Chapter 2. Building up local governments' capacity to implement infrastructure investment
The experiences of Indonesia, the Philippines and Viet Nam are used in this chapter to illustrate the local economic consequences of infrastructure projects, the roles and responsibilities of local governments, the means of financing investment, and the benefits and challenges of local governments’ involvement in the sector. While local governments can be important actors on infrastructure projects, they can face challenges related to financing constraints, limited capacities and co-ordination difficulties with higher levels of government and other partners. Improving the efficiency and effectiveness of local governments in developing and implementing infrastructure will require improvements to planning and co-ordination, the development of institutional capacities, the use of broader sources of financing, and the incorporation of ongoing maintenance and monitoring costs in project budgeting.
Introduction
Local governments around the world play a significant role in developing and maintaining infrastructure.1 In a sample of 95 countries in 2013, a simple average of 39.1% of total public investment came from local governments (OECD/UCLG, 2016[1]). This chapter examines the local economic impact of infrastructure, the role of local governments in infrastructure development and the benefits and challenges of their involvement. It also looks into the modes of financing utilised at the subnational level, such as transfers from the central government, raising revenues locally, public-private partnerships (PPPs), and other forms of private-sector involvement. Case studies covering Indonesia, the Philippines and Viet Nam are used to identify prominent policy issues (for instance, planning and co-ordination, capacity building, financing, and maintenance and monitoring) in practice.
Measuring the local economic consequences of infrastructure investment
While the positive externalities associated with infrastructure investment can be far-reaching, they are often strongest at the local level in the communities directly affected (See Chapter 1). Investments in quality transport infrastructure can directly generate employment opportunities related to construction, operations and maintenance; indirectly improve opportunities for individuals and firms and improve the efficiency of existing forms of economic activity; and generate various social and environmental benefits. Affected communities benefit from spillover externalities such as lower input costs, increased choice in input supplies, expanded local trade and access to new markets for output (White and Raitzer, 2017[2]).
Access to quality infrastructure differs considerably across regions in Indonesia, the Philippines and Viet Nam. In Indonesia, for example, only 29.6% of the villages in the province of Papua had access to roads that are passable throughout the year in 2014 and only 19.4% of the villages had their widest road either in asphalt or concrete (Figure 2.1). This condition is far off compared to that in the province of Bali, which has a proportion of above 99% in both measures. Not all villages and sub-districts in Indonesia have access to transportation infrastructure, for instance only 67 701 out of the 80 337 (84.3%) of the villages have roads where four-wheel-drive cars can pass all year, while only 53 883 (67.1%) of the villages had their widest road paved.
Source: BPS (2014[3]), Village Potential Statistics of Indonesia.
While it is clear that appropriate infrastructure development can provide many economic benefits, the local consequences of infrastructure investment are often complex. Transport infrastructure provide stimulus to the local economy, but could also crowd out other investment, and can produce negative externalities such as environmental and social issues.
Indeed, infrastructure projects play an important role in developing local areas. Empirical studies have strongly tied infrastructure with local development. Using data from 4 000 households in rural Indonesia, Gibson and Olivia (2010[4]) showed that improved access to roads and electricity positively affected both employment and income for non-farm enterprises. The Program Nasional Pemberdayaan Masyarakat (PNPM) Mandiri Rural Infrastructure Support helped villagers of Trimulyo to develop the local economy by constructing an all-weather road. The new road lowered transportation costs, which allowed greater use of fertiliser and increased outputs.
In the Philippines, Llanto (2007[5]; 2007[6]) indicated a critical link between infrastructure and regional growth. The authors’ findings support the view that infrastructure stock and growth potential are positively correlated. Earlier studies of Basilio and Gundaya (1997[7]) and Manasan and Chatterjee (2003[8]) also showed that inequitable access to infrastructure and growth are negatively correlated. Similarly, Reyes (2002[9]) showed that regions with the least access to basic infrastructure are also the ones with the lowest gross domestic product, such as roads while Cuenca (2004[10]) and Llanto (Llanto, 2007[5]) indicated that infrastructure could be a key variable in helping poorer regions to converge with richer ones. Furthermore, Evenson and Quison (1991[11]) found that roads had a significant impact on input use and output, with substantial net-profit effects, even if rural electrification had minimal effects on output. Urea fertiliser was more expensive in areas with poor roads, owing to higher transport costs. Llanto (2014[12]) found that access to electricity and paved roads had a positive and significant impact on the productivity of agricultural labour while Yoshino and Pontines (2015[13]) found that the Southern Tagalog Arterial Toll Road in Batangas province has contributed to increases in tax and other revenues in municipalities through which it passes. Lastly, Francisco (2017[14]) provided evidence that roll-on-roll-off transport system stimulated both agricultural and non-agricultural activities, resulting in higher incomes for agricultural households, which in turn increased likelihood that these households would send their children to school.
In Viet Nam, Dao Thong Minh and Le Thi Mai Huong (2016[15]) found that increases both in the consumption of electric energy and in the length of roads in 13 provinces in the Mekong delta from 2009 to 2013, helped increase economic growth. Despite its clear importance, many people in Viet Nam perceive their access to local infrastructure as insufficient. According to the country's provincial competitiveness index for 2016, in 44 out of the country's 63 provinces fewer than half of business owners stated that they were satisfied with the quality of the transport infrastructure (Figure 2.2). Across all provinces, meanwhile, the median approval rate was only 42%.
Source: OECD Development Centre’s calculations based on VCCI (2016[16])
Chung (2015[17]), which analysed data for Viet Nam's 63 provinces over 2006-10 likewise showed that investment in infrastructure helped reduce poverty rates. Moreover, a number of benefits for poor households have been observed, arising through several channels. For instance, infrastructure development directly increases wages and employment of the poor and indirectly ameliorates the poor’s well-being induced by economic development. Infrastructure development is also an essential component in national poverty reduction programme as well as in enhancing business environment (Box 2.1).
Viet Nam launched its national poverty-reduction programme in 1998. In its latest incarnation, this programme has an estimated total budget of VND 48.4 trillion for the period of 2016-20, of which 43% is for infrastructure. This category includes rural roads, health and education facilities, clean water and irrigation. An evaluation of the programme for the period 2006-10 found that the income of poor households residing or working in agriculture and rural areas had increased though remained much lower than the national average. This finding supports the conventional wisdom that positively links infrastructure investment and welfare through improvements in productivity and market access. However, issues concerning income inequality within the target group remained a concern. Other issues such as the lack of transparency and accountability, an ineffective land acquisition framework and insufficient expertise of local firms also persisted (Giang and Low, 2015[18]).
The development in infrastructure in Viet Nam, particularly transport, has also translated into better business environment. Based on the data from the World Bank Enterprise Survey, firms in Viet Nam identify transport as less of a constraint compared with the firms from Indonesia and the Philippines regardless of the firm size (Figure 2.3). The problem related to products lost due to breakage or spoilage during transit is also less extensive in Viet Nam than in the other two neighbouring Southeast Asian economies.
Source: World Bank (2017[19]), Enterprise Surveys (database), http://www.enterprisesurveys.org.
Reviewing local governments’ infrastructure responsibilities
Indonesia, the Philippines and Viet Nam are unitary states with multiple levels of local government (Table 2.1). Indonesia is divided into provinces and municipal-level regencies and cities. Meanwhile, the Philippines has provinces, intermediate-level municipalities and cities, and municipal-level villages. Viet Nam divides up into provincial-level entities, intermediate-level districts, and municipal-level communities. These levels of government often have considerable responsibilities – through local and regional rail and road networks – for developing and managing land-transport infrastructure. Moreover, decentralisation initiatives in Indonesia, the Philippines and Viet Nam have passed new responsibilities to these levels of government, or have clarified the division of responsibility with the central government.
Decentralisation accompanied Indonesia’s democratisation beginning with Law No. 28 of 1999, and then with additional reforms, particularly those in Law No. 32 of 2004. The 34 provinces and 508 regencies and cities now have elected governments. In 2014, the country's villages – numbering more than 83 000 – gained more autonomy under a new village law. Central government has passed on considerable responsibilities to local governments subsequently. These include responsibilities for public works, healthcare, education, culture and social affairs, labour, environmental protection, land, citizenship, and investment. Local governments also account for a large, if declining, share of general government expenditure. Local governments spent 904 trillion rupiah (IDR) in 2015, or 28.0% of the general government total, down from 39.1% in 2008.
Railway infrastructure in Indonesia is primarily the responsibility of the central government, and the country’s railway systems are operated by the state-owned Indonesian Railways Company (PT Kereta Api Indonesia) and its subsidiary, PT KAI Commuter Jabodetabek. Only Sumatra and Java have major rail lines. Notwithstanding this organisational structure, additional roles for local governments to work on rail infrastructure have opened up. For instance, Law No. 23 of 2007 defined a number of potential roles for local governments in the development, regulation, and operation of railways in the country. These included the potential for them to take the lead if there was an absence of an enterprise to operate public railway infrastructure or rolling stock. Local governments also have the right to develop and operate specialised railways within their jurisdictions, as long as they first obtain approval from the central government. Indonesia's national master plan for railways serves as a guide in co-ordinating local infrastructure development plans.
Participation of local governments in rail infrastructure development in Indonesia is important. This is relevant in the context of major urban areas, such as Jakarta, Bandung, Yogyakarta–Solo, Surabaya and Semarang where commuters make extensive use of rail systems. Local governments are currently helping to develop rail transport as part of urban public transit systems in Jakarta and Palembang. Broad details of the aforementioned projects are enumerated in the following bullets.
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The Jakarta Light Rail Transit system is currently under construction. Upon completion of its second phase, it will eventually cover 130.4 km, with four lines and 41 stations. The provincial government is implementing the project within Jakarta, with the central government responsible for sections extending beyond Jakarta.
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Jakarta Mass Rapid Transit is a two-line rapid transit system that will initially cover 15.7 km with 13 stations. Construction began in 2013 and the system should open to the public in 2019. The government of Jakarta is implementing the project, with funding from the Japan International Cooperation Agency (JICA).
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Palembang Light Rail Transit is under construction in Palembang, and should enter service in time for the 2018 Asian Games, which the city is co-hosting along with Jakarta. The line will run from Sultan Mahmud Badaruddin II International Airport to Jakabaring Sport City. While Indonesia's central government is taking the lead in this project, it is co-ordinating with the local government on issues such as land acquisition, financing and spatial planning.
Responsibility for the construction and maintenance of Indonesia’s road network is divided between central, provincial and local governments. By length, local district roads – which covered 421 541 km in 2015 – account for 80.5% of Indonesia's road network (Figure 2.4). Provincial roads accounted for 55 416 km, or 10.6% of the total, while national roads covered 47 017 km, or 9% of the total. The length of national roads has the grown fastest since 1987, with average annual growth of 4.8%. Over the same period, district roads have grown by 3.3% a year on average, while provincial roads have grown by an annual average of 1.8%. In terms of quality, national roads set the standards while district roads tend to be in worse condition. In 2015, 91.9% of national roads and 79.1% of provincial roads had asphalt surfaces, compared to only 50.9% of district roads. Similarly, 91% of national roads and 74.9% of provincial ones were rated as being in a good or moderate state, but only 61.4% of district roads received similar scores (BPS, 2016[20]).
Source: BPS (2017[21]), “Length of road by level of government responsibility Indonesia, 1987-2015 (Km)”, https://www.bps.go.id/linkTableDinamis/view/id/808.
In the Philippines, the 1991 Local Government Code (Republic Act No. 7160) is the key instrument of decentralisation and devolution of central government functions. The code transferred powers and functions from the central government to local levels of government. These include the country's provinces, cities, municipalities and villages, or barangays. The World Bank has hailed this as “one of the most far-reaching decentralisation reforms in the developing world” (World Bank, 2003[22]). Part of the 1991 reform was to devolve the provision of local infrastructure to local governments. As per section 17 (b) of the code, local infrastructure includes a broad range of installations. These are: public markets, public buildings, areas of public assembly, roads and bridges, school buildings and other facilities for basic education, health facilities, fish ports, water-supply systems, seawalls and dykes, drainage and sewerage, flood-control systems, and traffic signals and road signs. Meanwhile, section 17 (f) of the code also granted the national government the option of itself providing the basic services and facilities assigned to a lower level of government, or to add to local efforts in this regard. This has resulted in a two-track delivery system in infrastructure, with local governments mainly responsible for devolved responsibilities such as providing local roads and municipal ports, and the central government augmenting or complementing local delivery.
The 1991 reform also stipulated the institutional mechanism for formulating and implementing local plans. It mandates local governments to prepare two plans: the comprehensive land-use plan (CLUP), and the comprehensive development plan (CDP) (Figure 2.5). The CLUP is about the spatial aspects of local development. It identifies areas where development projects may or may not be located, and directs public and private investments accordingly. The 1991 reform made the local legislative council, or sanggunian, responsible for approving the CLUP.2 Another body, the local development council, formulates the CDP for approval by the sanggunian. This body also has the task of appraising and prioritising programmes and projects, and coordinating, monitoring and evaluating the implementation of development plans and projects. There is also a local development investment programme, which translates the CDP into programmes and projects for the next three years. It includes an annual investment programme, which identifies the projects that the local government will fund through its annual general-fund budget, or through special fund-generation schemes.
Source: DILG (2016[23]), Local Planning Illustrative Guide: Preparing and Updating the Comprehensive Development Plan.
In Viet Nam, there are six main types of infrastructure investments that are under the mandate of local governments. The first of these is transport, which includes provincial roads, urban and rural transport networks, urban railways in Hanoi and Ho Chi Minh City, and waterways, including sea ports and river ports. The second type encompasses systems of water supply and drainage, including water treatment plants, transmission pipeline networks, and drainage systems. The third type of infrastructure investments for which local governments are responsible concerns the collection and treatment of waste. Fourth, power-supply systems also come under the local government's mandate, as does a fifth area, post and telecommunication systems, and also a sixth area of infrastructure systems for health and education. The responsibility for infrastructure management is divided between the central and local governments according to the location of a particular project. The transport ministry manages national highways, radial expressways, national railway systems, inter-provincial transport, airway transport, and sea and river transport. On the other hand, the local People's Committees are responsible for the management of provincial roads, inter-district roads, rural transport, urban railways, parking lots, local sea and river ports, and water-supply and drainage systems.
Infrastructure investment planning is also decentralised in Viet Nam. The medium-term public investment plan is designed based on the provincial five-year socio-economic development plan (SEDP). This itself stems from Viet Nam's national SEDP, and also from the provincial-level master plan for socio-economic development. Plans that identify project portfolios and call for the mobilisation of investment capital have to be approved by the People's Councils (see Chapter 4 for details).
There is a clearly-defined process for approving the public investment projects that come under the management of the provincial People’s Committees (Figure 2.6). As part of this, a report on an investment intention undergoes appraisal in terms of its content and financial feasibility. An appraisal council established by the provincial People’s Committee is responsible for evaluating the contents of the report. There are two steps to implementing the appraisal of financial resources. In the first step, the provincial planning and investment department reviews the project's financial implications before submitting it to the appraisal council. In a second step, Viet Nam's Ministry of Planning and Investment and Ministry of Finance appraise the project’s financing before finalising the investment intention report. Lastly, the provincial People’s Committee approves the investment intention report.
Source: OECD Development Centre’s compilation based on Regulations of the Law on Public Investment, 2014 (No. 49/2014/QH13).
The appraisal of investment intention reports on projects managed by the People's Committees at the level of districts or communes does not require the establishment of an appraisal council. The planning and investment department of the provincial government reviews a project's financial resources and then submits it to the national Ministry of Planning and Investment and Ministry of Finance for further evaluation. Although the process for approving the investment intention report is quite clear in practice, specific criteria for project selection are not defined in the regulations and legislation.
Financing local infrastructure projects
Local infrastructure projects can be financed through transfers from the central government in the form of targeted or block grants, or through revenues raised locally. Increasingly, the private sector is called upon to participate in infrastructure projects as well, both financially and through PPPs. Various combinations of government and private financing are used in local infrastructure investments in Indonesia, the Philippines and Viet Nam.
Central government transfers and the mobilisation of local revenue account for most of the financing for local infrastructure
Indonesia's central government retains most of the responsibility for raising revenues, despite an increase in responsibilities at the local level and the allocation of specific taxes to provincial and local governments under Law No. 28 of 2009. The central government then transfers funds to local governments. In the 2017 budget, allocations for transfers to provincial governments totalled IDR 704.9 trillion, or 33.9% of the budget. Meanwhile, transfers to village governments totalled IDR 60 trillion, or 2.9% (Figure 2.7). These shares have remained fairly stable in recent years. From 2014-17, transfers to provincial governments accounted for 31.8% to 35% of budgets. From 2015-17, meanwhile, transfers to village governments accounted for 1% to 2.9% of the budgets. Local governments’ revenues came to a total of IDR 68.8 trillion in 2015, or 51.9% of general government revenues, up from 34.6% in 2008.
Note: Based on annual state budget (APBN). Transfers to village governments are not available for 2014.
Source: MOF (2017[24]), Realisasi Anggaran, https://www.kemenkeu.go.id/en/node/34644.
Transfers from Indonesia's central government include an equalisation transfer, the Dana Alokasi Umum, a fund of shared revenues from taxes and natural resources, the Dana Bagi Hasil, and a special allocation grant for funding national priority projects, the Dana Alokasi Khusus (DAK). In 2015, budget allocations for road infrastructure projects made under the DAK ranged from IDR 1.9 trillion in Papua, to IDR 34.2 billion in Banten (Figure 2.8). Expenditure on roads as a share of total DAK spending was highest in Kalimantan Timur, where it accounted for 96.8% of funds, and lowest in Banten, where it accounted for only 29.3% of funds.
Source: PUSDATIN (2015[25]), Informasi Statistik Infrastruktur.
Grants account for the largest share of local-government revenues in Indonesia, though their share is declining. They fell from 82% of local-government revenues in 2009, to 72.9% in 2014 (Figure 2.9). At the same time, tax and other revenues have become relatively more important. From 2008 to 2015, tax jumped from 1.3% of local-government revenue to 16.4%. Over the same period, sources of revenue other than grants and tax rose from 7.4% to 9.5%. While the central government was largely responsible for implementing infrastructure projects in the past, the central government’s budget has, in recent years, increasingly delegated infrastructure funds to provincial and local governments.
Note: “Other revenue” excludes social contributions, for which no revenues were recorded.
Source: IMF (2017[26]), Government Finance Statistics (database), http://data.imf.org/?sk=a0867067-d23c-4ebc-ad23-d3b015045405.
In the Philippines, financing from the central government is one of many sources of revenue available to local governments. The Local Government Code of 1991 gave local governments the authority to tap various sources of financing for development and infrastructure projects. These include loans and credits from any government, domestic private bank, or other lending institution. They also include bonds and other long-term securities, subject to the rules and regulations of the Bangko Sentral ng Pilipinas (Central Bank of the Philippines), and the country's Securities and Exchange Commission. Some of the other sources of financing that local governments may tap are loans between local governments, as well as grants and subsidies, and loans from foreign sources through the national government (official development assistance). Finally, local governments may enter into contracts with the private sector, including PPP arrangements (Figure 2.10).
Source: DILG (2016[27]), "Guidelines for the implementation of Public-Private Partnership for the people infinitive for local governments (LGU P4)".
To augment local resources, the 1991 reform code stipulated fiscal transfers to local governments in the form of a so-called Internal Revenue Allotment (IRA). This has been a major source of revenues, especially for smaller local governments. The allocation formula across different levels of local government (province, city, municipality and barangay) is based on population size, land territory and equity, with a bias towards large cities and rapidly urbanising areas. Under current rules, 20% of the annual IRA transfer will constitute a Local Development Fund, which may be used for investment planning on local programmes and projects. The central government's budget and management department monitors the use of the Local Development Fund to ensure that it goes to projects in the local development plan.
To some extent, the IRA has acted as a disincentive to local governments in using their own revenue-raising powers more fully. The high degree of dependence on the IRA as well as limits to their own taxation powers have curtailed the amount of resources that local governments have raised to finance infrastructure. Moreover, the provinces and municipalities that are most dependent on the IRA tend to demonstrate the weakest performance in revenue mobilisation (Manasan, 2007[28]). In addition to these problems of fiscal capacity, a weak administrative capacity and the perceived political cost of raising local taxes have also hampered revenue performance. Currently, local taxes constitute only around 36% of total local revenues.
In any case, local governments in the Philippines have relied mostly on locally-sourced tax revenues and fiscal transfers – consisting both of the internal revenue allotment and other transfers – to finance investment in local infrastructure. Local governments with the ability to borrow source their financing from government financial institutions such as the Land Bank of the Philippines, the Development Bank of the Philippines, and also the Municipal Development Fund, a bureau under the aegis of the finance department. These institutions dominate the local-government credit market. Local governments also obtain long-term loans for infrastructure projects from government financial institutions that are able to tap sources of ODA. However, the 1991 code does not allow local governments to borrow on international credit markets.
As already noted, the 1991 Local Government Code in the Philippines did devolve certain tax and spending powers to units of local government. The decentralisation improved local governments’ financial capacities by granting them powers over taxation and revenue raising (Section 129 of the code), by increasing their shares of internal revenue taxes (Section 284), by allowing them to share in the national wealth exploited in their area (Section 290), and by broadening their credit financing powers (Section 295). While the code has broadened local governments’ scope to generate revenue to support devolved expenditure assignments, these devolved taxes do not yield as much revenue as those taxes retained by the national government, such as value-added taxes or corporate income taxes (Table 2.2). The limits that the 1991 code placed on increasing local tax rates, and the national government’s retention of the more productive taxes, have constrained local fiscal capacity.
From 2016 to 2020, Viet Nam is allocating funds for its medium-term public investment plan in five areas: counterpart funds for PPP projects, counterpart funds for ODA projects, repayment of construction capital, funds for unfinished projects, and funds for new projects. Moreover, with the capital that is available, the government has prioritised leveraging the participation of partners in ODA and PPP projects, and financing unfinished projects from previous periods. Before 2011, local governments and ministries tended to decide to invest more than their available budgets, and many projects remained unfinished due to shortages of capital. Furthermore, contractors became indebted when public investors failed to repay them. In order to solve this problem, the prime minister issued Instruction No.1792/CT-TTg 2011, requiring public investors to prioritise available capital for the repayment of construction capital and for unfinished projects. Now, only once local governments have allocated funds to the first four of the five categories outlined above can they then allocate money to new projects.
However, many provinces faced difficulty in following these instructions directly. In 2015, Viet Nam's inspectorate of government reviewed the work of the 63 provinces and 15 ministries with regard to tightening up their management, and resolving unpaid debts from the state budget and government bonds. The report showed that 1 527 out of the 12 990 projects that were inspected had derogated from their construction-capital debts, and many provinces had not followed the prime minister's instruction from 2011.
Investment capital managed by local authorities reached 44.2% of total infrastructure investment in 2009, or VND 64.8 trillion. However, it fell to only 35.7%, or VND 54.6 trillion, in 2011. Multiple factors account for this decline, including the capacity limitations of local authorities (Table 2.3). Up to 50 out of 63 provinces are unable to balance their budgets, and have to receive extra funding from the central government. Moreover, provinces have the right to decentralise revenue sources and budget expenditure to districts and communes, which leads to differences in the fiscal management.
In 2014, Viet Nam's general statistics office provided data for 2012-12 on public investment for 63 provinces. These revealed very high demand for capital construction. In 2012, 46 out of 63 provinces and cities used more than 90% of their development-investment capital for capital construction, while the number in 2013 was 38 out of 63. Investment in transport usually accounts for the highest proportion of the total investment in infrastructure.3
For the roads that the central government manages and operates, maintenance funds come from the road conservation fund, the state budget, ODA, and also revenues from the exploitation of existing transport infrastructure.4 Provincial roads are maintained using funds from the provincial budget, the road conservation fund, and other official funds. Districts and communes manage the roads for which they are responsible from their official budgets, and through the mobilisation of local resources, the road conservation fund, supplementary funds from provincial budget, and other official funds. The road conservation fund comes from annual allocations in central and local government budgets, revenues from road-usage fees, and other official revenues. Businesses allocate maintenance funds for roads that provide access to their sites, with the costs of road maintenance determined in the dossier for the project that built them.
Governments are also seeking PPPs and other forms of private-sector involvement in the development of local infrastructure
In Indonesia, the contracting agencies for PPPs can be central government ministries or local government authorities. Indonesia’s decentralisation and the state-finance law of 2002 passed numerous responsibilities regarding the management of PPPs from the national development-planning ministry, or Bappenas, to the finance ministry and to local authorities. As a result, regional planning agencies reporting to local authorities now play a bigger role in implementing PPP projects, with Bappenas largely responsible for promoting local-level PPP projects (OECD, 2012[30]).
In Bappenas's 2017 plan for infrastructure projects in Indonesia, seven out of the 22 registered PPP projects have local-level government contracting agencies or implementing units. The Bappenas document includes projects for which the planning ministry has received proposal submissions stating that the contracting agency will be responsible for the planning, preparation and transactions of the project. The local-government projects in Bappenas's 2017 plan cover many sectors of infrastructure, including transport, utilities, and sport.
In the Philippines, private commercial banks have a very limited presence in the credit market for local government. Moreover, the market for local government bonds is in something of a hiatus, after an attempt to promote municipal bond finance more than a decade ago failed. Under this initiative, the Local Government Unit Guarantee Corporation (LGUGC) offered guarantees backing up municipal bonds. A few local governments did then issue bonds, but the nascent municipal bond market fizzled out when government financial institutions offered loans with better terms and conditions.
The construction of a public marketplace in a major city in 1991 that forms part of Metro Manila was the first PPP project in the Philippines for which a local government took the lead. In 2016, the Asian Development Bank (ADB) reported that local governments in the country have implemented 13 projects using build-operate-transfer (BOT) and other similar schemes. These have either been turned over to local governments already, or are still being operated by the private-sector partner. Many local governments find PPPs to be attractive arrangements to leverage their limited funds to address infrastructure gaps. However, a lack of technical expertise and financial resources for the preparation, monitoring, and implementation of projects is a major drawback for local governments undertaking PPP projects (ADB, 2016[31]). In particular, local governments often lack sufficient capacity both in identifying viable PPP projects, and in managing the tendering process. They also have limited access to long-term funds because of under-developed domestic capital markets.
In the Philippines, local governments have the right to use PPP arrangements for investing in local infrastructure, both under the country's law on BOT projects, and under Section 302 of the 1991 local government code. Articles 62 and 66 of the implementing rules and regulations of this code authorise local governments to enter into joint ventures with the private sector in infrastructure projects. However, the guidelines and procedures for entering into joint-venture agreements between government and private entities, which the National Economic and Development Authority (NEDA) issued in April 2008, do not cover local governments. Depending on their nature, scope, and cost, project proposals are evaluated by the local and national approving bodies in the approval phase, in line with Rule 2, Section 2.7 (b) of the implementing rules and regulations of the amended BOT Law (Table 2.4).
Local governments in the Philippines have access to guidance in developing and implementing PPP projects. The Philippine government's interior and local government department, or DILG, has produced a set of guidelines for local governments when implementing PPPs. This set of guidelines, which is known as LGU P4, serves as a template for any contractual arrangement between local governments and the private sector to deliver local services and provide infrastructure (DILG, 2016[27]). Local governments are encouraged to adopt a so-called LGU P4 code in order to establish an open and transparent process for the identification and implementation of projects that is coherent with local development plans and investment programmes. Local governments may customise these LGU P4 codes according to the needs of their constituents, as long as it remains consistent with law.
The PPP Center, the central co-ordinating and monitoring agency for PPP projects across the Philippines, is primarily responsible for monitoring and evaluating local governments' PPP programmes. Specifically, it has the task of assisting local governments in preparing projects, clarifying procedures, and evaluating PPP projects, while also providing training and capacity-building activities, and funds for pre-investment activities for potential PPP projects. In 2013, it launched a PPP strategy for local government, which included the preparation and dissemination of a PPP manual for local governments. In line with a recent instruction from DILG – Memorandum Circular No. 2011-16 – the PPP subcommittee assists the local development council in formulating action plans and strategies related to the local government's implementation of PPP programmes and projects. Furthermore, these governments also have access to the LGUGC, which plays the role of a private risk guarantor for PPP undertakings in the Philippines.
In Viet Nam, the pressure of rising public debt and budget deficits means that capital from the private and foreign sectors is a very important resource for capital investment. By the end of 2015, the structure of funding for capital construction for transport was as follows: state budgets, including ODA, accounted for 39%, while 26% came from government bonds and non-state sources financed 35%. Moreover, the proportion of state budgets in this mix is declining, while the contribution of the non-state sector is rising. Still, further capital mobilisation from the private sector will be needed in the future, even though the high deposit interest rate in the banking sector may imply that there is limited idle capital in the private sector. Furthermore, PPPs in transport infrastructure are often not very attractive to the private and foreign sectors due to the high risks and uncertainty typically involved.
The private sector has shown little interest in participating in infrastructure projects in Viet Nam, as these often require large amounts of financing and take long time to break even. As a result, most projects require government subsidies to be able to reimburse investors. However, the appropriate extent of government financial support for these projects has not yet been clearly defined. Currently, capital for local transportation infrastructure can be mobilised through bond issuance, loans from commercial banks, local development investment funds, auctions of land-use rights, and construction-project bidding. Challenges and limitations persist in the use of all of these forms of raising revenue.
Though bonds could potentially be an important source for infrastructure projects locally, the bond market in Viet Nam is underdeveloped and is largely composed of government bonds. By the end of 2006, only three provinces and cities (Hanoi, Ho Chi Minh City and Dong Nai) issued local government bonds, with a combined value of VND 16 trillion. In 2012, Ho Chi Minh City and Da Nang were the only two provinces or cities issuing bonds, with a total issuance value of VND 4.81 trillion. More local governments have joined the bond market, but central-government bonds continued to overwhelm the market for local bonds. The total value of local-government bonds until 2014 was only VND 17 000 billion, much lower than the VND 234 067 billion in central-government bonds mobilised in 2014.
Loans from commercial banks to local governments are still very limited. These loans are mostly steered into place by the central government using implicit guarantees. Recently, commercial banks showed some interest in funding PPP projects in transport infrastructure. However, Viet Nam's government inspectorate recently detected errors in implementing PPP projects in transport infrastructure. Among others, these included excessive cost increases in implementing projects, and an excessive time lag in collecting fees. This means investors have to trim the costs and fee-collecting periods in these projects. As a result, the interest on the part of the commercial banks appears to have waned.
Setting up local development investment funds (LDIFs) has helped to marshal a significant amount of capital for infrastructure investment in Viet Nam. These are special financial institutions that mobilise capital to invest in local infrastructure. Following the successful experience of the Ho Chi Minh City’s LDIF, at least 28 provincial governments have established funds of their own. In 2011, the total chartered capital of LDIFs, which comes mostly from state budgets, was estimated at approximately USD 450 million (World Bank, 2013[34]). So far, these funds have failed to raise significant additional capital from non-government sources.
Current regulations allow land to be used to finance infrastructure investments in two ways. The first of these is to auction land-use rights to generate cash to finance the construction project directly. The second is to associate land use rights with the construction phase starting from the bidding stage, as a means of generating extra capital for construction. Still, the exchange of land for infrastructure is on the decline in many big cities due to the malfunction of the real estate market. In small cities, meanwhile, the value of land is not attractive enough for private investors. This approach also raises concerns about the transparency of the land valuation process, as well as the extent to which local governments actually benefit from increased land values thanks to improved infrastructure.
Efficiencies in implementing local infrastructure projects
The decentralisation of responsibilities for developing and maintaining infrastructure can produce economic gains. One of the ways is when decentralised implementation makes it possible to use lower-cost local inputs and labour. Other ways in which this can happen include the streamlining of bureaucratic oversight and reductions in opportunities for corruption. Meanwhile, it is possible to achieve gains in efficiency by improving the alignment of investments with local priorities. However, a number of other factors limit the efficiency gains from decentralisation, and even point to certain advantages of pooling of resources at the national level. These include limited capacities at the level of local government. There are also factors that are external to local government itself, such as the need to manage spillover effects, the existence of economies of scale, equity considerations, distortions to internal trade and unproductive competition between regions (Peterson and Muzzini, 2005[35]).
In Indonesia, the implementation of some infrastructure projects at the local level has resulted in a number of productive efficiencies. For example, the evaluation of PNPM-Rural, a core programme of Indonesia's PNPM-Mandiri, found that locally-implemented infrastructure projects were significantly less expensive than those led by line ministries or district administrations. However, these cost advantages were found to decrease as a project became more complex. Cost savings are greater in building gravel roads than concrete roads or bridges, for example (PSF, 2012[36]).
In order to realise the potential economic gains that result from developing the kinds of infrastructure that reflect local priorities, some degree of local input or autonomy is necessary. In Indonesia, decentralisation and other local development programmes have been designed to encourage greater community participation in decision making. Indonesia has used community-driven development programmes since the beginning of the Kecamatan Development Project (KDP) in 1997, with the goal of empowering communities and reducing poverty. To this end, the country's government has provided locally-managed block grants for small-scale infrastructure. In 2007, Indonesia launched the PNPM-Mandiri initiative, aiming to reach a greater number of communities. As noted above, this initiative included the PNPM-Rural programme. The committees and project-proposal processes in this programme included measures to foster engagement from all citizens, including women, poor residents, and representatives of remote hamlets. In 2014, moreover, Indonesia enacted its new village law to give greater autonomy to local communities.
Notwithstanding the potential gains from decentralisation, there are also a number of factors that work in the opposite direction, potentially justifying larger roles for the central government in infrastructure projects. In fact, it is necessary to strike an appropriate balance of local and central government involvement for each project. A lack of economies of scale, or insufficient consideration of a project's spillover effects on neighbouring regions, for example, may raise costs or produce sub-optimal investments in projects pursued at provincial or local levels. As noted above, cost efficiencies in the local implementation of infrastructure projects through the PNPM-Rural programme in Indonesia tended to shrink with more complex projects.
More generally, capacity limitations at the level of local government may act to impede the decentralisation of responsibility for infrastructure in Indonesia, and indeed to show the advantage of pooling resources in certain areas. Other factors that have a similar effect include resource constraints and regional inequalities. While unequal access to infrastructure across Indonesia's regions remains a concern, fiscal measures help to finance projects in poorer parts of the country. In 2016, the DAU, a general-purpose grant, accounted for 50% of total transfers to the country's regions and rural funds. Allocations are determined through a complex formula using the wage bill, as well as a calculation of the difference between the needs of different governments, and their capacity to raise revenue.
In the Philippines, public investments in local infrastructure are based, at least ostensibly, on local development plans. The comprehensive development plan and the local development investment programme thus form part of the basis for the annual investment plan and budget. In practice, however, the linkage between planning and budgeting at the local level is poor, and the local development investment plan has practically no effect on actual investment decisions and budget allocation.5
There are several reasons for the poor linkage between planning and execution. First of all, institutionalised planning in local governments is weak. Not all local governments have local development councils or development plans to begin with. In fact, only 30%-50% of local governments have local development councils, while only 48.7% of local governments had devised their own comprehensive development plans as of 2015. Notwithstanding the absence of these, local governments prepare annual investment plans in order to comply with the reporting requirements of the country's budget and management department, with a view to Congress endorsing the local annual budget.
The second reason for the poor linkage between planning and execution is that local governments have a limited capacity for investment planning. Even if they craft their development plans and pipeline of projects, they still face problems in translating these plans into operational terms (World Bank, 2004[37]). For example, many lack the financial resources and technical capacity to prepare feasibility studies for local investment projects, such as water and wastewater facilities.
Third, investment programming is not transparent, and does not follow a bottom-up process. In a number of cases, the selection and prioritisation of projects becomes a political process that is carried out independently of the local development plans. The lack of analysis results in sub-optimal investment decisions, and in capital expenditures with unfunded mandates. This is exacerbated by the short-term perspectives of local officials, and an ad hoc approach to planning (World Bank, 2003[22]). In the past, this was also compounded by the practice of congressional insertions, where budget allocations to government agencies included funds intended to finance the pet projects of legislators, even if these were not consistent with local development and investment plans.
In Viet Nam, the planning and investment ministry carried out a survey in 2017 on planning capability in five of the country's provinces. According to this report, state agencies at the provincial level, such as, among others, the planning and investment department and the transport department, face human resource constraints in preparing plans and strategies. Provinces do not have planning specialists working for them, and officials usually hold multiple responsibilities. In general, people working in planning may not have the required skills. Consequently, most plans lack detailed roadmaps, consistency, implementing conditions, and criteria for monitoring and review.
The project selection process in Viet Nam includes the preparation, in a pre-feasibility study, of the investment intention report. It also includes in-depth analysis in the full feasibility study, and an appraisal process that focuses on assessing a project's economic benefits. This appraisal takes into account factors that will affect the effectiveness and feasibility of the project. However Viet Nam's law on public investment does not clearly establish the criteria for assessing these factors. The process can neglect to take into account connections with other social and economic goals, and complementarities between different modes of transport.6 A lack of compatibility between selected projects and future development plans can also cause duplication and waste in transport infrastructure investment.
Viet Nam continues to face a number of challenges with regard to transparency and accountability. For example, there have not been regular inspections and examinations of bidding. Moreover, a report on the requirements of the bidding process has not been taken seriously. According to a study in 2013, the examination of bidding was implemented independently and intensively when it did take place, but the inspections were insufficient in number, with several provinces having had only one inspection in the previous year (MPI, 2013[33]). In addition, bidding inspections were still combined with the overall supervision of public investment, or the inspection of construction investment. Moreover, because of limitations in terms of manpower and funding, inspections were implemented on the basis of reports. As a result, the overall effectiveness of these inspections was low.
The degree of transparency in the selection of contractors declines along a spectrum that stretches from open tendering, to limited bidding, and on to direct contracting. Current regulations clearly stipulate that public investment projects must use the open tender approach, and that direct contracting may only be accepted for projects that are small in scale or have a high degree of socio-economic urgency.7 In practice, however, many local governments do not meet the requirements in these regulations. For example, when submitting the proposal for direct contracting, local leaders in Ninh Binh province committed to completing the projects in question by the end of 2010. However, the government inspectorate found that four out of five of these projects remained unfinished in 2011. Moreover, many localities have applied for limited bidding, with some provinces taking this approach in over 90% of cases.
Key issues for improving the implementation of local infrastructure investments
Overall, the decentralisation of responsibilities for infrastructure has benefitted local communities, and has provided opportunities to make the development and maintenance of infrastructure more efficient. However, as seen in all three countries – Indonesia, the Philippines, and Viet Nam – central governments still play a large role planning, financing and implementing infrastructure projects. The involvement of local governments can improve the efficiency of infrastructure projects, though there are also limitations to the benefits of decentralisation in this area, as discussed above. Social, environmental and geographic, and economic factors can affect the appropriate degree of decentralisation in developing and maintaining infrastructure, which should be determined by countries in deciding how projects should be pursued. Local governments should nevertheless have the capacities to implement their responsibilities effectively and efficiently. To this end, efforts can be focused on addressing disparities in access to land transport infrastructure through improved co-ordination and planning, by developing the capacity of local governments, by looking at new financing mechanisms, and by integrating the monitoring and maintenance aspects of infrastructure planning. The lessons offered by these three countries' experiences are also likely to apply more broadly to other emerging economies in the region.
Improvements can be made to infrastructure planning and co-ordination
In order to develop quality transport infrastructure, effective planning is essential. However, the need for co-operation between various actors, and across multiple levels of government, can make this complicated. Therefore, enhancing the co-ordination between central and local governments on infrastructure issues can improve planning, project selection, and allocations. In Indonesia, for example, a clarification of the division of responsibilities between different levels of government would make it easier to develop future infrastructure projects, and to prevent project overlap. This would be of particular salience in the rail sector, where increased space has been made for local governments to operate in partnership with the central government (OECD, 2012[30]).
In Viet Nam, provincial infrastructure plans could be made more effective and more feasible by improving their alignment with provinces' future development needs and their capacity to mobilise local resources. Consistency could also be improved between provincial plans and the national infrastructure master plan by strengthening co-ordination between local authorities and the central government. Establishing clear criteria for project selection could also play a useful role. Local authorities in Viet Nam could start by implementing Directive No. 1792/CT-TTg, which requires the project-selection agency only to approve projects once the funding sources have been identified. Open bidding may also help to improve transparency in the selection of contractors.
Community-led programmes for the development of infrastructure have helped to strengthen the engagement of communities in the sector. However, reforms such as choosing appropriate consultation times, providing assistance in finding necessary information, developing a legal framework that requires public authorities to respond to comments, raising awareness of rights to participate in the supervision of provincial infrastructure projects, and strengthening the capacity of social organisations, could improve community consultation.
Local governments may benefit from capacity-building assistance
Wherever a lack of experience and insufficient scale limit local governments' ability to plan and implement infrastructure projects, capacity building will play an important role in overcoming these issues. In the Philippines, the shortcomings of local development planning and local development investment plans in driving local-level economic growth highlight the need for capacity building in local governments. While local governments have already undergone numerous training programmes, including on local fiscal management, and provided by institutions including DILG's Local Government Academy and the PPP Center, the scope for building local capacity in the preparation of local development and investment plans is certainly very large. This is especially the case when it comes to linking planning, programming and budgeting to the implementation of projects or programmes.
In Indonesia, the creation of new local units has further complicated local capacity constraints. The number of provinces in the country increased by over 30% from 1999 to 2015. Over the same period, regencies and cities expanded in number by 55%, districts by 77%, and villages by 20% (OECD, 2016[38]). Administrations at the provincial and district levels, meanwhile, could benefit from capacity-development programmes focusing on technical aspects and on human resources. These could include support in adopting new tools and technologies, technical assistance, and mentoring and training programmes.
Realising the full benefits of local-level infrastructure development also requires transparency and accountability. While perceptions of corruption in local governments in Indonesia tend to be less serious than those regarding the central government, addressing corruption and promoting transparency will be an essential part of capacity development. Indonesia’s Komisi Pemberantasan Korupsi – a commission to eradicate corruption – remains fairly centralised. It could do more work in the regions by providing training programmes for local governments, for example (OECD, 2016[38]).
Broadening sources of financing will help to fund infrastructure investments
The need to balance autonomy with considerations of fairness and equality make it more complicated to finance the development and maintenance of infrastructure at local levels. In Indonesia, the general-purpose DAU grant, which accounts for a large share of local governments' revenues, does function as equalisation mechanism, although its design could be improved upon. Indeed, the DAU has faced criticism both for its complexity (Shah, Qibthiyyah and Dita, 2012[39]), and for the role of the wage bill in calculating grants, which can encourage the hiring of additional civil servants and a diversion of funds away from infrastructure (OECD, 2016[38]). Increasing the use of infrastructure-specific capital grants may be appropriate. Similarly, in Viet Nam, the ask-give mechanism for capital allocation to the provinces could be eliminated, at least for the time being.
It is likely that developing more infrastructure, and covering its life-cycle costs, will also require a greater mobilisation of financing on the part of local governments. Private sources of finance can also be further developed, especially the kinds of long-term finance that are currently available in the market to finance infrastructure assets. Moreover, attracting more private investors points to the need to widen and deepen domestic capital markets. Furthermore, real estate taxes, idle land taxes, and other tax measures not fully exploited by local governments may be used more effectively, as well as infrastructure bonds, and other new ways of raising revenues for the public sector. Governments can also facilitate the creation of credit enhancements for infrastructure bonds, and can pursue reforms to allow pension funds and insurance companies to include infrastructure investments in their respective asset portfolios. In Viet Nam, as elsewhere, enhancing the transparency of regulations on exchanging land for infrastructure is important in encouraging additional private-sector participation in local infrastructure projects.
PPPs will continue to play an important role in local infrastructure development, as well as providing a means of attracting investment and external expertise. However, they require effective governance to be managed properly. Consultation and transparency remain important with PPPs, as with other forms of infrastructure projects. Competitive bidding plays a role in this, as well as improving efficiency by identifying better-matched private partners. Attracting these partners requires assurances of repayment from project revenues. Timely and appropriate regulatory responses to tariff-adjustment proposals are critical for the successful implementation of any PPP project. At the same time, the division of responsibilities between the contractor and the transport infrastructure manager requires certain commitments of responsibility in order to avoid the manager taking responsibility for risks caused by the builder.
PPP arrangements will not be the appropriate mode of infrastructure procurement for all projects. The political environment is a critical factor as decisive, transparent, and committed local leadership is crucial to the success of any PPP. Local governments are likely to need expert advice on technical and financing options, project packaging, the preparation and evaluation of bidding documents, and on the kinds of project monitoring and evaluation that will meet the legal requirements and expectations of private-sector investors. In the Philippines, the PPP Center, and the expertise of donors, may be of use in preparing local PPP strategies. Moreover, while local governments in Indonesia have some autonomy in that they do not have to follow central government rules regarding PPPs if they are not seeking guarantees or fiscal support, governments that lack the capacity or experience for managing PPPs should definitely seek support.
Ongoing maintenance and monitoring should be incorporated in infrastructure planning and budgeting
Regardless of the level of government that takes the lead in an infrastructure project, it is important, in developing these projects, to pay attention to maintenance and monitoring throughout the project life-cycle. The costs of infrastructure maintenance should be estimated, and then added to the initial cost of transport infrastructure projects, and allocated for later periods. In addition, governments may also need to find better solutions to mobilise contributions from the private sector and other sources for the maintenance of transport infrastructure.
A lack of funding for the maintenance of an infrastructure project results either in the accelerated deterioration of the asset, or in fiscal challenges. In Viet Nam, shortfalls in maintenance budgets are most commonly addressed either by passing on the management of some facilities to higher levels of authority in order to reduce the burden on the local budget, or by directing user fees directly into the maintenance of the asset. In 2016, Viet Nam's transport ministry permitted Nghe An province to transfer 620.45 km of local roads to the national highway network. At the same time, the province transferred 470 km of district roads to the provincial network. The province of Nghe An also earned VND 140 billion in road tolls, of which VND 94.14 billion was allocated to the renovation and repair of 45 transport works in the province (six by the transport department, and 39 by the District People's Committee).
Finally, limited capacities on the part of governments that are responsible for local infrastructure projects make it harder to monitor their performance. Viet Nam has a system for monitoring and evaluating investment that requires lower tiers of the country's administration to report back to the planning and investment ministry, but compliance is not universal. In 2016, only 79.5% of projects were reported on. Community-level monitoring has been similarly neglected in many cases. According to the planning and investment ministry, only 23 of the country's 63 provinces compiled community monitoring reports in 2016.
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Notes
← 1. In this chapter, all sub-national levels of government are included under the category of “local government”. These include regional and state governments, intermediate-level government, and municipal government).
← 2. The local chief executive (mayor) and other officials are elected for a three-year term. They can be re-elected for a second term.
← 3. According to the World Bank (2013[32]), the shares of investment for transport in overall infrastructure investment in Ho Chi Minh City, Quang Ninh and Quang Nam province, are 50%, 92% and 47% respectively.
← 4. Financial resources for the maintenance of road infrastructure funded by official development assistance are estimated in the financial plan for the project. However, funds and policies on maintenance differ between projects, depending on negotiations with donors.
← 5. However, the actual implementation of local infrastructure projects may be mayor- or governor-centric, that is, subject to the preferences of the local chief executive.
← 6. The criteria and procedures for project selection, notwithstanding the Law on Public Investment (Articles 60-64) and associated regulations, are not sufficiently clear and detailed (World Bank, 2013[32]).
← 7. The relevant rules are: Resolution 30/2008/NQ-CP (11 December 2008) on urgent solutions to prevent economic recession, maintain economic growth, and ensure social security; and Document No. 229/TTg-KTN from the prime minister (16 February 2009) on applying direct contracting for urgent projects.