In many respects, the municipalities of Beijing and Guangzhou could not be more different. Beijing is a capital city, and with the exception of a few notable interludes, has been so since the thirteenth century. Although the occupants of Beijing's palaces and government offices periodically change, the city itself has remained the cultural and political epicenter of China. Guangzhou, located 1,887 kilometers to the south of the national capital, is distinctly on the periphery of the national scene. Rather than being a home to culture and politics it has thrived as a city of commerce and a window to the outside world. It has often enjoyed a great deal of independence from central power; at many points in Chinese history it has been utilized as a base for those who have challenged Beijing's rule. In Guangzhou, according to the often-quoted proverb, “the mountains are high and the emperor far away.” A city of traitors and traders was the description of one manager.

Despite these differences, the patterns of development in the auto sectors of these two cities have been remarkably similar. Both cities chose to promote the sector as a pillar industry, and in the mid-1980s both created joint venture auto assembly projects with the hope of fostering the development of a network of local supply firms. When the negotiations creating Beijing Jeep, a joint venture linking the Beijing Auto Works (BAW) and American Motor Company (AMC), were completed in April 1983, it was the only automobile joint venture in China (one year before SVW) and the largest manufacturing joint venture.

This chapter reflects on four issues central to this book. Two are methodological: the nature of institutions and the analytical and empirical method with which to study them. Two are substantive: the insights from the comparative institutional analysis of institutions in the European and Muslim worlds and the policy implications of the perspective on institutions presented in this book.

Institutions are the engine of history because, as I argue in section 12.1, they constitute much of the structure that influences behavior, including behavior leading to new institutions. Their independent impact and their interrelations with social and cultural factors imply that we cannot study them as reflecting only environmental factors or the interests of various agents. Although institutions are not random and all institutions generating the same behavior respond to the same forces, their details and implications are not determined by these forces. Comparative and historical institutional analysis – the central aspects of which are reviewed in section 12.2 – fosters our ability to capture and study institutions from the required broader perspective.

Section 12.3 dwells on the insights from the comparative and historical analysis of institutions in the European and Muslim worlds during the late medieval commercial expansion. It emphasizes that many of the elements and features of modern, welfare-enhancing Western-style institutions were already present or in the process of emerging during the late medieval period: individualism, man-made formal law, corporatism, self-governance, and rules reflecting an institutionalized process in which those who were subject to them had a voice and influence.

To identify and understand the operation of the community responsibility system, the analysis in Chapter 10, like all of the empirical analyses in this book, used a particular case study method. Specifically, it employed a theoretically informed, case study method that extensively relied on contextual knowledge of the situation and its history, and context-specific modeling. This chapter first argues that this method usefully responds to the challenge that institutional analysis presents to the traditional empirical methods of the social sciences; it then presents this methodin detail.

The challenge that institutions present to the traditional empirical methods of social science has two sources. First, although institutions are not random – those that fulfill a particular function or interest respond to the same forces and considerations – they are inherently indeterminate, historically contingent, and context-specific. We don't have a theory of institutions to guide their empirical analysis, and what we know about them suggests that seeking such a theory is likely to be a futile exercise (section 11.1). Second, we cannot generally study institutions by considering only their observable features (section 11.2).

The method presented here responds to institutions' inherent indeterminacy, their context-specificity, and the need to coexamine institutions' observable and unobservable components. This method interactively combines theory, contextual knowledge of the situation and itshistory, and context-specific modeling. A case study approach such as this is promising for several other reasons. Institutions' inherent indeterminacy and context-specificity imply that we often need to study an institution as a historically unique phenomenon.

How does an institution persist in a changing environment? How do exogenous changes and the processes that an institution unleashes lead to the institution's demise? How do past institutions – perhaps even institutions that are no longer effective in influencing behavior – affect the direction of institutional change? Why do societies evolve along distinct institutional trajectories, and why is it so difficult to alter institutional dynamics to induce better outcomes?

These questions have long bedeviled institutional analysis in economics, political science, and sociology. Addressing them requires a framework that can accommodate both stability and change – a framework that can account for an institution's persistence and stability in a changing environment on the one hand and endogenous institutional changes and the limit on institutional persistence on the other. The framework must also facilitate studying why, how, and to what extent past institutions influence subsequent ones.

Since the 1970s economists have developed two perspectives – the intentionally created perspective and the evolutionary perspective – to study institutional dynamics. The intentionally created perspective postulates that institutions are intentionally established by forward-looking individuals to serve various functions. Institutional dynamics are best studied as reflecting responses to the functions the institutions serve (e.g., North 1981; O. Williamson 1985). Political economy models were found to be particularly useful in studying processes through which institutions are established and changed.

A prerequisite to studying endogenous institutional change is recognizing the mechanism that causes institutions to persist in the absence of environmental changes and to exhibit stability despite environmental changes. Sociologists such as Berger and Luckmann (1967), Searle (1995), and Giddens (1997) have long noted the importance of studying the mechanisms causing an endogenous institution to persist once it has prevailed. But sociology has not offered a satisfactory analytical framework with which to study the phenomenon. As Scott notes, “The persistence of institutions, once created, is an understudied phenomenon [in sociology]…. The conventional term for persistence – inertia – seems on reflection to be too passive and nonproblematic to be an accurate aid to guide studies on this topic” (1995, p. 90; see also DiMaggio and Powell 1991a, p. 25; Thelen 1999, p. 397).

In economics the study of institutional persistence is usually referred to as the study of institutional path dependence (North 1990; David 1994; Greif 1994a). The idea of path dependence was originally developed to study technology (David 1985; Arthur 1988, 1994). It postulates that “the present state of arrangements” requires examining the “originating context or set of circumstances and …[the] sequence of connecting events that allow the hand of the past to exert a continuing influence upon the shape of the present” (David 1994, p. 206).

The game-theoretic analytical framework and the view of institutions developed in the previous chapters highlight a particular mechanism for institutional persistence.

Societies face new situations when an institution that governed a transaction is no longer self-enforcing, when it is perceived to be losing its self-enforcing characteristics, or when technological, organizational, and other changes bring about new transactions. Do past institutions – perhaps even institutions that are no longer effective in influencing behavior – affect the direction of institutional change? If they do, why and how?

The intentionally created perspective on institutions, which often views them as rules, emphasizes that new institutions reflect the interests and inductive reasoning of economic or political agents. Evolutionary institutionalism emphasizes the importance of environmental – structural – forces and the lack of deductive reasoning. To explain the impact of past institutions, these perspectives commonly invoke as exogenous one set of institutions to explain subsequent ones. In studying economic institutions as rules, for example, it is common to study the formation of the rules while considering either political or informal – culturally determined – institutions as given. This position, however, amounts to pushing the question of institutional impact one step back.

In contrast, this chapter explores why and how the past, encapsulated in institutional elements, directs institutional change and leads societies to evolve along distinct institutional trajectories. Exploring the properties of the social elements that make up an institution is the central focus of this argument. These properties imply a fundamental asymmetry between institutional elements inherited from the past and technologically feasible alternatives.

INTRODUCTION

In this chapter we examine the interaction between globalization and India's federal system, in the context of the country's past decade of economic reform. In doing so, we recognize that the national government has subnational governments below it and that all these layers of government simultaneously interact with foreign governments and corporations in a global economy. These multiple interactions have become more important as reform in India has opened up the economy to foreign trade and investment, They have also reduced certain constraints on subnational governments. Globalization provides challenges as well as opportunities to federal systems such as India's. This chapter seeks to elucidate these and to draw implications for policy and institutional reform.

In economic terms, globalization can be taken as the increased international mobility of goods, capital, labor, and knowledge.

INTRODUCTION

The entire history of Nigeria has been characterized by conflict among regions, social classes, and ethno-religious groups over resource allocation. Exploitation of oil deposits in the East and Midwest in the 1960s has only added to the intensity of the conflict: There have been over fifty ethno-religious conflicts and numerous other types of conflict since 1960. Regional disparities are widely perceived as one of the causes of continuing ethnic tensions in Nigeria. According to Post and Vickers (1973, p. 58), the most important grievance of various regions since the early 1950s has been that their wealth was being used to subsidize poorer regions.

Nigeria's recent history has also been characterized by extremely centralized political and economic power. Of the country's forty-three years of independence (obtained from Britain in 1960), twenty-eight have been under military rule. The country was nominally a federation at this point, but local leaders were appointed by the central government. Local elections have come with the recent transition to democracy, but the center still dominates via its control over resources and the allocation of the transfers that make up a large portion of their budgets.

This chapter focuses on how Nigerian fiscal federalism, especially the characteristics of the country's system for transfers to state and local governments, has affected and been affected by these regional disparities and tradition of centralization. Overall, we argue that Nigeria is not fiscally federalist but, rather, a de facto centralized distributive state.

Canada is one of the oldest and, from most perspectives, one of the most successful federal countries in the world. But success has not come easily. Over the 135 years of its existence, Canada has changed in many ways. As the decades rolled by, its territory expanded greatly, the number of provinces (and territories) included in the union grew, its degree of political independence from Britain increased, and, from 1976 to 1985 and from 1994 to 2003, a political party whose explicit objective is separation of one of its provinces gained control of a major province while at the same time Canada's degree of economic dependence on the United States rose to new levels. These and other major changes in the nature of both the country and its environment have required equally major changes in the institutions of Canadian federalism. The union continues to endure, but not without a good deal of effort and not without continuing pressures and strains.

We examine three aspects of Canada's federal arrangements over the past half century. The marked change that has taken place in the sharing of the personal income tax between the federal and the provincial governments is a success story: Successful changes were gradually made over time to accommodate new economic and political circumstances. The unsuccessful attempt to amend the Constitution Act of 1982 to satisfy the demands of Québec, the majority francophone province in Canada, was a failure in spite of great political effort.

INTRODUCTION

What does the division of responsibilities and powers across levels of government – federalism – look like? How did it get to be this way? And how does federalism interact with the economic and political contexts, particularly growing integration with the international economy and ongoing economic reforms?

The chapters of this book seek to answer these three questions for a diverse array of countries. Argentina, Australia, Canada, China, Brazil, India, Mexico, and Nigeria span the full range of economic, political, and social contexts in which federalism currently exists. Nevertheless, there are some striking commonalities in their experiences with federalism.

This concluding chapter compares and contrasts three aspects of the countries' experiences with federalism. First, we discuss the division of expenditure and redistribution responsibilities, as well as taxation powers. The countries had a common tendency toward de facto (though not always de jure) centralization of control over expenditures. There were varying degrees of clarity in the assignment of responsibilities; in many cases, central and subnational government functions were interdependent so that subnational autonomy was limited. Taxation also tends to be fairly centralized in the countries we studied in this project, with subnational governments varying in the extent to which they exploit the tax bases assigned to them. The allocation of tax revenues, in particular whether all taxes were shared or only specific taxes were shared between national and subnational governments, appeared to influence all levels of governments' choice of taxes.

Public sector enterprises also complicated the picture in some countries.

INTRODUCTION

The Australian federation, as it has evolved over the past century, has a number of distinguishing characteristics. A high degree of separation of taxes with federal government control over major tax bases has led to a very high level of vertical fiscal imbalance. Much of the dynamics of center–state relations occurs against the backdrop of fiscal dominance by the federal government. Borrowing by all levels of government is subject to a process of Loan Council endorsement. With regard to redistribution, Australia employs the most elaborate system of horizontal fiscal equalization of any federation.

During the 1980s a worsening external debt position helped focus attention on structural weaknesses in the Australian economy. Efforts to rectify these weaknesses and increase public and private sector efficiency have led Australia to undergo a wide range of economic reforms, including some changes to federal institutions and arrangements, over the past two decades. There have been changes to the borrowing rules for national and subnational governments, a new tax-sharing arrangement, and reviews of intergovernmental administrative bodies. A significant increase in collaborative federalism over the past decade has facilitated major reforms to Australia's internal markets.

Over the past decade the Australian federal system has delivered substantial reform of the nation's internal markets, which has allowed Australia to increase its competitiveness and take advantage of greater global integration.

INTRODUCTION

Because of history, size, and economic potential China is a force to reckon with. It is a nation of 9.6 million square kilometers populated by 1.26 billion people with a varied geography: Traveling from west to east (Figure 6.1) one starts with the vast dry areas, moves to the mountains, valleys, and higher altitudes of the center, and ends up in the more temperate coastal regions, which have more rain, lower altitudes, and better communication and transportation systems. A main theme of this chapter is that, in great part owing to geography, but also owing to overt government policies, wealth and economic well-being tend to increase monotonically from west to east. That reality significantly conditions the past, present, and future of fiscal federalism in China.

A standard grouping of China's provinces is used in Table 6.1 to describe the economic geography. The Northern Region includes the large and rich cities of Beijing and Tianjin. These two cities, together with Shanghai in the Eastern Region and Chongqing in the Southwest Region, are granted provincial status, much as is the case for Moscow and St. Petersburg in Russia. The Northern Region also contains the relatively poor province of Inner Mongolia. The Northeast Region, also known as Manchuria, contains several relatively rich provinces with a long tradition of manufacturing dating back to Japan's occupation of this area in the first part of the twentieth century.

INTRODUCTION

Following decades of protectionism and a powerful interventionist state, the Brazilian economy suddenly exposed itself to external competition and went through a rapid process of privatization. The institutional reforms implemented in the 1990s helped stabilize the economy and create a friendlier environment for attracting investments and fostering growth. In spite of the still-looming uncertainties regarding the prospects for reconciling sustainable development and macroeconomic stability, the results achieved in the past decade are on balance positive.

The federal regime affected and was affected by the process of moving from a closed, state-controlled economy to an open, privately run market. Indeed, the greater the degree of subnational governments' interests in proposed reforms, the more difficult it became to implement the reforms. In some cases, subnational governments had to be lured into accepting changes that reduced state and local autonomy. The power of state and local governments in the National Parliament created the necessity for bargaining over compensation for reduced autonomy or financial losses even in cases where subnational governments did not have direct policy oversight.

Of the reforms that topped the agenda for modernizing the Brazilian economy during the 1990s, three deserve special attention: privatization, public employment, and social security and taxation. Given the central role of healthy public finances in the strategy for macroeconomic stability, these reforms were the object of intense debate and much disagreement. Of these, privatization has been the only successful reform so far.

INTRODUCTION

How does federalism affect policymaking? How do the details of the division of policy authority as well as expenditure and revenue powers across levels of government affect prospects for efficient and responsive governance? How does the economic, social, and political context – especially the recent wave of globalization and domestic economic liberalization – affect the workings of any given federal arrangements?

These questions have given rise to a large and varied positive literature on the actual workings of federalism as well as a significant normative literature full of suggestions for how federations should allocate fiscal and other decision-making authority across several levels of government. The literature ranges from stylized models of the costs and benefits of different ways of allocating fiscal authority among social planners in closed economies to detailed research on the nuances of interactions among levels of government in particular countries, time periods, and policy areas.

On one end of the spectrum of research on federalism, national and subnational governments are assumed to act as benevolent social planners who are omniscient and omnipotent, with national planners capable of addressing any externalities from subnational social planners' actions that spill over from one region to another. Social planners at all levels are assumed to have all the relevant information and capacity for enforcement of their decisions. Opportunistic behavior is assumed to be nonexistent. Evaluating fiscal federalism in a closed-economy setting is another common simplification used to keep models tractable and implications for federal design and function clear.