There is a global trend towards decentralization in public administration.An important reason for decentralization is to develop more effective participation in local affairs, including activities of central government that are carried out locally.Such participation not only enhances the dignity of individual and the sense of community at all levels, but also adds vitality to governmental programs and provides a means for local control over them.Under the development of decentralization, the position of local government within all state systems in the world has changed significantly.Accordingly, local government has been realized as a vital institution efficiently and directly rendering valuable services to the local community.Local government and local politics are becoming more and more important, and local forms of political accommodation among local executive and legislative branches, and interest groups are pointing to new styles of political practice which significantly influence budgeting and financial management.
Current organization downside efforts and restructuring of government level in Taiwan reflect realized decentralization of power.County-level governments have greater power since province-level government has been shrunk since 1999.Although local governments in Taiwan have generally arisen since the outburst of local democracy, local deficit has become the new challenge to local-self governing bodies.Local finance is the nerve center of the local political universe.However, local deficit suffered by local governments in general has seemed undermining public service capability of local governments in Taiwan since 1996.
This paper tries to examine financial managerial inertia of local governments in Taiwan through a principal-agent theoretical analysis. Particularly, the paper will investigate managerial problems of budgeting system in terms of “rational” managerialism and “irrational” political practice.In Taiwan, local financial deficit fundamentally lies at failed financial institutions that suffer from a “financial triangle” involving elected officials, local councilors, and interest groups.In addition, paper will explore impotence of audit agency that fails to play an effective monitoring role in financial institution. As a matter of fact, financial deficit in Taiwan generally occurring in local-level governments reveals that financial system is mismanaged or even totally collapsed under a collusive coalition between local politicians.Deficit problem shows that some local governments have no money to pay their staff.This paper based on principal-agent theory explores a unique local deficit problem in Taiwan through examining interplays among fiscal regulatory system, the budgeting process, and financial politics.Particularly, the paper focuses on agency problem taking place in the interaction among executive, bureaucracy, local councils, and interest groups which deeply involves in local politics and determines severe local financial deficit. Finally, paper will elucidate how financial institutions fail to withstand rational and professional position in the fiscal regulatory institution.
<>II. Theoretical Reviews
The history of rational budgeting has changed significantly in the 20th century, beginning with the introduction of executive budgeting in the 1920s. Since the 1950s, a relatively major reform has been proposed about once each decade in an effort to overcome some of the perceived deficiencies of incremental line-item budgeting-performance budgeting in the 1950s, program budgeting in the 1960s, and zero-base budgeting in the 1970s. In the 1990s, entrepreneurial budgeting is being proposed in response to both severe financial deficit in general and to emerging New Public Management perspective specifically.
Although it goes by various names such as performance-based budgeting or mission-driven budgeting, all of these might be characterized as entrepreneurial budgeting because of emphasis on decentralization and incentives. It is a common observation that governments throughout the world were faced with a more difficult fiscal problem in the 1980s and 1990s than previous decades. This fiscal problem was a result of the combination of increased demand for public services and growing taxpayer resistance to higher taxes, a situation that has been called the “scissors crisis” in public finance . This fiscal stress prompted adaptive behavior by governments, including more privatization, contracting out, increased user fees, and an array of other devices either to make movement provision of services more efficient or to shift the burden for the financing of those services. Virtually every account of the decentralized approach to budgeting at the local level points to fiscal stress as a major reason for its adoption.
Along with the general increase in discretion over the use of funds, it is supposed to improve both management and morale by giving more discretion to those who actually administer various public programs. The more decentralized approach gives local governments the flexibility to manage their finance in more creative ways and to respond to newly emerging local democracy. In that way, it allegedly departs form the rigidity frequently attributed to government bureaucracy and moves toward the flexibility often associated with private enterprise.In short, a major goal of decentralization is to encourage the development of a new administrative culture in which program managers see their objective as maximum achievement with the available resources, rather than as acquiring the largest possible budget for their programs and then spending all they get.
The managerial logic assumes that the decentralization and more intensive accountability will lead to greater efficiency and effectiveness with the funds available. It is not an accident that these techniques emerged soon after the beginning of the tax payer revolt in the late 1970s. While our findings indicate that the managerial logic has been undermined by political logic in two ways: first, for local politicians, including elected officials and councilors, financial decentralization means more resources that could be used by politicians who only care about getting reelected rather than performing rational and efficient public programs. Second, the willingness and capacity of implementing performance budgeting are not sufficient in local governments, thereby many local politicians and officials are not interested in the performance and results of public spending. Third, executive branch, local council and bureaucracy have longer involved in “financial politics” dominated by interest groups and local politicians through voting mobilization. These financial politics shaped by “triangle”, i.e. involving elected politicians, local council, interest groups, are formed by the agency problems which essentially lead to serious local deficit in general.It is apparent that whole managerial inertial of financial system of local governments in Taiwan is embedded in agency cost characterized with combinative effect of information asymmetry, hidden action, and moral hazard.Principal-agency theory can be a proper analytical approach to exploring local deficit problem in Taiwan.
<>III. The Agency Problems
Kenneth Arrow , a Nobel laureate, points out that the agency relationship is a pervasive fact of economic life, at least one significant component of almost all transactions.Principal-agent models, derived from such disparate disciplines as law, finance, accounting, and economics, have become the basis for an extensive set of studies relating bureaucracy to elected officials .Agency theory assumes that social life is a series of contracts. The principal-agent relationships is governed by a contract specifying what the agent should do and what the principal must do in return . Agency theory posits a dynamic process of interaction between principals and agents.In this process, bureaucrats are assumed to have distinct information and expertise advantages over politicians, i.e. elected officials and legislators.Yet, elected officials better understand the financial management and organizational procedures that are required for budget process than local councilors.In the same vein, local councilors have better access to financial allocation, distribution, and management that voters lack.They have both the opportunity and the incentive to manipulate politicians and bureaucrats and budget process for political gains .These four actors involving in budget process not only confront information asymmetry of financial institutions but also have different preference choices in dealing with financial allocation in local-self governing bodies.
Theoretically speaking, what the most prominent forms of organization have in common is the delegation of authority to take action from the individual or individuals to whom it was originally endowed--to one or more agents. One major organizational theorist, in fact, defines organizations as "networks of overlapping or nested principal/agent relationships". Delegation from principal to agents is the key to the division of labor and development of specialization.In such a relationship the agent seeks to maximize his or her return subject to the constraints and incentives offered by the principal. The principal, conversely, seeks to structure the relationship with the agent so that the outcomes produced through the agent's efforts are the best the principal can achieve, given the choice to delegate in the first place. There is, then, a natural conflict of interest between the two. In economic settings this conflict is often over the amount of effort expended by the agent. In political settings, it is more likely to be over the course of action the agent is to pursue. The policy agenda of agency bureaucrats, for example, can be quite at odds with the preferences of the elected officials who oversee them. Similarly, the priority of public goods and services proposed by elected politicians may differ that of citizens who delegate decision-making authority to politicians.Certain conditions that are generally present in principal/agent relationships, however, make it a particularly congenial environment for opportunism. Information asymmetry, hidden information, hidden action, and moral hazard which form agency cost are generally embedded in institutional arrangement of all kind of public and private sectors.
Principal-agent theory assumes that there are principal-agent relations, e.g. elected governorsand bureaucrats, elected governorsand local councilors, local councilors and voters in local-self governing bodies, do not necessarily similar goals and preferences. However, they are rational utility maximizers .Elected governors have an interest in policies that benefit their constituents but have no interest in implementing public programs with rational and efficient considerations.The features of the dynamics of interactions between principals and agents are information asymmetry and goal conflict.As a result, hidden action and moral hazard intensify agency cost in public and private institutions.Obviously, local financial deficit in Taiwan can be explored through such an agency structure.
1. Information asymmetry
In a wide variety of agency relationships, the agent possesses or acquires information that is either unavailable to the principal or costly to obtain, The agent has incentives to use this information strategically or to simply keep it hidden--a situation referred to variously as the problem of truthful revelation or incentive incompatibility. In a firm, workers have information that is not available to management, such as how fast the assembly line can run before quality is compromised. They would prefer not to reveal this information, however, because they would rather not work at a breakneck pace. Another type of information that agents often have and principals do not is the agent's type . This variation on the hidden information problem is referred to as adverse selection.
Situations in which agents acquire information that is unavailable to the principal pervade public policy-making. The basis of Niskanen'sargument as to how bureaus maximize the size of their budgets is that bureaucrats are privy to information about service delivery costs that is not available to elected politicians. Through their investigations, congressional committees uncover information that is not available to other members of the chamber. Individual members, similarly, have better information than do congressional party leaders as to whether or not supporting the party's position might cause them trouble back home
Information asymmetry exists, with an advantage to elected officials.Elected officials as agents seek to manipulate and mold the behavior of local councils as principals in budget institutions.Institutional arrangement of budget process in local governments in Taiwan is advantageous to the executive rather than local councils. Agents could be motivated by public interest or by their own narrow self-interest.Since agents enjoy information advantages over their political principals, local councils and then voters.Voters in this game are losers since they are short of sufficient information to monitor financial management.Accordingly, in the principal-agent relationship there is “an inevitability of control loss”. Local councils as the political principals never perform a financial monitoring agency to police or monitor its bureaucratic agents, since that principals are unlikely to directly bear any cost incurred by the agents’ continued shirking.Instead, the bulk of that cost is passed along to general public, which is the legislative branch’s political principal.Local councilors would never pay any direct cost for their lax oversight of bureaucracy and elected officials, because voters are generally not aware of what happens in budget process.
2. Hidden action
The second problem, regarding principal-agent relations comes from hidden action which manifests itself in a variety of situations. Stockholders cannot observe whether the actions that firm managers take are in their best interest. Voters cannot observe whether the actions of elected representatives--their agents--are in their best interest. However, hidden action basically results from hidden informationexisting in information asymmetry of an agency relationships.As a result, it causes incentives of moral hazard taken by agents to achieve their preference choices.
Hidden action is especially problematic when the agent's actions only partially determine outcomes, as in the case of team production or committee decisions, or when outcomes are partially determined by chance. In such cases, the principal is unable to infer the appropriateness of the agent's actions even from observed results.Countless financial mismanagements are essentially caused by hidden action which often takes place between the executive and legislature or between elected officials and bureaucracy.The executive and legislature may disagree over policy.Legislature as principal is forced to expend resources both trying to instruct the executive as agent what to do and in monitoring and policing the executive’s behavior.Theoretically speaking, principal and agent usually have different preferences and goal conflicts. Principal must make use of his information advantages to achieve financial goals, probably getting reelected or top priority policies and programs.
3. Moral hazard
Information asymmetry resulting in hidden information and hidden action within and between organizations often generate executive’s moral hazard.Moral hazard and agency problem are deeply imbedded in the institutional arrangement of financial managerial system. Both executive branch and local council try to enlarge expenditure, in particular they have a high propensity to carry on various local development programs and never consider financial burden and efficiency of financial resources available to local governments.Since Taiwanese-type “triangle” formed by elected politicians, local council and interest groups, is not responsible for financial stress, fiscal moral hazard has become a substantial threat to public finance in local governments in Taiwan.
The most important power relations in both public and private sectors are the delegation of power.As Figure 1 shows, the feature local political institution reveals that all actors involve in principal-agent interactions.The executive branch is principal of bureaucracy; yet, local council becomes a principal of executive branch.The executive as principal may employ bureaucratic agent to deliver public services.In contrast, executive branch is an agent of local council, and council constitutes an agent of voters.As policymakers, elected politicians are always recognized as principals in their relationship with public administrators, who, in turn, act as their agents in implementing policy.Figure 1 shows that these institution arrangements of delegation of power forms a multiple agency relations, existing in whole political, economic, and social systems appearing a division of labor in order to sustain goal of efficiency.However, twin-goal of division of labor and efficiency turn out agency cost as a fundamental barrier to resource allocation and utilization of organization and institution.In terms of public finance, agency cost becomes an obstacle to financial management in all levels of public sectors. There is the question of how executive as the principal interacts with the agent it employs or delegates.Apparently, agency problem becomes a key factor of financial mismanagement in local governments in Taiwan.Particularly, local politics in this island state embedded on the “triangle” rent-seeking involving elected officials, local councilors, and interest groups enhances agency cost and consequently swells up significant local deficit.Under a principal-agent relations, the public interest is so often made subservient to private interests in financial institution of local governments.Voters as political principals never adequately monitor local councilors’, the agents, behaviors in budget process, then voters would directly bear the cost by paying financial deficit rendered.
<>IV.Agency Problem and Local Deficit in Taiwan
In the financial process of local governments in Taiwan, there are three major forms of delegation of decision-making authority:votersvs. elected politicians; local councilors vs. elected officials; elected officials vs. bureaucracy; and central governmentvs. local governments. The preceding discussion of managerial logic has shown that the goal of financial decentralization, normatively, is to improve performance and effectiveness by giving more discretion and flexibility to those who actually administer public programs. In the Taiwanese case, local governments strongly advocate "financial decentralization", in which central government should give local government more revenue sharing and grants-in-aid along with more local autonomy and reduced control from the central. As Table 1 shows, for township-level governments the total tax revenue as percentage of annual outlay is averagely 44.21% comes from grant-in-aid of central government from 1991 to 2001.For county-level government, it is 65.33%.Taipei City and Kaohsiung City Governments get higher tax revenues.It indicates that finance of township-level governments highly depends on grant-in- aid from central government.Table 2 reveals that simply 58.58% of annual outlay comes from pure local revenue, and 41.42 % is from grant-in-aid of the central government.Grants from central government is 34.6%. Average debt rate of local governments is 5.19% of total revenue .Most of debts are loans from state-run banks.Some debts are use for employee’s salary. However, most serious problem is that some local governments, particularly township-level, can not pay staff since fiscal shortage.Construction expenditure or development programs are suspended because of severe deficit. Those evidences have exposed that local government is facing bankruptcy.
How does local governments in general confront such a serious deficit?As Niskanen argues, the elected politicians are self-interested in terms of maximizing votes in order to get reelected. They force executive branch to extend budget in order to benefit their political sponsors and never take financial rationality into account. Obviously, they put rational and efficient finance behind political consideration. The budget process reflects an interest articulation among elected politicians, local councilmen, and interest groups under moral hazard. Overspending is not unusual and balancing budget is not important for local governments. As a result, local deficit seems to be an inevitable situation and become a serious challenge to public financial management in local governments.
Budgeting plan in Fiscal Year meeting is controlled by chief executive, in particular budget planned by accounting office are made for achieving political preferences and goals of chief executive, majors or governors of local governments.As Figure 2 shows, chief executive gets elected through keen local political campaign Anyone who wins election, he or she must face with overwhelming political and financial demands from all kind of interest groups and political sponsors.Both <>
Tax revenue of Central and Local Governments
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