Conditional Transfers to Promote Local Government Participation in Mexico

Mexico is a very centralized country mainly as a result of the involvement of the federal government (FG) in functions that would be more efficiently provided by subnational governments (SG). The concentration of activities in the FG is the result of two institutional features: the unclear legal assignment of expenditure functions across levels of government, and the assignment of sources of revenue that concentrates a larger share of revenues in hands of the FG. In the presence of multiple uses of federal transfers, and in the absence of information on the costs of providing SG services, the FG has been reasonably reluctant to decentralize more functions. As long as the FG remains in control of most of government revenues, it is important to ensure that the benefits from decentralization also accrue to it. The transfer of functions should avoid SG neglect of those functions that generate benefits to the rest of the country and keep control over the size of transfers. One instrument that can achieve both objectives is a widespread use of conditional grants.