Save Federalism From Rent-seeking Practice

Nepal’s 2015 transition from a unitary to a federal state was intended to restructure the social contract and devolve power under the vision of "Gaun Gaun Ma Singha Durbar" (power will be distributed to each village). However, after a decade of local governments exercising power, there is still a long way to go with regard to improvements in allocative efficiency. 

Scholars argue that instead of an evidence-based approach to development planning, local development agendas are instead shaped by politics and rent-seeking behaviour, such as building viewing towers and distributional infrastructure rather than productive sectors. This article will examine this situation through the theory of Second Generation Fiscal Federalism (SGFF), arguing that politicians act as utility maximisers and are driven more by political incentives. So, better institutional design, accountability mechanisms and capacity building of bureaucratic organisations crucial for functional federalism.  

"Big Bang" approach

The transition to federalism in Nepal was characterised by a "Big Bang" approach, where political imperatives often outpaced administrative readiness. There is a debate among scholars about whether the chaotic nature of this transition was an unexpected consequence of rapid change or a deliberate outcome of political bargaining.  Although many advocated for federalism for the purpose of increasing regional autonomy, for most political parties, it often served as a bargaining chip in constitutional negotiations to settle identity-based demands while preserving their influence.

This political genesis produced unintended structural consequences. One expert argues the federal structure was adopted at a pace that was beyond the ability of fiscal and administrative systems to accommodate it. As a result, local governments enjoyed broad constitutional powers but lacked the capacity to exercise them. More importantly, the ambiguity in the early framing of the constitutional provisions facilitated the creation of patron-client networks by the political parties at the federal and local levels. 

Many scholars insist that the political arrangement in federalism impacted the incentives at the local level. For instance, discretionary power concerning resource allocation and infrastructure can be a site where rent seeking, clientelism, and selective allocation of finances take place, despite the legal framework that promotes transparency and inclusivity. Federalism has therefore produced a paradox of empowerment: while it expanded local participation, it has also created a space where political and economic incentives can influence development priorities. 

Traditional literature, often called First Generation Fiscal Federalism (FGFF), mainly focuses on efficiency and fairness. This framework assumes that public officials are good "social planners" who want to maximise social welfare. In Nepal, this was the promise: moving power closer to the people would result in development projects that address immediate local issues, like agriculture, capacity building, and drinking water, instead of relying on general central planning. 

The FGFF framework has difficulty explaining situations where local spending seems out of touch with pressing public needs. This calls for the approach of Second Generation Fiscal Federalism (SGFF), which questions the assumption of benevolence. The SGFF emphasises the incentives created by political and fiscal systems, viewing politicians as utility maximisers motivated by self-interest, re-election goals, and chances for personal gain. 

A central concern in the SGFF is the risk of "elite capture." Bardhan & Mookherjee (2000) argue that while decentralisation brings government closer to the people, it also brings it closer to local elites who may manipulate resources for their own benefit. In areas with high social inequality and weak democratic institutions, local governments might be more vulnerable to being influenced by powerful local interest groups than the national government. This theoretical finding raises the question of whether or not a "viewing tower" could be a mechanism for transferring public resources to certain members of the local elite, such as construction interests who are disguised under the guise of being a part of a development process. 

One of the more compelling examples of this misallocation is the lack of attention afforded to the agricultural industry. Although agriculture contributes to one fourth of total GDP, World Bank data shows that "irrigation construction" receives only about 2 per cent of the budget, while "animal and horticulture" gets less than one per cent of total local government expenditure. The stark allocation of around 65 per cent of local government’s capital expenditure for civil works versus less than 3 per cent for agriculture supports the argument that local governments prioritise visible infrastructure over productive investment, as roads and towers offer immediate, credit-claiming assets within electoral cycles. 

By underinvesting in agriculture and long-term economic drivers, they perpetuate low growth and voter dependency, a politically rational choice favouring “concrete” over “content.” As Keefer & Khemani (2003) argue, infrastructure projects offer high visibility to voters and, crucially, high rent-seeking potential through construction contracts.

Problems

The Office of the Auditor General’s (OAG) 2022/23 report found widespread problems: when they reviewed Rs. 1.13 trillion in spending across 746 local governments, they found that about Rs. 35.67 billion, roughly 31 per cent of the audited funds, had problems linked to shady contracts and lax financial controls. The International Budget Partnership's Open Budget Survey (OBS scores) similarly illustrates weak checks and balances that allow rent-seeking easily in budgeting. Public participation is low at 31 out of 100; oversight is limited at 46 out of 100; and transparency is modest at only 50 out of 100. These figures all point to the deep-rooted problems in how budgets are managed.

Nepal’s federal transition shows that fiscal federalism succeeds only with strong institutional design, aligned incentives, and accountability. Building local administrative capacity, linking transfers to performance, strengthening audits, and promoting transparent, participatory budgeting are essential to reduce rent-seeking, correct allocative distortions, and ensure decentralisation delivers effective public services.

(Author is a graduate student of Global Affairs (Governance and Policy) at the University of Notre Dame, USA.)