Global Decentralization and the Subnational Debt Problem

By Schwarcz, Steven L. | Duke Law Journal, February 2002 | Go to article overview

Global Decentralization and the Subnational Debt Problem


Schwarcz, Steven L., Duke Law Journal


ABSTRACT

According to the World Bank, decentralization of government is a pivotal force that will shape global development policy in the twenty-first century. Subnational debt restructuring has emerged as one of decentralization's most difficult problems. Financially troubled municipalities face many of the same concerns, for example, as financially troubled nations: holdout creditors can stymie collective attempts at debt restructuring, and reliance on politically motivated lenders of last resort (the International Monetary Fund in the case of troubled nations, the central government in the case of troubled municipalities) can foster moral hazard. In a prior article, I argued that an international convention for sovereign debt restructuring based on several universal principles of bankruptcy reorganization law can effectively address these concerns for nations. In this Article, I argue that similar principles can be applied even more easily to the financial problems of subnational governments. To this end, I propose a model law based on these principles that might form the foundation for national laws, informed by local political and legal culture. Then, using the Japanese municipal crisis as an example, I show that countries enacting such a law can prudently and equitably resolve their subnational debt burdens.

INTRODUCTION

The World Bank has identified decentralization--meaning the "growing desire of people for a greater say in their government, [which] manifests itself in the assertion of regional identities [and] pushes national governments to reach down to regions and cities as the best way to manage changes affecting domestic politics and patterns of growth" (1)--as one of the two forces that will shape world development policy in the twenty-first century. (2) Even now, governments are shifting numerous public responsibilities to the subnational, or municipal, (3) level. (4)

To meet these responsibilities, which often entail the construction of infrastructure and other capital projects, municipalities worldwide are raising funds by issuing debt. (5) Debt issuance allows a municipality to fund the construction of projects that cannot be managed within the financial resources of a single fiscal year; permits a municipality to "allocat[e] taxes over a period of many years for principal and interest payments on outstanding bonds, [thereby making it] possible to share the burden with future generations which benefit from the project"; and also can offset temporary shortages in taxes or other financial resources. (6) Although some of this debt is domestic, much of the debt is being issued in the world's capital markets. (7)

It is becoming increasingly difficult for municipalities to repay all this debt. (8) Furthermore, because municipalities rarely have the flexibility to substantially reduce expenditures, (9) a fall in subnational income can lead to a further mushrooming of debt not only in order to finance needed projects but also to refinance the debt of existing projects. (10)

As a result, the problem of subnational debt restructuring has become pandemic. The most severe problem today is in Japan, where the overall municipal financial deficit is at the highest level ever seen in the world, (11) and matters are only expected to get worse. (12) But Japan is merely the tip of the iceberg. In Central and Eastern European countries, for example, municipal debt financing is leading to "deficits [that] will exceed 10% and deteriorate further" over time. (13) Russia faces a "significant deterioration of the cities' and regions' fiscal and debt positions." (14) In Brazil, decentralization "has resulted in a prolonged macroeconomic crisis sparked by the growing indebtedness of the [subnational] states." (15) Existing or potential concerns have arisen in Mexico and Argentina. (16) Indeed, the problem extends to subnational entities in many of the world's most developed countries. …

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