What Determines the Quality of Local Financial Management? The Case of Tanzania

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Abstract

For the public sector to deliver public services and achieve its policy objectives, it is critical that public finances are managed well. Critics of decentralization point out that local governments are often administratively weak, and that poor local financial management can negate the potential benefits from decentralization. While the available research suggests that local financial management outcomes are influenced by more than a local government’s financial management practices, little is known in the literature about the determinants of effective local financial management in developing and transition economies. The empirical analysis in this paper uses data for local government authorities in Tanzania in order to explore the relationship between local financial management performance on one hand, and local management practices, local governance, and other local characteristics on the other hand. While the exact local management practices that matter for the quality of local financial management in Tanzania vary depending on how financial management performance is measured, it appears that councils with better financial management practices (e.g., stronger internal audits), better planning and budget processes, and better project implementation practices achieve better local financial management outcomes. In addition, the empirical analysis reveals that local political conditions and other local circumstances such as the poverty level and the urbanization rate also play an important role in determining local financial management performance in Tanzania.

Introduction

In order for the public sector to efficiently deliver public services and achieve its policy objectives, it is critical that public finances are managed well. While the efficient and effective use of public resources is a universal concern at all levels of government, the appropriate use of decentralized public resources at the local government level is a special point of contention. This is particularly true in lesser developed countries (LDCs), where local financial management seems to be at a relative disadvantage compared to central public financial management systems.

Whereas proponents of decentralization reform in LDCs argue that decentralization makes the public sector more accountable by bringing the public sector “closer to the people,” critics of decentralization point out that local governments are often administratively weak, that they typically lack sufficient financial management capacity, and that local political accountability mechanisms are generally inadequate to assure that local political leaders respond to the needs and wishes of their communities (e.g., Olowu 2003). Poorly designed intergovernmental fiscal systems and weak local financial management practices would make local government finances prone either to being illicitly diverted by (central or local) government officials before reaching the local community or to being “captured” and redirected away from their intended use by local political elites (Crook 2003). Indeed, the available evidence indicates that the inadequate management of intergovernmental transfers and local government finances results in substantial leakages of local public resources that are intended to fund pro-poor public services such as primary education or basic health services (Reinikka and Svenson 2004). In turn, poor local government performance could reduce popular confidence in the public sector and undermine the support for decentralization reforms (Hiskey and Seligson 2003).

The specific linkages between local government performance on one hand—both in terms of sound local financial management practices as well as in terms of adequate local service delivery—and local government administration and governance on the other hand, have not been the subject of extensive research. While (as is discussed in greater detail below) some empirical research has explored the relationship between local government performance outcomes and the administration and governance characteristics of local governments in developed economies, this question takes on greater urgency in the context of developing economies where overall resource scarcity makes the detrimental impact of local government waste and inefficiency disproportionately greater. In response, this study seeks to answer a basic question: what factors are important in assuring that local government finances are managed properly in LDCs, so that they can be used for their intended purpose?

In order to explore the relationship between the quality of local government financial management and local government characteristics in a developing country setting, the empirical analysis in this paper uses data for local governments in Tanzania. Although Tanzania is among the poorest developing economies in Sub-Saharan Africa, local governments deliver key pro-poor government services (including primary education and basic health services) as the country has been pursuing decentralization since the early 1980s (Boex and Martinez-Vazquez 2006). Furthermore, good governance reforms—both at the central government level as well as for local governments—have been an important theme in the country’s development strategy since the mid-1990s (United Republic of Tanzania 1999). Recent local government reform initiatives have resulted in the availability of data on local government finances, local administration characteristics, and local government performance that are necessary in exploring the question at hand.

In limiting our attention to Tanzania as a single developing country case, we recognize that the impact of local government management practices, local governance mechanisms, and other factors on local financial management performance are likely to be quite context-specific. In fact, the local administrative practices or local governance mechanisms that contribute to improvements in local financial management performance in Tanzania are likely to be quite different from those that might improve local government performance in other developing countries in Africa, Asia, or Latin America respectively. Nonetheless, given the dearth of research on this question in developing countries, the case of Tanzania provides important insights into the determinants of local financial management performance in a developing country context.

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