STANFORD – While central governments’ fiscal problems plague many economies, a parallel crisis is enveloping many subnational governments around the world. From Spain to China to the United States to Italy, these governments – regions, states, provinces, cities, and towns – face immense fiscal challenges. Higher levels of government are “on the hook” to bail out local insolvent governments, and may even suffer bond downgrades as a result; in Spain, Italy, and China, that role falls to the national government, and for US cities and towns, to their states.
There are many similarities within and among countries in terms of the nature and causes of these local fiscal calamities. Local officials used growing revenues during the boom to fund pet projects or boost pay and benefits, with little regard to future costs. In the downturn, revenues and subsidies from the central government collapsed and the bills came due. Creative accounting gimmicks masked the full extent of the problem. Now comes the reckoning.
To finance local businesses, Chinese local governments use local-government financing vehicles (LGFVs) to circumvent bans on direct borrowing. In Spain, housing and employment collapses have hammered revenue. Rumors of an imminent default swirl around Sicily, whose governor has resigned as borrowing soared after cutbacks from Rome. A new report from a task force co-chaired by former Federal Reserve Chairman Paul Volcker indicates that unfunded pension and health-care costs make many American states’ medium- and longer-run fiscal prospects bleak.
California’s fiscal crises may also provide lessons for subnational governments around the world. Three California cities have recently declared bankruptcy: Stockton, the largest American city ever to do so; San Bernardino, the second-largest bankrupt city; and Mammoth Lakes. Compton is rumored to be next; most observers expect more to follow.