Decade of local finances: two crises and in between.

Figure 6 Stable level of decentralisation in CEMR countries, 2010-2020 Subnational and local government expenditure as % of general government expenditure and GDP

Figure 7 Increased local spending in more decentralised countries Subnational government expenditure as % of general government expenditure, 2020, changes 2010-2020

Diverse options for countries with fragmented or amalgamated municipal models

Countries with bigger municipalities could opt to devolve more services to local governments with larger populations. However, this economic rationale positing that the scope of expenditure decentralisation is related to local government size could only be observed at work in a small group of countries. There were six countries in total with higher local spending levels and above average municipality population size: Denmark, Latvia, Lithuania, Sweden and the Netherlands – all from the North where amalgamated models with extended municipal functions are common – and Kosovo (see the upper right cell in Table 3).

Table 3 Main types of local governments in CEMR member countries
		Scope of decentralisation (local expenditures in general government expenditures)
		Centralised (low)	Decentralised (high)
Average municipality population size	Large	Centralised, amalgamated Turkey, Georgia, Greece, Serbia, Albania, Bulgaria, North Macedonia, Bosnia and Herzegovina, Montenegro, Israel Centralised, fragmented Slovenia, Slovakia, Hungary, Portugal, Austria, Belgium, Germany, Spain, France, Luxembourg, Cyprus, Malta	Decentralised, amalgamated Denmark, Sweden, The Netherland, Latvia, Lithuania, Kosovo Decentralised, fragmented Finland, Norway, Estonia, Poland, Ukraine, Moldova, Romania, Croatia, Italy, Iceland
	Small	Centralised, fragmented Slovenia, Slovakia, Hungary, Portugal, Austria, Belgium, Germany, Spain, France, Luxembourg, Cyprus, Malta	Decentralised, fragmented Finland, Norway, Estonia, Poland, Ukraine, Moldova, Romania, Croatia, Italy, Iceland

However, many more CEMR countries follow a distinctly different model, with small municipalities and limited local functions (bottom left cell in Table 3). Fragmented municipal structures with a low local share in general government expenditure also characterise the federal countries (Austria, Belgium, Germany, Spain) since the regional governments actually take up the lion’s share of the subnational budgets. France, with its particular hierarchical and cooperation-based municipal model, also belongs to this group. The other members are relatively small countries, with several from Central and Eastern Europe (Hungary, Slovakia, Slovenia), Luxembourg, Portugal and small island States (Cyprus, Malta).

The smaller municipalities in the decentralised countries (bottom right cell) usually coexist alongside a rather powerful intermediate government tier. This group includes Italy, Poland, Ukraine, Finland, Norway a few transition countries primarily from the Balkans (Croatia, Moldova, Romania), the Czech Republic and Estonia. The latter, with its single tier subnational government structure, is the outlier in this group.

The fourth model, characterised by large amalgamated municipalities and limited local functions, are most typical of the Western Balkans; however, Georgia, Israel and Turkey also belong to this group of countries (top left cell).

This rough classification of first tier local governments is important for benchmarking various decentralisation models. Any transfers of best practices and policy solutions need to take these basic differences in local government systems into account. The responses to the past decade’s two crises and the options for supporting municipal reforms all depend on these critical factors of municipality size and scope of local functions. The territorial administration reforms mentioned in Box 3 laid out the basis for further decentralisation, namely by allocating more public functions to amalgamated municipalities (see the example from Estonia in Box 6).

Local functions

Subnational governments in the CEMR countries provide a wide range of services, although there are considerable disparities across the continent. The options for rationalising municipal expenditure and crisis management very much depend on the scope and form of decentralisation, i.e. the types of local public services provided. The services discussed in the section below constitute the ten main functions of government (“Classification of the Functions of the Government” (COFOG) categories).

Education represents the largest expenditure item in the budgets of both types of subnational government tiers (Figure 8). It accounts for more than one-fifth of the budgets of local governments (municipal, intermediate tier) and, in the federal countries, of the regional governments. As municipalities are responsible for a large number of devolved or deconcentrated administrative services, the spending on general public services (mainly public administration) is also significant (17%).

Social services, covering both institutional care and social assistance as well as pre-school services, is also a major item in local budgets (14%). Economic affairs, primarily transport services, energy, agriculture and tourism, is a similarly important spending item (14%). Health care services are divided up among the various government tiers, but it represents a significant local responsibility in many countries (10%). Recreation and culture, including sports, accounts for 5% of local budgets.

Housing and community services, mainly water supply, public lighting and social housing expenditure, uses 7% of local budgets. Environmental services, essentially solid waste and wastewater management, takes up only 6% of local budgets since this usually involves privatised or outsourced services with only a limited connection to the public budget.

Social services and health care also represent major items in the regional governments’ budgets; together, they account for 19% of total expenditure. As the regions also manage infrastructure network services (e.g. transport), spending on economic affairs (13%) is also significant.  

Between 2010 and 2019, the structure of local government expenditure changed only slightly. Share of public education, health care and recreational services marginally increased. These human services are usually subjects to strict national regulations, so their higher local budget proportions might be caused either by national programs or further devolution of these services.

There was a marginal increase in the share of public education, health care and recreational services. As these human services are usually subject to strict national regulations, their higher share in local budgets may be tied to a national programme or a further devolution of these services.

The budget share of administration, housing and community services and environmental protection decreased. These are usually areas where municipalities have more discretion and capacity to control local spending. This minimal restructuring of local budget expenditure demonstrates that local governments were able to improve service efficiency in these sectors. Since demand for these typical local services remained stable, it follows that the usual service standards had to be provided even with a lower local budget share.

The restructuring of local budget expenditure could be seen to continue in 2020 and afterwards, even if no comparable data is available for the first year of the pandemic (CEMR, 2021, OECD, 2021). There was a greater need for public health services and social service activities, even as social distancing and work from home decreased the demand for other communal public services.

Locally provided services cover a wide array of areas in the CEMR countries. In the cases where local expenditure is reported by function, the budget shares for health care and social services correlate to the scope of decentralisation (Figure 9). In the most decentralised countries (measured using local expenditure as a % of GDP), these two costly services represented more than 30% of local government budgets.

In countries with an average degree of decentralisation (around 10% of GDP), education and culture were the dominant items in local expenditure. In the less decentralised systems, basic infrastructure services represented the core local mandates. In this group, higher local budgets could be found only in the countries where education was devolved (e.g. Bulgaria, Slovakia, Moldova, Slovenia).

Spending efficiency

After the 2008-2009 economic crisis, subnational governments everywhere were operating under constant pressure to improve the efficiency of their administration and other locally provided services.

Given the difficulty of measuring service efficiency in the public sector, it is not easy to quantify changes in these areas. Fiscal indicators of higher spending can either be a reflection of the inefficient use of resources or it may simply be indicative of better service quality resulting from more spending on a local service.

Conducting an objective assessment is further complicated by the limited comparative data available on expenditure by economic category. The indicator used here to compare data therefore looks at standardised costs, i.e. the current expenditure per capita as a percentage of GDP per capita (for purposes of comparison, both in USD). As this indicator excludes differences in prices, salaries, taxation and level of economic development, it is an effective benchmarking method (Figure 10).

According to this indicator, local service management is less efficient in the countries above the trendline. Their spending exceeds what is considered the average (standardised) level of costs. The countries below the line are regarded as more efficient in their management of local current budgets, in comparison to others with municipalities overseeing similar responsibilities.

In the decentralised countries (local expenditure exceeding 20% of general government expenditure), there is potential for efficiency savings among the transition countries of Central-Eastern Europe and Italy (red circle). In the less decentralised group, the Western Balkan countries, Hungary and Turkey are the ones with above average current expenditure (blue circle). The countries below the trendline are regarded as more efficient in their total current budget usage.

Subnational government current expenditure is saddled by inescapable labour costs, i.e. gross salaries and wages. Options for improving local service efficiency are determined by the cost structure of municipal actions. Expenditure on employment represented 46% of current expenses on average in the CEMR countries, according to the OECD-UCLG World Observatory (Table 4).

Table 4 Composition of subnational government current expenditures, 2018
Compensation of employees	46,0
Intermediate consumption	29,9
Social expenditures, subsidies, transfers	23,2
Other	0,9
Total	100,0

Other spending went towards intermediate consumption (30%), the operational costs of goods and services, and various local subsidies, social expenditure and transfers (23%). Actions to improve government financial efficiency could therefore focus on labour costs, which constitute the largest current expenditure category.

However, climate change mitigation may also bring about significant improvements in service efficiency. This is why local governments have often invested in energy efficiency programmes, which produce savings on public lighting and facility management budgets. They can also consider investing in solar energy production (see Box 8).

Capital expenditures

This sub-chapter looks at the nature of subnational capital spending and in particular expenditure on local government investments. Generally, public budgets comprise current expenditure, which covers daily operational and maintenance costs such as salaries, materials, energy, etc., and capital expenditure. The latter generally consists of investments in physical infrastructure (buildings, utility networks, other assets) with a useful lifespan of more than one year as well as financial investments. After a brief description of the main expenditures by competence, this report will study the proportion and composition of subnational capital expenditure.

Capital investments represented only 15-18% of total subnational expenditure from 2010 to 2020. . More capital investments are managed by first tier local governments (e.g. municipalities, counties) than by regional (state) governments, where capital expenditure only accounts for 5-7% of total budgets. Since 2010, the share of capital investments in subnational budgets has remained relatively stable. The 2016 and 2017 fiscal years were the exceptions when capital expenditure ratios fell slightly (15-16%) amidst a decline in overall government expenditure. In the first year of the pandemic, current spending (operational, maintenance) took up a large proportion of subnational government expenditure and the capital investment ratio fell again to 15% (2020).

However, subnational governments are responsible for a significant part of all government capital expenditure. Over the past decade, the trends in subnational government capital expenditure have followed the overall pattern of decentralisation.

Capital budgets were constrained after the 2008-2009 economic crisis. Subnational governments were the target of national fiscal policies and central government actions aimed at balancing public budgets. Following a gradual decline in the ratio of local investments that lasted until 2016, this trend reversed course and the share of subnational investments increased until 2019. In the first year of the pandemic, subnational government capital investments again dropped, especially at the local government tier (down to a ratio of 37.9% in the countries that reported data for 2020).

Setting aside these CEMR averages, there are major differences in subnational governments’ responsibilities over capital investments depending on the country (Figure 11). In the less decentralised countries, local governments manage one-fifth or more of total government investment (Cyprus and Malta are exceptions). In the decentralised countries, subnational governments manage more investments than the national governments (see the federal countries and those with a high local expenditure-GDP ratio). Among the federal countries, however, it is the regional government tier that is more active in this area in Belgium and Spain.

Throughout 2010, almost an equal number of CEMR member countries reported a declining share as they did an increasing share in total capital spending of subnational governments (Figure 12). Subnational governments lost the most in the less decentralised countries (e.g. Montenegro, Serbia, Bosnia and Herzegovina, Slovakia) and where major centralisation reforms were implemented (e.g. Hungary).

However, at the other end of the spectrum, subnational governments in some less decentralised countries did increase their role in public investments (e.g. Moldova, Portugal, Albania, North Macedonia, Greece). Others from the more decentralised countries in the middle were mostly able to maintain their share in general government capital investments; while some even managed to carve out a larger portion of total government investment (e.g. Croatia, Sweden, Finland, UK, Denmark).

This fluctuation in capital expenditure can be explained in part by political electoral cycles. In some countries, local government elections coincided with higher local capital spending: Moldova (2019), France, Romania and several regions in Italy (2020).

Local government capital expenditure is mainly driven by national investment programmes and grant schemes. For example, the “Facilities for Syrian Refugees in Turkey” programme has a municipal component, which allocated EUR 400 million to local infrastructure projects (see Box 9). It also has grant and loan components from three donors under a joint coordination mechanism.

Local green investments

This sub-chapter sheds some light on the state of play of local and regional green finances where the financial data is available. Subnational governments have been conferred powers to manage capital expenditure in several areas pertaining to the six climate and environmental objectives of the EU Taxonomy regulation , primarily the following: climate change mitigation, climate change adaptation, the sustainable use and protection of water resources, the transition to a circular economy, pollution prevention and control.

Municipalities and regions play a crucial rule in global efforts to achieve the Greenhouse Gas (GHG) reduction in line with the Paris Agreement of 2015 and to reduce global warming to 1.5 degrees Celsius above pre-industrial levels. According to the Greenhouse Gas Protocol, cities are responsible for an estimated 75% of global energy-related CO2 emissions . Commission estimates that there is a yearly investment shortfall of EUR 350 billion to overcome to meet the EU’s climate mitigation goals and an additional EUR 130 billion needed each year to attain its other environmental objectives (European Commission, 2021).

These investment gaps cannot be bridged by national governments alone. It requires the mobilisation of private and public financial resources and this is where subnational governments also play an important role. They exercise partial control over the main sources of emission since housing, energy infrastructure, public transport, waste management, etc. are usually local government competences. As will be discussed later in this study, the main pillars of the European Union funding mechanism (Recovery and Resilience Facility) also entail a significant local dimension.

Most subnational capital investments are implemented in the infrastructure, communal and utility sectors. Local green investments are typically reported in three COFOG service areas: housing and community amenities, environmental protection and economic affairs (Table 5). In EU member countries, subnational governments were predominant in this respect in two areas: in housing and community services, almost all capital investments were local (88% of all government capital formation in 2019); in environmental protection, which includes reporting of waste management, an overwhelming majority of capital investments were local (74% in 2019).

Table 5 Subnational government capital formation as % of general government in selected services, EU countries, 2019
	2010	2015	2019
Housing, community amenities	85,0	90,2	88,2
Environmental protection	75,3	70,9	73,8
Economic affairs	50,9	48,8	50,0
Total subnational investments	54,1	52,9	54,3

Over the past decade, the local share of spending on housing and community investments has even increased despite the unfavourable economic conditions. This further highlights the importance of subnational governments in public services relating to climate change, green development and environmental protection.

Transport-related investments, which fall under economic affairs, have been almost equally implemented by the national and local government tiers (see the case of Austria in Box 10).

Local governments can do a lot more for a better environment beyond investing in municipal service improvements.Local >strategies on environmental risk management have an impact not only on municipal services but affect other actors such as businesses and citizens as well. Goal 13 of the UN Sustainable Development Goals aims to combat climate change and promote adaptation actions. It is worth noting that the sub-indicator measuring progress in this field specifically refers to “proportion of local governments that adopt and implement local disaster risk reduction strategies in line with national disaster risk reduction strategies”.

Table 6 Number of local governments that adopt and implement local disaster risk reduction strategies, 2018
Germany	11,092
Austria	850
Norway	394
Finland	310
Slovenia	212
France	101
Lithuania	100
Estonia	79
United Kingdom	42
Netherlands	25
Ukraine	25
Poland	16
Czech Republic	14
Source: UN SDG database, indicator 13.1.3

Some CEMR countries have been major actors in this field since the early days of the agreement on the SDGs. The number of local governments that have adopted and implemented local disaster risk reduction strategies is listed in Table 6. Municipalities from countries listed at the top have been the most active (some cities have even come up with multiple strategies), while in other countries, only a few cities have experimented with risk reduction strategies thus far. Overall, subnational governments in the CEMR countries have been active in developing local climate-related programmes (see Box 11 on Tartu, Finland, Box 12 on Austria and Box 13 on the model of urban green areas in Turkey).