAL AND REGIONAL DEMOCRACY

(CDLR)

REPORT ON

THE IMPACT OF THE ECONOMIC DOWNTURN

ON LOCAL AUTHORITIES

Secretariat Memorandum

prepared by the Directorate General of

Democracy and Political Affairs

Directorate of Democratic Institutions


This document is public. It will not be distributed at the meeting. Please bring this copy.

Ce document est public. Il ne sera pas distribué en réunion. Prière de vous munir de cet exemplaire.

Introduction

The attached document has been prepared by a team convened by LGI (the Local Government and Public Service Reform Initiative of the Open Society Institute) and the Council of Europe, as part of their established collaboration and as agreed by the CDLR at its meeting in April 2009. It draws on the findings of a substantive report compiled (to be finalised shortly) by an editorial group team comprising: Kenneth Davey (Overview and Efficiency), Katalin Tausz (Social Protection), Boyan Zahariev (Efficiency), Gabor Peteri (Capital Financing) and Pawel Swianiewicz (Territorial Reform). Valuable comment has been provided by Jorgen Lotz. The editorial group has been greatly assisted by observers in 27 countries who have supplied data on the financial performance of local governments up to the first half of 2009 and commented on the relevance to their countries of the policy options discussed below.

The aim is that the attached document be reviewed by the CDLR in order that it be submitted to the Ministerial conference as a basis for discussion at the 16th session in Utrecht.

It is also proposed that the full report, which is currently being finalised, will be produced in English only and be made available to the Ministerial conference (only) as an information document.  

Action required

Members are invited to examine this document with a view to making any proposals for change they deem appropriate in order for this document to be submitted to the Ministerial Conference.

The Committee is invited to review the document and to approve it as a document for the Ministerial Conference, making any changes it deems appropriate.

It is further invited to agree that the full report be made available to the Ministerial Conference as an information document.

Appendix

THE IMPACT OF THE FINANCIAL DOWNTURN ON EUROPEAN LOCAL GOVERNMENT

INTRODUCTION

Local government across Europe is bound to suffer from the prevailing economic crisis. But how much?  How far are the impacts cushioned by national counter-cyclical grants or delayed by taxation time-lags, and for how long? And what, if anything, can be done to lessen the harm to the public services it performs?

These questions are addressed by this analysis, for consideration by the conference of ministers responsible for local government at Utrecht in November 2009. It has been prepared by a team convened by LGI (the Local Government and Public Service Reform Initiative of the Open Society Institute) and the Council of Europe, as part of their established collaboration. This overview draws from the report compiled by an editorial group team comprising: Kenneth Davey (Overview and Efficiency), Katalin Tausz (Social Protection), Boyan Zahariev (Efficiency), Gabor Peteri (Capital Financing) and Pawel Swianiewicz (Territorial Reform). Valuable comment has been provided by Jorgen Lotz. The team has been greatly assisted by observers in 27 countries who have supplied data on the financial performance of local governments up to the first half of 2009 and commented on the relevance to their countries of the policy options discussed below. The full report has been produced and will be distributed in English only.

IMPACTS

The Crisis

The World Bank expects the world economy to contract by 3% in 2009; OECD predicts a fall of 3.7% in its member states’ GDP over the same period. EUROSTAT records  a drop of  4.5% in the European Union over the year to March 2009, with performance differing  radically between member states, from a decline of 18.6% in Latvia to a slight growth of 1.9% in Poland.

It all started with the collapse of overheated housing markets, initially in the United States late in 2007, but repeated in the United Kingdom and other western European countries. This undermined banks who had provided mortgages too generously, again initially in the United States but soon infecting European banks who had bought into the sub-prime mortgage market. Bank failures and bailouts by national government dominated the first three quarters of 2008. Those banks which did not fail were imbued with a new and heightened caution which led them to scale back or deny previous support to business through working capital, letters of credit and investment loans.

The banking crisis affected local governments directly through

The collapse of housing markets has devastated construction industries across Europe (and the employment of much migrant labour sending remittances home). The contraction of bank commercial credit has widened the impact to business activity overall leading to

Inevitably this has subjected local governments to a budget squeeze between falling revenues and the rising costs of debt service and social assistance to affected households, or will do so sooner or later. The timing and magnitude of that impact depends, however on both tax procedures and national policies. These forces will be discussed in the following paragraphs.

Current Revenues: taxation and fees

The impact of the crisis on local government current revenues has varied widely depending on

OECD analysis of its member states finds that revenue from property taxes has been the least affected by previous economic downturns, personal income taxes moderately vulnerable, taxation of business turnover more responsive and of corporate profits the worst affected. These statistics confirm common sense expectations and are borne out by experience so far of the current recession.

The dramatic fall in housing values might have been expected to affect revenues from local taxes on property, the most common local tax source in Europe. Radical declines have occurred in those American cities (20% in Washington DC) where assessments are automatically indexed to changes in market values. This is not the case, however, in those European countries where property taxation is based on formula valuations which are updated very infrequently, if ever. This robs the tax of buoyancy when times are good, but provides welcome stability during economic downturn. In the United Kingdom revenue from the residential property Council Tax has continued to rise by £1 billion in each of the last four years.

Property tax receipts are, however, vulnerable in times of recession to growing default and to pressure, particularly from business owners, for exemptions and reductions. The UK tax on commercial property is forecast to fall slightly in 2009/10. In France President Sarkozy has promised to abolish the Taxe Professionelle which is assessed on the rental value of business assets; Rural municipalities in Poland have granted 32% more individual rate concessions in 2009. In both France and United Kingdom incapacity to pay the tax is effectively compensated by government, a hidden but rising subsidy in times or places of economic distress.

By contrast, local taxes on property sales have fallen instantly and dramatically.  Previously worth over €8 billion annually in France their decline has been a particular blow to French departements (who are also faced with the major costs of social assistance).In Bulgaria revenue from this source in the first five months of 2009 has only reached 40% of the level over the same period in 2008. In Spain 2008 receipts were 40% lower than in 2007.

Access by local government to personal income taxation varies across Europe, as does its method – whether by sharing with national government or local  surcharge, whether assigned by origin (place of residence or employment) or by formula. But regardless of method, where such access exists the revenue is highly significant to local budgets (70% of total local revenue in Ukraine, 50% in Estonia) and buoyant (growing by 47% in Slovakia over the four years preceding the crisis). PIT is also a major resource for large local governments throughout Nordic countries and Switzerland.

Rising unemployment obviously hits PIT revenues, and those still in a job may earn less through cuts in hours, bonuses or even wage rates (15% for public employees in Latvia, excluding teachers and the lowest earners). Some countries have also reduced income tax rates in attempts to boost consumption; (maximum rates in Poland had already fallen from 40% to 32%, and taxable income thresholds have been raised in Hungary). Most dramatically in Ukraine, where PIT accrues entirely to oblast, city and rayon budgets, revenues have fallen over the last year by over 20% in real terms largely due to wage arrears.

Local taxes on business profits or turnover are isolated and idiosyncratic, often victims to accusations of distorting competition in a global marketplace. They are also highly vulnerable to economic recession. German local governments are reporting major declines in the Gewerbesteuer (a local tax based on company profits) though this will take time to become statistically measurable. Similarly the Hungarian Business Tax, levied retrospectively on turnover, will show the effects of downturn mainly in 2010. But Czech municipalities have already experienced an 11.6% fall in corporate profits tax shares in the year to March 2009, and Finnish municipalities expect revenues from their 22.3% share of this tax to be halved in 2009. Polish regions have received 15.7% less from their share in the first half of 2009. Portugal reports reduction in Municipal Contributions (a surcharge on corporate profits tax).

Value added taxation is widely shared with local governments in south Eastern Europe, as compensation for the abolition of the local sales taxes, prevalent in the former Yugoslavia. Its yields are directly related to volumes and values of production and commerce and therefore highly vulnerable to their decline. These shares represent half municipal revenue in Bosnia and yields had already declined by 13.9% in the year to March 2009. A fall of 23% is forecast over 2009 in “the former Yugoslav Republic of Macedonia”.

Impacts on revenue from fees and charges are less clear since they are divided between the budgets of local authorities and their utility companies. Reductions of income from building permits and other development charges have been widely reported, particularly in the United Kingdom. Falls in water supply, sewerage, heating and refuse collection charges have been reported in Latvia, while in Ukraine only 60% of households are actually meeting utility charges.

Revenues: intergovernmental transfers

OECD analysis of previous recessions indicates that intergovernmental transfers are historically the most volatile source of local budget revenue. This experience is being repeated.

National government responses to falling municipal revenues have varied radically.  Albanian, British, Danish, Finnish, Norwegian, Polish and Swedish governments have compensated local governments for falling revenues and rising expenditures, partly through deliberate counter-cyclical policy and partly as an automatic result of equalisation formulae. Danish fiscal rules require general grants to be counter-cyclical. Norwegian grants have risen by 1.2 billion krone. The Ukraine Government has added 10% of corporate profits taxation to the equalisation pool. The Russian Federal Budget for 2009 includes a 36% increase in transfers to regional governments.

In contrast, Bulgaria has reduced its grant for mandatory services (education, social welfare, health service etc) by 10% in 2009 and is threatening to increase this cut to 25% in 2010. Serbia has reduced grants by 15bn dinars (equal to 8.5% of total revenue) in 2009. Estonia has reduced its Equalisation Fund by 23% in 2009 while grants for pre-school education and road maintenance have been eliminated in Latvia.  The Irish Government has cut its general purpose grants by 9.6% in 2009. The Hungarian block grant has been cut by 2% in 2009, but levels of actual cash payments at the end of May were 18% down on the same stage in 2008.  Despite increases in federal funding, a number of Russian regions have reduced equalisation grants to their municipalities because of falls in their own CPT revenues. In a number of cases such as Bulgaria and Serbia, these cuts have been mandated by standby agreements with the IMF (International Monetary Fund).

Current Expenditure

Mention has already been made of the increasing cost of servicing debt, due partly to banking failures, partly to rises in bank lending rates and partly to the devaluation of national currency against the euro in which many municipal loans have been denominated. The cost of municipal debt service in Serbia, for example, is rising by 26% in 2009. The burden is particularly severe for those local governments which were already heavily indebted before the crisis.

The impact of increased social expenditures on municipal budgets varies greatly, partly because of differences between countries and regions within them in the severity of the crisis, but also because of great variations in the extent of municipal responsibility in the social assistance sector. A further variable is the duration of unemployment insurance benefits after dismissal, delaying eligibility for social assistance.

Responsibility for basic entitlements like unemployment benefits, old age pensions and incapacity allowances normally lies with national government or its insurance agencies. Depending on country systems, however, local government may bear some of the extra costs of

Local governments may also administer state benefits, subject to reimbursement.

Social assistance costs to Polish local government increased 13% at the end of March 2009 (20% in rural municipalities), while costs to Estonian municipalities have risen by an annual rate of 67%.  Slovak local authorities spent 28.6% more on social welfare in the first half of 2009. Croatia and Russia also report rising social assistance costs, while both British and Italian local governments are coping with higher demand for housing allowances and homelessness. Since there is generally a time lag between recession and the growth of unemployment (and between economic recovery and recovering employment), this burden may be expected to grow in 2009, although it might have peaked already in the Baltic States. The full impact is also delayed by the short term coverage of unemployment insurance.

Capital Budgets

Local government capital expenditure has generally ranked highly as a proportion of general public investment, 55.6% in the EU in 2008 Its regular funding sources have, however,  been badly depleted by the crisis:

 Nevertheless there has been a vigorous and widespread governmental response to this aspect of downturn. Accelerated capital investment features prominently in counter-cyclical policy, protecting employment particularly in the damaged construction industry and stimulating consumption generally.  

As a result governments have widely made additional funds available to local governments for capital projects. For example

Similar funds have been established in Portugal, Spain (€8 billion), Sweden and Ukraine (371 projects repairing schools, hospitals, sports stadia etc at a cost of UAH 20 billion).

These funds mostly have two common features. They are expected to finance projects that are “shovel ready” i.e. capable of immediate execution. Secondly they frequently have a strong environmental bias; e.g. energy saving modification of public buildings (and occasionally social housing), replacement of street lighting bulbs (Netherlands), home insulation (UK).

Coupled with this effort by national governments is some acceleration in the disbursement of European Union structural funds in new member states. This has involved some relaxation of the EU’s own rules; the time limits for utilisation have been extended from three years (“n + 2”) to four (“n + 3”), and provision of advance payments has been expanded. It has also been facilitated by national efforts in countries such as Bulgaria, Estonia and Hungary to provide bridging finance for municipalities faced with heavy costs of pre-financing and non- eligible expenditure. In Hungary over 80% of structural fund allocations available under the 2007 to 2013 EU budget are already covered by construction contracts.

In some respects the abrupt decline of supply-led pressure by banks to lend is a benefit. The flow of bank credit to local governments is in most countries now well regulated by appropriate debt or debt service ratios and legal procedures governing municipal default. Much of the accelerated flow of EU investment funding is now supported by short term bank funding of matching contributions, pre-financing and non-reimbursable costs.

The Overall Impact

The impacts of the crisis on local budgets have been very specific to individual countries and authorities within countries. Falling revenues and rules prescribing balanced budgets make contraction almost universal, but its scale and timing are not. It may be modified where national government is both anxious and able to sustain levels of local expenditure through grants or facilitate increased borrowing as part of a counter-cyclical policy. The impact may also be delayed substantially by tax procedures. Suddenness is a common feature, with several countries recording declining revenues in the first quarter or half of 2009 despite growth through 2008.

Various types of situation have emerged:

·         Countries such as the Baltic States where the recession grew rapidly from early 2008 and where the impact on local budgets has already been severe. (Estonia expects local revenues to shrink by 16% in 2009, Latvia 23% ).

·         Countries, particularly Nordic, where  local revenues have fallen significantly, but where local budgets have been protected by increased grants.

·         Countries like Hungary where recession has been severe, but tax processes will delay the worst effects on local budgets until 2010 or later.

·         Countries like Czech Republic and Croatia, where reductions in revenue are readily absorbed by previous levels of operating surplus, although to the detriment of capital expenditure.

·         Countries, particularly in south eastern Europe where recession has arrived later than elsewhere; Bulgaria’s GDP, for example, has only dropped in the first quarter of 2009, having continued to grow by 6-7% in the first half of 2008; local revenues grew by 18% in 2008 compared with 2007.

·         Countries where impacts so far have been both late and slight. In Poland both GDP and local revenues continued to grow in the first quarter of 2009 (by 1.9% and 4.7% respectively), but local revenues fell by 0.4% in the second quarter. A very similar situation has occurred in Slovakia.

RESPONSES

The Need for Policy Responses

Every local government system in Europe is experiencing some financial downturn, in some cases merely a slowdown in growth rates, but in most a real contraction. It has come as a shock, following a period of sustained growth.

The downturn’s severity varies greatly and its duration is unknown. Most forecasts predict a slow recovery of GDP beginning late in 2009 or 2010, and this is already apparent in France and Germany. The rate and extent of recovery, and whether the recovery will be V shaped, U shaped or even W shaped are  matters of ardent speculation with no consensus. Everyone agrees that on past experience falls in unemployment, which affect local governments’ incomes and costs, will lag behind. As we have seen, some local revenues will only feel the impact of current circumstances in one or two years’ time. Inflation has halted (zero in May 2009 according to EUROSTAT) and construction costs have generally fallen, but the recent rise in oil prices underlines the risk of resumption along with its effect on local expenditure. How soon local governments’ fiscal fortunes will benefit from recovery and how far remain very open questions.

Moreover, OECD’s memory of a squeeze on local government following, rather than during previous recessions is sobering. It is when economic recovery is in progress that governments seek to reduce their newly inflated debt, cutting transfers and encouraging tax increases in the process. To add to this pressure on local budgets, most European countries face the long term consequences of demographic change involving local government in the care of an increasingly elderly (though not necessarily infirm) population. The percentage of the developed world’s population over 60 is set to increase from 22.5% now to 35% by 2050. The IMF reckons that the effect of increased pension, health and social care costs on public budgets will be about nine times the cost of servicing the extra debt incurred during the current fiscal crisis. Serious measures to slow down the rate of global warming are likely to add to the strain.

Economic and social distress may also lead to wider threats to public order with their own consequences for public budgets at all levels of government. Conversely recovery will demand local investment in the infrastructure, skills and environmental improvement critical to the revival of local employment and economic activity.

Governments, national and local, should not therefore treat the current strain on local government as a purely temporary blip, with a return to previous growth just round the corner. Longer term measures to cope with fiscal pressure and make the most of lower resources have to be considered. This section outlines some of the options. Their feasibility and desirability vary from country to country, an a la carte menu, not table d’hote.

Reforms of Intergovernmental Financial Relations

Conceptually, one way to relieve pressure on local budgets is to change the framework of intergovernmental finance, to

Is such reform feasible or desirable?

As mentioned already, some European governments have compensated local governments for falls in revenue and/or increased costs, but this has not involved any fundamental reform, just the application of existing equalisation systems. The only substantive reform has been in Ukraine where 10% of corporate profits tax (not a pot of gold in current circumstances) has been added to the equalisation pool and its scope extended to the lowest tier of local government and the cost of housing and communal services; this is likely to represent more a redistribution of local budget resources than an increase.

However bad the impact of the downturn on local budgets, that on national finances is generally worse. Country reports show national budgets contracting to a greater degree than local budgets in all except three countries (Estonia, Serbia and Ukraine). National governments are more dependent on the more vulnerable revenues from corporate profits, customs duties, VAT etc and have to pay unemployment benefits and fund fiscal stimulus packages. They are generally ill placed to relieve local governments of cost burdens or transfer revenues to them.  Most are struggling to raise debt finance and will be struggling to repay it.

Only one reduction in responsibilities has been reported by observers; the Romanian Government has assumed the full cost of minimum income guarantees (previously co-funded by municipalities).  This is rational since gross disparities in local revenue bases were spilling over into basic social provision, a clearly undesirable result. Generally, however, a diminution in local government responsibilities is not an answer to the fiscal crisis which gives added importance to the potential virtues of local initiative and responsiveness.

Major changes in intergovernmental finance are, therefore, unlikely. But two issues remain. The first concerns the assignment of shares in volatile taxes like VAT and corporate profits taxation to local government in the relatively few countries where this is practised. It seems logical that levels of government with a high percentage of fixed, recurrent commitments like public employee wages and service maintenance should not depend significantly on volatile revenues. One can argue, au contraire, that local public services should enjoy their fair share of rising public revenues and equally share the consequences of their decline. The question is open, the answer depending both on the severity of the crisis and on which services are performed by local government; more political priority usually attaches to the protection of education and health care than to maintenance of physical infrastructure.

The most lucrative local tax source across Europe is sharing or surcharging of personal income tax. It is the only tax base which is both technically susceptible to variation by local decision and capable of funding a large proportion of the costs of the major educational and social care services. Local freedom to determine its incidence has expanded in recent years from its Scandinavian and Swiss heartlands to Spanish regions, Italian regions and municipalities and Croatian counties and municipalities.  That expansion should continue if major progress in fiscal autonomy is to be made, but accompanied by an adequate system of equalising differences in the tax base and some limits on rates to avoid adverse effects on labour market supply in an increasingly globalised world.

Property is the most common base of autonomous local taxation, (i.e. subject to local rate setting), but a relatively low percentage of local revenue overall. It is unlikely that radical changes in valuation methods will be undertaken, but the political resistance to increased incidence could be countered by greater attention to the link between tax bills and household income. In Eastern Europe experience has shown that municipal freedom to apply cautious but regular increases in tax rates in line with, or just ahead of the general rate of inflation, is a necessary condition for maintaining the tax’s significance.

One interesting conclusion of our data analysis is that the most vulnerable revenue bases have been those relying heavily on a single source, whether own revenue or intergovernmental transfer. The most resilient bases have been those like the Polish combining a mix of revenue sources with rational distributive formulae.

The second question relates to the freedom to set the rates of local taxes and charges, enjoined by the European Charter of Local Self Government but still very restricted in several eastern and south-eastern European countries.

Increasing taxes and charges may ease budget strain and improve the efficiency of utility services, but (as opposed to countercyclical grants) it may restrain consumption and exacerbate recession. This is a dilemma, with which local authorities are already grappling. Different Polish municipalities are taking contrary approaches, variously increasing or reducing rates of property tax. Danish and Finnish municipalities wishing to increase PIT surcharges are in conflict with national government. The Irish Government has persuaded local authorities to restrict annual property tax rate increases to 1.15% overall. On the other hand French departements and communes have  increased taxes in 2009 by an average 5-6% without national restraint.

Whatever the short term desirability of restraint, the longer term period of recovery will probably demand increases in local taxes and charges and the Charter’s requirement of local autonomy in this respect should be respected universally. Two considerations, however, argue for some restraint. For some kinds of taxation –notably PIT – high tax rates may have long term effects on labour supply. The second is that a number of national laws and policies impose restrictions to ensure that local taxation does not discriminate unfairly between domestic and business payers. These are justifiable, not only because commercial recovery should not be impaired, but also because the underlying reason for fiscal autonomy is to encourage accountability to electors, and households should therefore share the consequences of local fiscal policy. Increases in utility charges also need to be accompanied by an adequate system of housing subsidies for the lowest income households.

Based on the Council of Europe acquis, the Centre of Expertise of the Council of Europe and OSI/LGI developed a set of benchmarks to assess both the intergovernmental financial relations and the quality of the financial management performed by local authorities. While the benchmarks concerning local financial management proper met with demand and have already been successfully implemented, the ones aimed at helping central governments to assess their policies concerning local finance are yet to raise interest among central governments. These benchmarks could, however, be very useful for governments seeking to understand their strengths and weaknesses and aiming at reforming intergovernmental financial relations in response to the crisis and beyond.

Improving Accountability and Efficiency

Making the most of more limited resources is likely to be an ongoing challenge. Improving the efficiency and effectiveness of local government expenditure has many manifestations, discussed more fully in Chapter III. They aim chiefly to make both elected and appointed officials more accountable for the use of public funds.

Cost Control

Country observers’ reports detail many efforts by individual local governments to reduce costs. These mainly apply to administrative overheads and include cuts in overtime, bonuses, official entertainment and telephone usage, while purchases of vehicles and furniture and filling vacancies have been frozen. In the case of Romania some of these have been mandated by efficiency measures agreed with the European Union as conditions for national budget support. In Latvia municipal employees have shared a national 15% cut in public service pay. In Serbia GPS systems have been fitted in municipal vehicles so that both drivers and town halls know where they are.

Justified as they may be, these are temporary or one-off savings which do not greatly affect longer term efficiency. This requires more fundamental examination of the practical ways in which services are run, the subject of “value for money” approaches and performance audit systems developed over the last three decades under the umbrella of New Public Management. Chapter Three outlines three such efforts which deserve wider application:

Benchmarking is one of the tools designed to help the public scrutinise the care with which its money is being used. Another is the Citizens Charter, usually a promise to citizens to deliver services at certain standards and a set of procedures by which they can check its fulfilment.

The Council of Europe has been helping to develop performance management capacity in a number of countries such as Bulgaria, Russia and Serbia. It also supports French efforts in this field. The financial downturn emphasises the need.

Performance Audit

In 2006 LGI surveyed the audit of local government in 12 eastern and south-eastern European states. It found that most states had an adequate legislative framework, much of it newly enacted with EU assistance, but so far implementation has been weak. In particular:

The Council of Europe has been helping to develop performance audit capacity in a number of countries such as Bulgaria, Russia and Serbia. The financial downturn reinforces the need.

The current ambitious Strategy for Innovation and Good Governance at Local Level launched by the Council of Europe includes among its implementation measures the development of a European Label of Governance Excellence (ELOGE) which would be attributed in a decentralised manner to municipalities reaching a certain level of quality in their overall governance. Based in particular on a benchmark/measuring tool specifically tailored to the needs of local authorities, the label, if successful (its road test should start in late 2009) could be very effective in supporting the improvement of local governance. 

Removing Incentives to Expensive Service Provision

Administrative and financial arrangements frequently encourage local government to provide services in an unnecessarily expensive way.

For example, in a number of countries such as Hungary and Ukraine responsibilities for residential care for the elderly and infirm and hospital care lie with upper tiers of local government, while the municipalities provide domiciliary and primary health care. Funding of the upper tier service may well be based on formulae including the numbers housed or treated. These arrangements may well provide strong incentives to place social service clients in residential homes or patients in hospitals when it may be neither the most appropriate nor sympathetic response to their need. In most cases it is the more expensive solution.

 Medical care costs can also be inflated by a system of paying providers per admission or individual treatment. These perverse incentives are widely recognised and systems like DRG funding have been designed to reduce them. But such reforms have not been universal and the crisis underlines their importance. The recent introduction in Hungary of a small charge for seeing general practitioners was also effective in reducing unnecessary demand on their time, until countermanded by a referendum.

Other examples of excessive social sector costs abound. Schools with declining pupil populations, for example, frequently retain previous numbers of teaching staff numbers while mandated contact hours with pupil are generously low.

Reviewing Unsustainable Norms

Local governments which would like to cut costs are frequently debarred by national regulation. This applies particularly in countries which distinguish between the “autonomous” and “delegated” tasks of local government and place the more expensive services like education, social service and health care in the latter category.

Delegated services are often regulated by detailed standards of provision and local government management subject to close supervision by sectoral ministries.  These norms typically govern inputs, rather than outcomes. Ukrainian local governments cannot close grossly underutilised schools or social and cultural institutions without the permission of national ministries, frequently withheld. Such institutions may well have lost their custom through changes in population or public preference.

The problem is typically exacerbated by the fact that the sectoral ministries concerned are not faced with the consequences of running uneconomic services, since the financing of delegated services is usually governed solely by the Ministry of Finance. Several national rapporteurs comment that failure to meet unsustainable service standards is widespread but tolerated. Others identify national insistence on observing the norms as a serious problem. Signatories of the European Charter should be ensuring that national ministries do not micro-manage services entrusted to local government whether technically delegated or not.

Delegating  Institutional Management

The same principle applies to the relations between local governments and their own subsidiary agencies and institutions.

When budgets have to be cut, it is usually their managers who know best where waste is occurring. It is only the school head who will bother that lights are switched off at the end of the day and only then if the school budget keeps the savings.

Delegating budgets and their managements to service institutions is another aspect of New Public Management which is now widespread; per-pupil funding of schools is now widely adopted, for example.

These solutions, though timely in a period of recession, need careful introduction, however. Budget allocations need to take full account of exogenous variations in cost.  Population density and social background have major impacts on school expenditure, for example. Audit and other forms of accountability must match degrees of financial delegation.

Territorial Re-organisation

The average size of local governments varies enormously between countries; average municipal populations range from 1,640 in the Czech Republic and 1,720 in France to 56,570 in Lithuania and 139,480 in the United Kingdom. Amalgamation, widely practised in the 1960s and 70s but also widely reversed in former Socialist countries after 1989, is back on national agendas.

Denmark has merged 271 municipalities into 98. Georgia replaced 985 municipalities, mostly villages, with 64 large district authorities based on the former rayons, a policy already adopted in Lithuania.  The number of Finnish municipalities has been reduced from 447 to 348, aided by the pressure of new rules governing the minimum population required for administering health care and basic education. Proposals have been submitted by the Estonian Government to reduce the number of municipalities tenfold, although not so far accepted by Parliament.

Larger municipalities should spend a smaller proportion of their resources on administrative overheads and achieve greater economies of scale. But while amalgamation may enable local authorities to provide a larger range or quality of services, there is no evidence that it saves money overall. Quite apart from the one-off costs of re-organisation, there is a tendency for merged authorities to adopt the most expensive habits of their individual forerunners. The failure of empirical studies to show savings from amalgamations may be explained by the fact that the more obvious economies of scale had already been realised by inter-municipal co-operation.

It may be easier to achieve economy by increasing co-operation between municipalities. In Hungary the number of municipal landfills has shrunk by 90% through the formation of joint utility companies able to maximise the use of modern technology and EU structural funding, while sub-regional associations share the professional resources and equipment needed for administrative operations like tax collection and development control. In France both legal and financial incentives have led to a large increase in the number of commaunates urbaines providing integrated planning and service delivery within conurbations.

Improved Targeting of Social Benefits

Social benefits are frequently distributed without regard to financial circumstances. All British pensioners (including the writer) automatically receive a winter fuel allowance of £200, without application. In Lithuania, 64% of social assistance costs are on universal benefits, notably child allowances. In the countries of the former Soviet Union numerous allowances or free services are provided to various categories of “veteran” (of war, labour, natural catastrophe etc).

Mothers of young children and pensioners tend to be the main beneficiaries. What probably unites pensioners is not poverty (those with inflation proof pensions, discharged mortgages and grown up children may well have ample disposable income), but the time to vote and complain.

Means testing the allocation of social benefits is resisted by governments because it is divisive,  open to corruption - and plain difficult. But if money is tight, its introduction may be the price of providing assistance to those who are in real poverty. The World Bank estimates the proportion of the poorest households receiving cash benefits to vary from 25% in Poland to 95% in Hungary.  LGI funded research in Armenia, “the former Yugoslav Republic of Macedonia” and Moldova found that many very poor households were excluded from entitlements by bureaucratic hurdles such as the difficulty of people moving into towns getting certificates of residence, or of obtaining evidence of previous employment when both the enterprise and its owner, the former Yugoslavian state, have been disbanded. The Russian report cites the need to queue for a mountain of documents as a deterrent to the claim of housing allowances.

The Boundaries of the State

The severity of the crisis in some countries and its abruptness everywhere has stimulated a welcome concern to reinforce accountability and improve the productivity of local budgets.

These responses do not, however, challenge the underlying nature or scope of what local government is trying to do – simply its ways of doing and funding it.

Yet such challenge will arise if the crisis is even more severe or long lasting than currently forecast.  Predictions tend to be based on the experience of past recovery from recession, not on hard current evidence. Given the accumulating levels of public debt, long term demographic trends and the responses needed to global warming, a return to previous levels of public service cannot be taken for granted.

Much of what government, national and local, now provides its citizens was the responsibility of communities and families before the Second World War. Turning the clock back is hard to imagine; abandoning mass literacy and letting old people shiver to death in winter are not conceivable options.

But burdens could be shared to a greater extent. Means testing has already been mentioned. Another option is the greater involvement of civil society in the provision of welfare. Partnership between local government and non-governmental organisations is common in Europe, aided by the growing numbers of retired people who are still physically fit and potentially active.  But there are still countries where NGOS are seen as threats rather than allies, and also where “volunteering” is associated with memories of totalitarian coercion.

These attitudes of mind are neither healthy nor affordable. It is true that they are often associated with societies where family solidarity remains a stronger support for the aged, infirm and unemployed than in Western Europe. But in an ageing and urbanising society family support can no longer be taken for granted. Voluntary care can be subsidised and supported, such as by “respite breaks” for family carers or petrol allowances for volunteer drivers.  Public funding of public services is not all or nothing.

The downturn challenges both the public expectation that the State should provide for everything and the politicians’ pretence that they can. Modern technology offers more and more interactive processes. Perhaps it is the model for post-crisis local government.

Finally, we return to the boundaries within the State. The downturn has demonstrated the dependence of local fiscal fortunes on differences in national policy. But this should not be exacerbated by a deliberate or instinctive re-centralisation of authority. The responses outlined above call for more local flexibility and discretion, not less. The case for the principles and provisions of the European Charter of Local Self Government remains intact.


[1] “All reference to Kosovo, whether to the territory, institutions or population, in this text should be understood in full compliance with United Nations Security Council Resolution 1244 and without prejudice to the status of Kosovo.”