Political economy relates to the prevailing political and economic processes in society by taking account of the incentives, relationships, distribution, and contestation of power between different groups and individuals (GSDRC 2014). The interaction between these forces generates particular policy outcomes that may encourage or hinder development (DFID 2009). Formal institutions – such as the rule of law, elections, and intergovernmental systems – and informal social, political, and cultural norms play key roles in shaping human interaction and political and economic competition.

Decentralization reforms – as well as other public sector reforms – are not just technical processes to be decided by technocrats, but rather, reflect a political or institutional contestation of power between different groups and individuals across and within different government levels. They can restructure the local political setting, reshaping local actor and voter incentives in many ways, such as changing the size of municipalities, reformulating local electoral legislation, and redefining formal relationships between the representative and executive bodies (Keating, 1995). They can also change the structure of legislative bodies, the balance between elected local authorities and local executives and administrators, the way councils are elected, the way executives are elected or appointed, and the structures for local legislative and executive bodies to relate to citizens.

Taking time to understand the political economy of decentralization reform is particularly useful for development practitioners since it helps consider the drivers of political and institutional behavior, forces us to reflect on who the main “winners” and “losers” are within public sector systems, and how incentives and institutional relationships shapes the design and implementation (or the lack of implementation) of particular policies and programs (ODI 2009). In turn, this allows us to evaluate and design better policy solutions by ruling out reforms that are politically or institutionally not viable, and by addressing, fine-tuning or working around processes where political and institutional motivations or incentives get in the way of public sector efficiency.

Why is it important to consider political economy drivers across different dimensions of decentralization? Intergovernmental systems are highly interlinked. For instance, each pillar of fiscal decentralization – as well as each other element of an effective intergovernmental system – is not only related to other pillars of fiscal decentralization in terms of design and implementation, but also to the other dimensions, such as political and administrative, of an effective intergovernmental system.

Often problems in one dimension of decentralization or at one government level are merely symptoms of more widespread systematic obstacles or failures. Weak service delivery is a symptom that is commonly identified in discussions on local governance, decentralization, and localization as being a major problem at the local level. Similarly, weak local administration or weak local public financial management might be singled out as challenges to be addressed. More often than not, however, these problems are merely the symptoms of problems in the political or administrative sphere. Without considering the political economy context, the policy response would be to treat the issue narrowly as a technical problem, which would be inappropriate and ineffective. In some cases, fiscal instruments—especially intergovernmental fiscal transfers—can be leveraged to improve constraints in the political and administrative dimensions of intergovernmental relations.

Box 3.1 The political economy of subnational government structures

In addition to the influence of political economy forces on the design of the political, administrative, sectoral, and fiscal aspects of multilevel governance and intergovernmental relations, political economy forces often have a direct impact on the underlying intergovernmental architecture – that is, the number of subnational government levels, the number and size of governments at each level, their functional responsibilities, and the degree of their control over financial and human resources.

It is not unusual for decentralization reforms to devolve powers to a lower government level for political reasons to circumvent possible political capture at a higher level. For example, Indonesia, during its “big bang” decentralization reforms, shifted powers and functions to the local government level in order to avoid potential centrifugal forces at the provincial level. Similar political economy forces helped to inform the post-conflict transition of state structures in Mozambique (preventing opposition capture of provincial governments), the nature of decentralization reforms during the Musharraf era in Pakistan (bypassing provincial structures in favor of the Tehsil and Zila), and the fragmented local government structure under the new federal system in Nepal.

Another challenge common across many countries is that central government powerholders have a tendency to promote the creation of new local governments as a way of dispensing favor to different local jurisdictions. Uganda is a frequently cited example in this regard (Awortwi and Helmsing 2014). While this practice strengthens the central executive’s influence over subnational actors, the result is often an inefficient and excessively fragmented local government structure.

A third political economy dynamic related to subnational government structures is the practice of politically ring-fencing the power of larger urban areas. In the United States, this phenomenon is known as “red states, blue cities,” and has been identified as an important factor in the state-level preemption of local government powers in many U.S. states (NLC 2018).

Given that urban areas tend to be the springboard for opposition parties and politicians, it is not unusual for ruling political parties to be sensitive to preventing such subnational political space from emerging. There are examples to show that it is not unusual for larger city corporations to be assigned fewer functional powers than smaller municipalities (Bangladesh), redefining jurisdictional boundaries or breaking up the capital city into multiple jurisdictions (Tanzania), or placing the national capital – in part or in whole – under the purview of a Capital Authority rather than an elected body (Kampala).