Creating Incentives for Fiscal Discipline in the New South Africa 1

In a recent compilation of lessons learned about decentralization, Roy Bahl (1999) highlighted three channels through which central interventions often undermine the discipline of a hard budget constraint for local governments. These are “deficit grants” to cover year-end deficits on local government budgets, direct central government coverage of shortfalls on specific items of expenditure, and bailouts on delinquent debt. All three channels involve direct or indirect fiscal assistance at the end of the year from central authorities. Repeated over time, such assistance can potentially create a regime of soft budgets, effectively undermining the fiscal resolve of sub-national governments and the efficiency gains expected from moving government closer to communities. In the case of South Africa, all three of the channels-deficit grants, coverage of specific expenditure shortfalls, and bailouts-have been utilized by the central government to provide assistance to sub-national governments in both the apartheid and the present democratic eras. That South Africa, at first glance, conforms to the international experience of how hard-budget constraint for sub-national governments have been violated adds little new information to the vast policy literature on decentralization that has emerged over the last decade. Instead, the case of South Africa provides insights into why and under what conditions the constraint of hard-budgets may