EFFICIENCY IN LOCAL PUBLIC INVESTMENT: PROOF OF TIEBOUT HYPOTESIS IN BOLIVIAN COUNTRY Mónica Meneses Covarrubias ∗ Fernando Michel Ayala Vargas ∗∗ Carlos Meneses Covarrubias ∗∗∗ ∗ Master in Sciences of Economics. Graduated from Lovaina-Namur (Bélgica) university. Researcher in the Institute of Social and Economics Studies (IESE)-UMSS. ∗∗ Lic. Fernando Michel Ayala Vargas. System Ingenier. Graduated from San Simon University. Enterprise JALASOFT S.R.L. ∗∗∗ Lic. Carlos Meneses Covarrubias. System Ingenier. Graduated from San Simon University. 1 Introduction Decentralization has become an increasingly familiar theme in development theory and practice over the past two decades. There is a worldwide trend toward increasing transfer of power, resources and responsibilities to the sub national levels of government. Both federal and unitary countries, whether industrialized or developing are moving toward more fiscal decentralization. This trend towards greater fiscal decentralization that began in 1980’s with many developing countries embarking on the path to devolve more functions to the local jurisdictions, gained momentum during 9o’s. Paul Smoke (2001) asserts that during the 1990s, fiscal decentralization and local government reform have become among the most widespread trends in development (Sharma 2005). Proponents of decentralization claim a number of benefits for the efficiency and equity of government performance. However, this basic economic rationale for decentralization of the public sector is not quite so simple and compelling as it appears. Some of the more recent literature provides, first, a thoughtful and provocative critique of the traditional view of fiscal decentralization, and, second, some new approaches that reveal its dark side, especially in practice. There is emerging, in short, a broader perspective on fiscal decentralization that raises some serious questions about its capacity to provide an unambiguously positive contribution to an improved performance of then public sector. Oates (2007). Yet the literature on decentralization has tended to concentrate on theoretical discussions rather than empirical analysis, and few studies have explored the practical consequences of decentralization policies in a quantitative way (Khaleghian, 2003). Many of the proposed benefits of decentralization are open to question, especially in developing countries. The case of Bolivia it is not an exception to this trend. There exist only a few studies about this topic in this country. One of them is the study of Faguet (2002), who found that the change in the pattern of investment from centralization to a decentralized government has been leaded by the local needs of the population. This paper has centered on the comparison between centralization and decentralization of public good provision as most of the literature that started with Oates (1972)’s seminal contribution. However in this line of investigation the efficient conditions of the decentralization have not been treated. The aim of these papers relies precisely on the efficiency of local public good provision. In his celebrated paper published a half century ago, Tiebout (1956) argued that although Samuelsonian pure public goods may be underprovided due to consumers’ free-riding incentives in reporting preferences, examples of pure public goods are very rare, and impure local public goods can be provided efficiently (efficiency) by consumers’ revealed preferences through voting with feet (self-selection) and competition among jurisdictions (entrepreneurship) (Konishi, 2007). As suggested by the work of Tiebout (1956) and as explained by Oates (1972, p. 35), a system of decentralized local governments can achieve allocative efficiency in the provision of local public goods by allowing consumers with different preferences for government spending to reside in different communities (homogeneity within the communities). Instead of having many heterogeneous consumers who are dissatisfied with the quantity of government services offered by a single centralized government, decentralized provision can increase consumer welfare by improving the match between consumers' demands and the services provided. This paper seeks to assess more formally the relevance of Tiebout hypothesis. Our strategy is to derive a more realistic version of these. We first generalize the Tiebout model and show in a general environment that there is homogeneity across municipality’s demands and heterogeneity across municipalities’ investment. This suggests that Tiebout incentives do not hold because there is no an efficient match between consumer’s demands and the services provided. To evaluate this prediction, we consider: (i) a sample of Bolivia municipalities (318) in one year (2001). Almost all of our empirical results stand in opposition to the Tiebout prediction of heterogeneity across communities and investments. It is important to contrast our approach with previous empirical tests of the Tiebout (1956) hypothesis. The present investigation includes de spatial component in looking for the efficiency in the allocation of public goods. Two factors determine this inclusion. The first refers to the definition of local public goods which have the geographic components which is their essential difference respect to the definition of club goods. The second arise because of the proper definition of efficiency in Tiebout hypothesis. Tiebout (1956) himself wrote that: "there is no way in which the consumer can avoid revealing his preferences in a spatial economy. Spatial mobility provides the local public goods counterpart to the private market's shopping trip." Tiebout showed that a quasi-spatial adjustment mechanism (what has since been termed 'voting with one's feet') could, under certain conditions, lead to equilibria that satisfy the efficiency conditions for a local public good (Heikkila, 1995). No one of the studies dealing with Tiebout hypothesis include the spatial component. Konishi (2007) introduce to his theoretical model spatial considerations; however the spatial model proposed is related to spatial location of each jurisdiction and it is not related to other jurisdictions as in our study. Moreover, we use a second approach to analyse public investment efficiency of Bolivian local governments, using non-parametric technology. Specifically, we calculate an index of efficiency for two technologies: Free Disposal Hull (FDH) and Data Envelopment analysis (DEA). The objective is to complement the results from Tiebout hypothesis, studying how the local heterogeneous government’s investment is matching the local requirements. The basic idea of the methodology is to compare the use of public resources related to the public services obtained, among the municipalities. The paper proceeds in several related stages. In section 2 we systematize the literature review, in section 3 we present a description of the methodology, data and specification of the model, section 4 exhibit briefly the results and finally section 5 the conclusion of the investigation. 2 Literature Early tests of the Tiebout model primarily attempted to evaluate whether fiscal variables affect residential decision of households. The Tiebout hypothesis implies that there is at least partial sorting of individuals in communities based on local public goods. Some studies looked at migration and mobility patterns explicitly, and others focused on indirect tests. These studies investigated primarily whether public spending affected property values (Rubinfeld 1987). The most prominent approach was introduced by Oates (1969), who studied whether public spending and taxation were capitalized into land values. Oates reasoned that an increase in public spending, with everything else including taxes held equal, should increase property values. The idea is that more public spending would attract more individuals to the community and hence increase the demand for housing in this particular community, resulting in an increase in price. Most of the studies following Oates´s find evidence that capitalization of public spending and taxes is prevalent. Kobayashi and Ribstein (2006). However, critics noted that no such relationship should exist in full Tiebout equilibrium, when taxes equal the price of efficiently provided local government services (Hamilton 1976). Thus, the rejection of the null hypothesis of no relationship between housing prices and fiscal variables indicated that such a Tiebout equilibrium did not exist. Epple et al. (1978). Kobayashi and Ribstein (2006) distinguish a second set of papers testing the Tiebout theory used sub-county data to examine whether lower mobility costs were associated with greater Tiebout sorting. Gramlich & Rubinfeld (1982) estimated public spending demand functions and found that variance in local spending demand within communities was significantly lower than the statewide variance. This finding is consistent with Tiebout sorting of individuals with similar demands for public spending. Gramlich & Rubinfeld also found that estimated preferences for median voters in urban areas were consistent with actual levels of local government services provided. However, the results were weaker in rural areas, where mobility costs are higher. These results are consistent with local jurisdictions providing the desired level of services in the presence of low mobility costs. On the other hand, Rhode & Strumpf (2003) found that decreased mobility costs over time were not associated with increases in intercommunity heterogeneity