Briefing Room

POLITICS | ECONOMY

Weak LGU spending capacity threatens expected gains from devolution, poses risks to business

Key Insights

The implementation of a 2018 Supreme Court decision – widely referred to as the Mandanas-Garcia ruling – will increase the share (Internal Revenue Allotment or IRA) of local government units (LGUs) across the Philippines by as much as 55 percent of the 2022 national budget.
Facing a decrease in its budget, the national government, through Executive Order No. 138 issued by President Rodrigo Duterte, will be fully devolving to LGUs a wide range of functions and services expected of them and provided for in the Local Government Code of 1991 but presently performed by national agencies due to limited local fiscal and other resources.
In its Philippines Economic Update in June, the World Bank while acknowledging the opportunities for strengthening decentralization through the increased budgets of LGUs also identified challenges including among others, weak budget execution rates associated with larger and increasing budgets and low absorptive capacities due to gaps in technical capacity and coordination.
Strengthening the spending and absorptive capacities of LGUs demands, however, boosting the technical planning, documentations, and procurement processes as well as capabilities of involved LGU entities.
Enhancing the research capacities of LGU staff towards the generation of data, benchmarks, and subsequent interpretation of information and integration into key plans and documentary requirements can provide a foundational support for these aspects.

What the fiscal impact of full devolution means for business

The resulting increase in fiscal resources for LGUs and its consequential decrease for the national government is likely to cause a decline in overall government spending and public investments if the transferred budgets are not effectively absorbed and executed by LGUs.

Public sector underspending does not necessarily reflect efficiency in the utilization of public funds or translate to savings for an agency. In fact, it means that the government, despite the availability of funds and resources is unable to meet its key capital outlay targets and use the appropriated funds to deliver services and projects for their constituents. This subverts the core principle behind why the government spends on public infrastructure, facilities, and other services, that is, to stimulate economic sectors, address growth and development unevenness, and make access to opportunities more inclusive especially for vulnerable segments of the population.

While the incumbent administration has been able to cut public sector underspending from 13.3% and 12.8% in 2014 and 2015 down to 2.9% in 2017 – one year when it assumed office – national government agencies and independent organizations have raised the alarm over underspending the budgets appropriated to address the effects of the Covid-19 pandemic even as state auditors and civil society watchdogs have also flagged alleged overpricing and other irregularities in the public procurement process using the Covid-19 funds.

The transfer of key public works, agriculture, environment, tourism, health and social welfare functions and their corresponding budgets to LGUs imply then that delays or inefficiencies in the use of these transferred funds and the accomplishment of their outputs by the receiving LGUs can still stall and even undermine overall government efforts and strategies towards economic growth and sustainable development.

More concretely, this means possible declines in the construction of new farm-to-market roads, bridges, hospitals, medical centers, and other health, agriculture, disaster risk management, or tourism facilities, services, and equipment as well as investments in new programs that can enhance the overall climate for business and drive sectoral productivity.

Without realizing effective and sustained public investments in these areas as a result of bottlenecks in budget execution, persistent issues faced by the business sector – infrastructure inadequacies, transportation problems, health and nutrition vulnerabilities among workers and locals, etc. – that have an adverse impact on the attainment of firm or organization-level business objectives will remain unaddressed.

Not just a political or governance issue

The rollout of the devolution process then is not merely a political or governance issue. With both macroeconomic and firm-level consequences, this new phase in the country’s decentralization efforts makes the proper and effective functioning of local governments, now more than ever, a clear business issue.

With bigger budgets, cautions Albay Province District Representative Joey Salceda, devolution provides locally elected public officials more resources for potentially channelling and consolidating patronage and spoils for their supporters, further entrenching political authority and influence in their respective localities.

In addition, the World Bank also warns against LGUs resting on their laurels by de-prioritizing efforts and initiatives to generate local revenues through effective policies, incentives, and support services. Even without the current devolution process, LGUs across the country are already highly dependent on their IRAs with even the bigger and more economically progressive localities unable to generate local revenues commensurate to or at the same amount as their share from the national revenues. A guaranteed and bigger source of funds is a potential disincentive for LGUs to coordinate and collaborate with local stakeholders in reducing local threats to business operations, growth, and sustainability.

And in the absence of strong transparency and accountability mechanisms to check on the appropriate utilization of these funds – from project identification, prioritization, and even implementation – the risks for arbitrary decisions and excessively discretionary and personally-defined policy preferences are considerably elevated.

The impact to business is not new such as transaction and other associated costs in dealing with local policies and policymakers as well as growth-inhibiting policies (or conversely, the absence of growth-conducive policies).

What is new, however, is the political climate that can potentially embolden local authorities (and their respective families, clans, and support networks), make them more self-contained and less receptive to cultivating stakeholder collaboration and making better-informed public decisions, priorities, and policies that are responsive to the needs of local and national markets and of course, to their respective constituents.

A stake in effective local governance

The stakes for business in the devolution process include, first, ensuring that the provision of essential public services and the continuous implementation of key infrastructure projects are not derailed by the weak spending capacities of LGUs; and second, maintaining or further enhancing business environments that are mutually beneficial to both the public and the private sectors.

Various studies have suggested that key to eliminating underspending bottlenecks is strengthening the technical capacities of public sector entities tasked to develop and implement the programs with appropriated budgets.

And while national government entities, such as the Department of Interior and Local Government’s Local Government Academy remain at the forefront of enabling the capacities of local government workforces and decision makers, the private sector has much to offer and contribute in a complementary way. Knowing well what local markets need to sustain growth potentials and having a deeply entrenched tradition of data-driven, evidence-based, and researched-backed decision-making, diffusing these knowledge to local public authorities and their staff to equip them with the skills and information needed for high-impact and market-conducive public spending and project prioritization is a track that businesses may want to consider to avert possible some of the forecasted risks arising from devolution.

Through the CITELOCAL Coalition which we co-convened with Balikatan sa Kaunlaran (BSK) National Foundation, the Miss Earth Foundation, and powered by the Ecosystem mobile app, we are inviting the business sector to consider supporting initiatives that aim to strengthen the technical capacities of LGU workforces and decision makers across the country by promoting a research-oriented organizational culture and mainstreaming policy research among scientific, academic, and industry research communities to better align knowledge production with what local governments need to spend their bigger resources more effectively and to implement the appropriate policies to maintain economic competitiveness and productivity.

We believe that the benefits of devolution – lower administrative costs for public service delivery, reduction of vertical coordination problems between national government agencies and their local counterparts, and closer feedback structures – far outweigh its potential costs.

But we need a convergence of efforts and a synergy of initiatives to realize shared goals and objectives.