Fiscal Stress and Its Impacts on Local Expenditure Autonomy

｢지방정부연구｣ 제16권 제3호(2012 가을) : 235～247

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* First author

** Corresponding author

재정위기가 지방정부 지출자율성에 미치는 영향 분석

Jong Youl Lee*

Jill L. Tao**

2008년 경 시작된 글로벌 경제위기는 모든 수준의 정부에 큰 영향을 미쳤으며, 지방정부는  재정수입 삭감과 근검절약의 큰 압박을 받게 되었다. 이로 인해 재정이 풍요로웠든 시기와는 다른 정책선호의 경향을 보이게 되었다. 이러한 재정위기 제약 상황에서 한국에서의 지방자치단체는 지출정책에서 어떤 대응을 하는가가 본 연구 의 주된 목적이다. 즉 재정자립도의 변화가 지출에 어떤 영향을 미쳤는가 하는 것이다. 거의 모든 한국의 지방자치단체의 수입과 지출의 자료를 이용하여 (약 237 지방자치단체) 다음과 같은 사실을 발견하였다. 이러한 결과는 미국의 일반적 경향과 약간 상이한 점이 있는데, 인건비를 포함한 일반경비의 지출삭감이 큰 반면, 공공안전이나 중소기업지원 등은 오히려 증가하였다. 교육부분은 지출에서 보호받지 못하였다. 이는 흥미로운 결과로서 한국의 교육시스템의 중요성과 연관이 있다고 본다.

주제어 : 재정 스트레스, 지방정부 지출, 예산감축, 재정자율성

With credit markets still locked up and investors getting worried about the big banks,

Wall Street marked a grim milestone in late November 2008, when stock markets

tumbled to their lowest levels in a decade. (New York Times 2012)

Introduction: Global Fiscal Crisis

The worldwide financial crisis that struck in late 2008 that upended financial markets and devastated real estate also wreaked havoc on the ability of local governments around the world to raise revenue. In the United States, Auerbach and Gale (2009:123) noted that the balanced-budget rules in place for almost all states meant that lower revenues would require tax increases or spending cuts. This crisis could not be averted through reliance on the traditional sources of fiscal autonomy found in cities. Municipal governments saw revenues decrease as property values dropped, sales dwindled, and overall transactions stalled. Municipal governments lacking these resources also saw their revenues drop as national governments cut back on revenue-sharing and other forms of intergovernmental assistance. Local governments that had become accustomed to a steady flow of income and to balanced budgets found themselves looking at balance sheets awash with red ink.

At the national level, governments charted widely disparate courses to attempt returns to fiscal stability. In the United States and some other countries, stimulus measures meant to assist aggregate demand were put in place, sometimes through direct aid to cities, and sometimes indirectly through aid to citizens to increase revenue from sales and other local taxes. However, large scale bank bailouts and brokered aid to national financial enterprises eroded public support for large-scale government stimulus efforts.

Fiscal Stress and Its Impact on Local Expenditure Autonomy

｢지방정부연구｣ 제16권 제3호(2012 가을)

In Europe, the response was quite different: "luxury" spending went out the window and austerity was to be the new watchword. Election victories by conservatives in the European Union (EU), in Spain as well as in England, coupled with the influence of Germany over EU monetary policy meant that a tight money supply and what were characterized as “draconian” cuts to shrink budgets were more commonly voiced policy preferences.

The Case of South Korea

One of the major effects of local fiscal autonomy dating from the early ‘90s is that individual local governments in South Korea now have much more discretion over expenditures. However, and in stark contrast to the U.S. case, most cities do not control their own revenue stream. During the first few years of the global economic downturn, this autonomy proved to be a means for the central government to reduce expenditures while encouraging continued growth. Cities were encouraged to ease their own debt restrictions, so that they could continue to build and expand by acquiring more debt, even as revenues and real growth were slowing.

The 2010 local elections illustrated that the issues of debt and balanced budgets were becoming increasingly relevant to South Korean voters. The Metropolitan City of Incheon is perhaps the most dramatic case in point. Mayor Ahn Sangsoo was coasting to reelection with a comfortable margin when his challenger revealed Incheon’s high level of indebtedness, quickly turning it into a major campaign issue. Song Youngkil subsequently won with 53% of the vote, and the opposition party went from having one seat on the Incheon City Council to commanding three quarters of the council. The defeat was so total that former Mayor Ahn even lost in some of his neighborhood strongholds.

The situation since the 2008 financial crisis has not improved. While Korea was in recovery from an earlier recession, the continuing worldwide downturn has limited Korea's ability to export its way back to a sound and growing economy. As the recession has lingered, Korea's once booming real estate market has also faltered, leading to a rapid decline in real estate transactions, and into a subsequent decline in real estate transaction tax revenues. An additional factor has been limits on revenue transfers from the central government, which is also facing pressures from the global downturn.

Austerity cutbacks in social services, basic services, and education in the United Kingdom have been famously met with the UK uncut movement, as well as mass protests. In the United States, meanwhile, state and local budgets have included pay cuts, early retirements, and layoffs of teachers, social workers, and other government employees. Personnel expenditures make up the largest proportion of local budgets, and are therefore often targeted during times of fiscal stress (Kettl 2003).

The main question of this study is whether this trend holds true for local government in Korea. Strong rhetorical attachment to welfare as a buzzword across the ideological spectrum in contemporary Korean government, the promises of liberals to implement a welfare state, and the popular thrust of the free school lunch campaign promise by the left-liberal alliance in the 2010 local elections suggests that local governments in Korea may be more reluctant to cut back on welfare spending, especially during a time of perceived need. Therefore this study tries to determine where budget cutbacks in Korean municipalities have had the greatest impact since 2008. This study will also try to place the Korean case within the context of expectations raised by the literature on local government behavior during times of fiscal stress. Since this literature largely discusses evidence from the U.S., we will examine how the Korean case performs in comparison. Thus we hope to contribute a new perspective on local government behavior to the extant literature.

Cases for Comparison: Times of Fiscal Stress

What areas of the local budget are most prone to cutback in times of fiscal stress? Much of the literature that addresses this question examined the impact of the infamous New York fiscal crisis and other cities’ crises of the late ‘70s and early ‘80s. Clark and Ferguson (1983:245) find that "a turning point was 1974, half the cities again trimming their local expenditures" and assert that, prior to New York's fiscal crisis in 1975, most public management discussions assumed the government growth was a natural inevitability. Harvey (2008:6) sees parallels between the crisis in 2008 and the New York fiscal crisis of 1975, suggesting that the response to the current crisis may look something like New York's response to its crisis writ large, described by Harvey as neoliberalism.

Katznelson (1981:108-9) referred to the crisis of the ‘70s as stemming from the urban crisis and the “assault on the trenches” of the entrenched urban elites by youth and racial minorities. In particular, the financial crisis was based on "relevant economic factors that (sic) were not susceptible to control by the city," limiting the ability of urban governments to respond without assistance from higher levels or drastic measures.

O'Connor (1973:221) found the fiscal crisis of the capitalist state to be "the inevitable consequence of the structural gap between state expenditures and revenues." In other words, fiscal problems came from simultaneous political demands for more services and lower taxes. He saw a possible solution whereby monopoly capital would transform social expenditures into social capital to develop a social-industrial complex that would expand production on the basis of increased employment instead of through capital-intensive technologies. Instead, he predicted the class biases of the Democratic and Republican parties would not prove capable of such reform and predicted that the tax revolt would place greater pressures on government, particularly in state and local government, where revenues are most closely linked to expenditures. In the state and local governments, the most politically attractive budget targets would be increasingly unionized public workers with then‐rising wages and benefits, as well as services for the poor, such as welfare expenditures.

Bahl et al (1978:20) saw public perception of “excessive public compensation” following rising public unionizations as driving efforts to cut back public employment, particularly in big cities. The next responses were service cutbacks, followed by program elimination, and deferred expenditures, particularly on new capital investments (Bahl et al 1978:33). Finally, they predicted that the large older cities with rising expenses and declining workforces and tax bases would turn to no-growth budgets to manage their budget pressures (37-38). In the same volume, Peterson (1978:74) predicted the deferral of repair/upgrading of capital stock by local governments would be a trend until the emergence of new forms of capital assistance.

Discussing large cities with increasing expenses and declining population, Margolis (1987:38) referred to them as "fragmented metropolises," divided between the central city and the suburbs. He pointed to the redistribution of resources in the central city (including the equalization of services across neighborhoods, increasing services to the poor, and cash transfers to the poor) as leading to the relocation of the wealthy to the suburbs outside of the city. This was due to the general tendency for the wealthy to pay more in taxes than the value of the public services they received making cuts to such redistributive services attractive.

Judd and Swanstrom (2002:341-9) point out that city expenditures are driven by forces that are largely beyond the control of local officials. Cities are caught between a rock and a hard place between the demands of higher-level governments and the demands of voters. The 1975 fiscal crisis led to a much more fiscally stable 1990s, with “Chicago, Miami, Denver, Detroit, San Francisco, and Cleveland making stunning comebacks.” They conclude by emphasizing that political and leadership factors played a role in Chicago’s turnaround and New York’s continuing difficulties in balancing budgets (Judd and Swanstrom 2002:358-363). While using New York City in the late ‘70s as a baseline suggests a preference for cutting welfare expenditures, one of the reasons that that was the case was that the State of New York placed much greater responsibilities for welfare expenditures on the city. They also cited the low level of national support for local budgets in the United States as a constant source of fiscal stress.

Looking at several cases of local government in California, Chapman (1999) found that counties and cities forced to make cuts sacrificed operating expenses, made across-the-board cuts, or targeted expensive services that included welfare and protective services but tried to protect education.

In the realm of leadership and politics, Clark (1994: 233) finds three different types of leadership when looking at the parties and mayors from the US and around the world. The categories include the traditional right to the traditional left (including in this category clientalist and patronage‐oriented parties and mayors) to new fiscal populists who combine fiscal conservatism with some measure of social liberalism. He found traditional left and right parties behaving as expected in some European countries, but with the Democratic- Republican divide in United States explaining relatively few differences in strategy selection whereas the new fiscal populists were the most likely to attempt productivity strategies in order to balance budgets.

Eleven years earlier, however, Clark and Ferguson (1983:246) found differences between the Democrats and Republicans differentiated mayors between Democrats, ethnics, Republicans, and new fiscal populists in the United States. The Democrats would search for new revenues first, borrow, cut capital expenditures, and then cut employee compensation. The ethnics were similar to the Democrats but would emphasize retaining in group ethnic group members on city staff and in symbolically important services and projects were the dominant ethnic group. The Republicans would cut taxes, reduce services, cut programs for the poor the most, and might pursue productivity improvement programs. A new fiscal populist would emphasize productivity improvement, maintain a symbolic commitment to the disadvantaged, and would then make cuts similar to Republicans.

Clark (1994:215) surveyed 517 cities as part of the US Fiscal Austerity and Urban Innovation (FAUI) project and asked what strategies they had employed since January 1978. Among the strategies that involved cuts in spending, they found that 71% of the cities had reduced spending on supplies, 58% reduced capital expenditures, 56% made across-the-board cuts, 53% reduced overtime pay, 52% reduced administrative expenses, 51% kept expenditure increases below the rate of inflation, 48% eliminated programs, 46% made layoffs, 40% reduced locally-funded services, 39% cut the least-efficient departments, 35% deferred payments, 31% froze salaries, and 23% reduced pay-levels. It is interesting to note that Clark’s local level evidence contradicts the priority given to personnel at higher levels (state and national) of government. A city’s final recourse would be to cut positions, rather than its first. Finally, Clark also cited noted examples of drastic and controversial solutions. He gives examples of selling off assets under fiscal pressure in the 1970s, including controversial land sales in downtown New York and Chicago, as well as the sale of park land particularly valued by environmentalists in San Diego (Clark 1994: 220).

Since this literature documents conditions arising from the U.S. context, it is legitimate to ask the question: Do Korean local governments follow these patterns? Since recent changes have allowed Korean local governments to exercise more discretion over their own revenue flow, an examination of their local budgeting behavior can answer this question. This study will focus on where local governments expended or reduced funds between 2008 and 2010 in Korea. Therefore this study will try to determine which areas of the budget were most affected by cutbacks in Korean municipalities since 2008, and therefore what policy preferences were exhibited during this time of fiscal stress. These will then be compared to the expectations provided by the literature, to see whether the model offered by U.S. experiences holds true in Korea.

Data Collection and Analysis

Revenue and expenditure budget data for fiscal years 2008 and 2010 were collected from almost all local-level governments in Korea (n=237), representing approximately 89% of all local government units (Hermanns 2009: 220). Although data from 2006 would have been more desirable, it was not available for a large proportion of the local governments, so data from 2008 was used as the baseline year for the analysis.

Variable Definitions. Our variables of interest (dependent) are the per capita expenditure variables for each policy area. The differences in per capita expenditure levels between 2008 and 2010 were calculated for each local government unit, and are reported according to the policy area in which the expenditure occurred. Therefore, a negative value indicates a reduction in spending (2008 exceeds 2010), and a positive value represents an increase. The expenditure data includes both local sources of revenue and intergovernmental funding from the central government, and the units are in million won (KRW).

<Table 1> Descriptive Statistics Change in Per Capita Expenditure Categories

Variable	Minimum	Maximum	Mean	St. Dev.	N
Autonomy	-20.8	12.4	-.1992	4.098	236
General Administration	-.3850212	9.52029	.12433	.72632	234
Public Safety	-.2193464	.9625093	.05260	.11340	234
Education	-.1386578	.5103237	.01139	.04581	234
Culture/Tourism	-.2521461	1.6444	.07605	.20953	234
Environmental Protection	-.3835782	1.299364	.05873	.18993	234
Social Welfare	-.4189342	1.349182	.18653	.24747	234
Health	-.3322347	.8168356	.02939	.10045	234
Agriculture, Fisheries, Forestry	-1.582099	1.89832	.13933	.36450	234
Small Business	-1.197998	2.413789	.05495	.22337	234
Planning and Public Transportation	-.6010059	.8657433	.04421	.17623	234
National Parks and Public Lands	-.7906758	2.387599	.11078	.31909	234

The autonomy variable was calculated as the proportion of local government revenue that is own source. To put it another way, own source revenue is the revenue the local government generates itself. Data from fiscal years 2008 and 2010 were collected, and the difference between the two years was calculated for each local government. In order to get an idea of what range the data could take, we tabulated some descriptive statistics. Since the expenditure data was calculated per capita, spending across local governments could be compared on a relatively stable basis.

There are a few points that need to be highlighted before discussing the analysis that follows. The first has to do with expenditures categories. As might be expected, general administration costs represented the greatest share of expenditures. For all of the expenditure categories, change in per capita expenditures between 2008 and 2010 were, on average, positive. This is in contrast to the average performance and direction of the autonomy variable, which appears to be skewed towards losses between 2008 and 2010.  Thus local governments were, on average, losing own source revenue over this two-year period, but per capita spending remained fairly constant. This makes the analysis that follows more intriguing.

Statistical Analysis.  In order to get an idea as to how the discretion exercised by local governments might change from 2008 and 2010, we regressed the autonomy variable on each of the change in expenditure variables to produce a general goodness of fit measure. This enables us to examine which areas of spending are the best “fit” for levels of autonomy in generating revenue by calculating both an R-squared statistic and an F-test statistic. The results are somewhat surprising.

<Table 2> Bivariate Regression Results with Autonomy (Independent Variable)

Dependent Variable	Unstandardized Coefficient (std. error)	t-statistic *-0.10 **-0.05	R-squared	Prob> F
General Administration	.0279 (.01217)	-2.29**	.0221	.023
Public Safety	.0035 (.0019)	1.85*	.0145	.066
Education	-.00002(.00077)	-.03	.0000	.9759
Culture/Tourism	.0039 (.0035)	1.10	.0052	.2719
Environmental Protection	-.0031 (.0032)	-0.96	.0039	.2719
Social Welfare	-.0036 (0042)	-0.87	.0032	.3874
Health	.0013 (.0017)	0.77	.0025	.4435
Agriculture, Fisheries, Forestry	.0012 (.0062)	0.19	.0001	.8524
Small Business	.0072 (.0024)	1.91**	.0155	.0572
Planning and Public Transportation	.0008 (.0030)	0.28	.0003	.7827
National Parks and Public Lands	-.0002 (.0054)	-0.03	.0000	.9746

Given that revenues should be a fairly good predictor of expenditures, the overall poorness of fit was indicative of how little discretion local governments actually exercise over the policy categories they have. This was especially true in categories where one would expect the national interest to exceed that of local governments (national lands and parks, for example, shows absolutely no influence whatsoever of local discretionary revenue over expenditures).

However, there were some categories that demonstrated more surprising results than others. Expenditures on general administration costs saw the best fit between own source revenue and expenditure levels, and the direction of the relationship was positive. This means that for every one percent increase in autonomous revenue sourcing, there was an increase of, on average, 27,900 won in per capita spending on general administration.  Given the data distribution for the independent variable, however, this may also be interpreted as a similar declining relationship for both variables. As a city government loses autonomy, its expenditures would also decline at the same rate stated previously. This latter interpretation would be in keeping with some of the anecdotal evidence that cities are shifting their costs when possible to reduce payments to their own staff in order to cover other areas of expenditure (Korea JoongAng Daily, 2012). This finding stands in contrast to the U.S. findings of Clark (1994), where city governments were less likely to cut personnel costs until other areas had been explored first.

The second area of interest is in public safety, which includes expenditures for police protection and fire services. Here the fit is also significant (although by no means fully explained), but in a positive direction. Thus for each percent increase in autonomy over revenues, local government would increase spending, on average, by 3500 won per capita.

This would also be consistent with expectations of service requirements during a recession: public safety needs may rise, especially in larger cities, which are more likely to exercise higher levels of autonomy over revenues. But it may also indicate that the reverse is true―as own-source revenues decline, expenditures on fire and police decline as well. Although the decline is small, this latter interpretation is more troubling.

The third area of interest is in small business and industry expenditures. Here again, the fit is significant, and the direction is positive, indicating that as autonomy increases, so does per capita spending on small business and industry. This finding is much more in keeping with the neoclassical approaches to city government expenditures offered by Tiebout (1956) and more recently, Peterson (1981) regarding conditions in the United States. Local governments are closer to local business interests, both politically and economically, and are therefore more likely to form alliances that will benefit both sectors. But it could also mean that as local government fortunes fail, so go the fortunes of small industry.

Lack of Autonomy

It is equally important to note those areas where fiscal autonomy had almost no impact of expenditure levels. As noted above, policy areas where the national government was presumed to be the dominant interest, such as national parks and lands, and somewhat secondarily, agriculture, fisheries and forestry, saw almost no influence being exercised over expenditures by local level governments. The other area demonstrating equal levels of lack of autonomy was public education. This is understandable since curriculum is set at the national level, but as more parents and local governments seek more control over public schools, this seems contrary to public sentiment. These areas of policy seem to demonstrate a relationship between the national and local governments that Nakamura and Smallwood (1980) describe as “classical technocrats”, where the local government serves as a direct implementer of national policy, with very little exercise of discretion.

The other variable that was somewhat surprising in the lack of local control was planning and public transportation. This is perhaps not unexpected, since per capita measures were used, and smaller cities, which comprise the majority of cities in Korea, cannot pay for large infrastructure projects out of their own budgets. Here the relationship between the national and local governments may be vary according to local need and the level of autonomy, but not for the majority.

The other variables that demonstrated insignificant levels of autonomy, but not as little effect as those just mentioned, were environmental protection, culture and tourism, health, and social welfare. These are all areas where local governments, especially those with metropolitan status, can exercise some discretion, but not to the detriment of national priorities. However, both environmental protection and culture and tourism during this period are local responsibilities. Local officials are largely responsible for determining the level of implementation. For example, environmental protection is enforced at the local rather than national level, so even though the influence of autonomy in these budget categories is not significant, there is evidence that some degree of discretion is being exercised at greater levels than for those policy areas in the classical technocrat category mentioned above. Nakamura and Smallwood (1980) would designate such relationships between national policymakers and local implementers as “instructed delegates”, where local officials use their knowledge of local needs and sentiments to determine the appropriate level of expenditure.

Since no fiscal story is complete without some concrete characters, Table 3 illustrates which cities benefitted the most from central government largesse, and which were not so lucky. The most striking finding is the consistency with which the city of Daejeon received the lion’s share of central funds. This may reflect a continued attempt to move the central government to a more southerly locale, but the expenditures indicate that this was far more than symbolic rhetoric. As Edelman (1967) would argue, if one really wants to understand policy preferences, ignore political rhetoric and pay attention to the budget. In this instance, it appears that national leaders were putting their money where their mouths were.

Also worth noting here is the recurring role of Incheon City as hosting the largest expenditure cuts in education, social welfare, and public transportation and planning areas.  Previous to this time, the local government was concentrating efforts and expenditures on investing in infrastructure in Songdo-dong, as well as preparing to host the forthcoming Asian Games in 2014. These cuts could reflect the growing recognition of tight fiscal conditions from the central government (which reneged on a promise to provide funding for the Asian Games) and a shift in expenditures from more traditional areas.

<Table 3> Minimum and Maximum Value by Local Government

Variable	Local Government with Minimum Value	Local Government with Maximum Value
Autonomy	Jinhae City (-20.8)	Uiwang City (12.4)
General Administration	Gimpo City (-35233)	Daejeon City (253109252)
Public Safety	Goheong Gun (-17089)	Daejeon City (16768279)
Education	Incheon City (-372280)	Daejeon City (191277730)
Culture/Tourism	Masan City (-62063)	Daejeon City (130813737)
Environmental Protection	Masan City (-55480)	Daejeon City (71880170)
Social Welfare	Incheon City (-582071)	Daejeon City (553657339)
Health	Anseong City (-56149)	Daejeon City (33346079)
Agriculture, Fisheries and Forestry	Jinhae City (-107428)	Daejeon City (29203429)
Small Business and Industry	Anseong City (-47146)	Daejeon City (53292598)
Planning and Public Transportation	Incheon City (-632124)	Daejeon City (330930573)
National Parks and Public Lands	Nonsan City (-101046)	Daejeon City (98575985)

Discussion and Conclusions

Overall, the picture illustrated by this analysis differs substantially from patterns exhibited during fiscal crises in the 1970s and 1980s at the local level of government in the United States. Large cities running deficits often cut their welfare budgets in an attempt to recoup losses prior to declaring bankruptcy (New York, Philadelphia, and Miami were all notable examples). However, because of the strong role played by the central government, this kind of pattern was not exhibited here in Korea, even during periods of intense fiscal stress.  This may indicate that models of local government behavior that are premised on conditions in the U.S. are incomplete, and Korea may offer some instruction as to whether local autonomy can be considered without an appropriate context.

However, the nature of this role may not be as benign as the expenditure levels alone would lead us to conclude. With falling revenues, and national funding levels declining as well, keeping expenditures constant when inflation is increasing means only one thing: local governments are increasing their levels of debt. This has also been the case in the United States, and it has had severe consequences for local governments. Over a longer time period, increased debt in a reduced revenue environment means reduced autonomy for local governments, since they will become more reliant on central government funds to help cover their increased costs.

What such findings indicate for future attempts to increase local autonomy will require further study, but for the moment, they would seem to indicate that whether local governments benefit or ultimately pay a price for the strong role played by the national government, their willingness to push for more fiscal independence will hang in the balance.

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Jong Youl Lee: is a Professor of Public Administration at the University of Incheon in Songdo. He received Ph.D. from the City University of New York(The Practice of Protest: Three Case Studies in Urban Renewal, 1990). He has recently co-authored two books on urban administration, Urban Administration: Issues and Practices with Profs. Jill L. Tao and Chad D. Anderson(Daeyoung Publishers: Seoul, 2012) and The Politics of Urban Cultural Policy: Global Perspectives with Carl Grodach and Daniel Silver (Routledge, 2012).

<E-mail: jylee@incheon.ac.kr / 논문접수일: 2012. 10. 05 / 심사개시일: 2012. 10. 15 / 심사완료일: 2012. 11. 13>

Jill L. Tao: is an Associate Professor of Public Administration at the University of Incheon in Songdo. She has published articles in American Review of Public Administration, State and Local Government Review, and Public Administration Quarterly. She has recently co-authored a book on urban administration, Urban Administration: Issues and Practices with Profs. Jong Youl Lee and Chad D. Anderson (Daeyoung Publishers: Seoul, 2012). Her areas of research interest are urban governance, local economic development, and fiscal competitiveness for local governments.

<E-mail: j.tao.808@gmail.com>