Municipal sector review

Need for a Strategy

1.2 The Turkish republic was established in 1923 as a unitary state with a strong central government. The urban sector was small and management of the few cities was closely linked to central government. Since then rapid urbanization and economic growth have led to profound socio-economic changes, and have placed extraordinary demands on central and local governments alike to meet the constantly growing demand for urban services.

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   Municipalities provide the following three core services either through public and self-governed utilities (in large municipalities) or through individual departments (in smaller municipalities). The municipal enterprises are commercial in nature and maintain separate accounts distinct from the municipal budgets.
   

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  Transportation - urban road construction and maintenance, urban rail systems, drainage, public transport operations;
  
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  Water supply and waste water management including provision of services and construction and maintenance of the assets; and
  
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  Solid waste collection and disposal¹.
  

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   The municipalities’ regulatory responsibilities also include land use planning and development, management of the environment, and conservation of natural and cultural/historical assets. The services that Turkey’s municipalities are obliged to deliver are more limited than in many other countries but are nevertheless crucial for the welfare of the residents and for the productivity of the urban economy. The municipalities are not responsible for the delivery of health, education, and other social services. The State, either directly or through its provincial administrations, has the responsibility for delivering these services. Some municipalities also own enterprises – such as bakeries, gas companies, ferry services etc. - that are not directly related to the above core services.
   

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   By and large the municipal sector in Turkey has been able to meet the growing urbanization demands. Overall coverage is high for the above-mentioned basic services (Table 2.4), although there is a need to focus on the efficiency of service delivery. Further, over time the growth of municipal revenues as a percentage of GNP has been higher than the rate of population growth. Between 1980 and 2000, the urban population increased by 2.2 times while the municipal revenues, as percentage of GNP, increased almost 3 times.
   

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   In the past increasing service demands have been met by assigning the responsibility for basic urban services to the municipalities, allocating increasing amounts of central government funds to them, and maintaining traditional central government administrative control measures. Some elements of this strategy have worked well, and the towns and cities in Turkey have managed to escape many of the difficult problems affecting rapidly urbanizing areas in other countries. Urban slums have been largely avoided as settlement policies towards rural-to-urban settlers have provided reasonable security of tenure, incentives to develop and maintain real estate, and even stimulated the emergence of a local construction industry in the bigger cities. Migrants living in illegal settlements join their neighbors and elected leaders to lobby for, and often succeed to obtain, formal tenure and basic urban services.
   

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   While the municipal sector is functional, there are worrying signs that the current strategy is not adequate to meet the increasing pressures of urban growth.
   

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  First, the long-standing practice of meeting growing service demands with increased allocations from the central budget has become impossible due to macro economic fiscal pressures. The current size of the public sector is 45% of GDP and the high public debt creates a pressure to reduce the size of the public sector and the public debt. These factors are extremely relevant for the municipal sector that has traditionally relied on assistance from the central government. Following a decade of lax fiscal policies, the fiscal burden and the size of the public sector debt have both reached unsustainable levels. Current Government economic policies focus on restoring growth and incomes after the 2001 financial crisis. A broad based program has been put in place within which measures have been taken to reduce public spending and improve public expenditure management. So far, the local governments have been largely untouched by these reform efforts. However, changes in municipal operations, in line with the larger reforms, would promote more efficient use of public resources and reduce the dependence on the State for local expenditures.
  

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  Second, continued reliance on traditional administrative control has become increasingly ineffective to actually oversee, influence and guide Turkey’s large and growing urban sector and economy and has failed to prevent the emergence of growing municipal financial arrears. Central government oversight is strong in the sense that government has the power to reverse local decisions and sanction local authorities. At the same time, the narrow focus on legal and administrative compliance does not provide relevant knowledge or tools to actually influence local behavior. The system for public oversight needs to be revised to develop better monitoring and incentives for financial and economic behavior; and to develop a guiding regulatory framework within which the municipalities can prosper and manage their own affairs. Initiatives at the central government level to strengthen public sector financial management need to be extended to the local authorities.
  

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  Third, the large share of central government funding for local operating and capital expenses has caused a split between responsibilities for taxing and spending at the municipal level. The State is seen as the ultimate funding source and more efforts often go into securing support from the central budget rather than to raise funds locally. Sometimes, economic and financial justification for investments are not in place. Measures are needed to strengthen the link between service levels and local affordability; to pursue least-cost solutions; and to replace central funding with locally controlled taxes, fees, and cost-recovery mechanisms.
  

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  Fourth, the role of the private sector both in providing basic infrastructure services and bringing in capital to finance them has been limited (except for some private urban transport). There are two reasons for this: (i) many municipalities keep the traditional services in the public domain, and also expand their activities into areas that could and should be carried out by the private sector; (ii) municipalities have increasingly defaulted on their debt to the central government related to infrastructure loans and failed to honor payment obligations to the tax and social security offices. Their poor creditworthiness and perceived political interference have led to little or no interest from private providers of capital or services to do business with the municipalities. The public borrowing arrangements have been partly reformed, but further follow-up actions and effective sanctions are needed to put existing public municipal credit schemes on a sustainable path. In the long run, measures are needed to prepare Turkey’s cities for tapping into private and commercial funding sources to meet the investment needs.
  

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  Fifth, as part of the ongoing EU accession related reforms, Turkey will have to harmonize its environmental regulations in line with EU standards. This would imply the need to invest more in activities related to water and wastewater services as well as solid waste management. Consultants have estimated the cost of environmental compliance to be around US$ 20 billion². Reforms are needed to ensure that municipalities and their utilities can raise capital and can implement investments. The need for improvement and the absence of sustainable municipal borrowing are evidenced by the fact that municipalities use 1/3 of their current revenues for investments.
  

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   There is recognition in Turkey that local government operations need to improve and to the credit of the policy makers, a draft bill on Public Administration is being debated in Parliament. The drafting of this bill was prompted by the need to bring about changes in municipal operations. The bill covers many aspects of municipal services and touches a number of constituencies at the central and local level. However, given the number of interest groups associated with the bill, the debate in Parliamentary committees and other forums is not yet over. The current version of the bill focuses largely on increasing the local governments’ share of national budget revenues and on modest changes in the existing systems for oversight and financing of the municipal sector. These changes will have to be matched by increasing the accountability of municipalities in their operation. Moreover, increasing the size of the local governments through additional central resources has to be considered in the context of the fiscal pressures for the central government.
   

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   Turkey now has a great opportunity to reform the municipal sector and this review outlines the important items to consider as part of the reforms. Broadly, the suggestions center around: a) public sector reforms, both at the central and local level; and b) reform of the existing municipal financing (including borrowing) mechanisms to restore financial discipline and sustainability, and ensure economic efficiency in the selection of investments.
   

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   To support and sustain the development in the municipal sector, progress on two other broader issues is critical. First, there should be overall macroeconomic stability and the size of the public sector and the public debt should be reduced. Second, the financial sector should be strengthened to allow for an improved mobilization of capital. Reforms in these two areas have to progress in parallel for the municipal sector to provide sustainable services to the urban population.
   

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  Macroeconomic stability and size of the public sector: The fiscal burden, i.e. the public sector’s share of GDP, is estimated to have increased from a reasonable 23% in 1993 to about 45% in 2002. Similarly the aggregated public sector debt (excluding enterprises) is high. Thus, the fiscal room to increase resource transfers to the local level is limited. An increase in local tax revenues would need to be accompanied by reduced central taxation to avoid increasing the total share of the government in the economy. Furthermore, the current high marginal effective tax rates make it difficult to increase local taxation.
  

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  Financial sector: While there is a clear need for the municipalities to increase their creditworthiness so that they can raise resources for investments, the supply of capital is restricted due to the current situation in the financial sector. Long-term domestic loans are not available today and the high cost of borrowing from external sources, without a State guarantee, limits debt financing by the municipalities. Further, overall foreign direct investment in Turkey is low, even for productive sectors that tend to yield higher financial returns than the municipal sector. These factors must be taken into account while reforming the municipal finance strategy.
  

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   Chapter 2 provides some key features of urbanization, a broad overview of the local government sector, and the relationship between the local government and the national economy. Chapter 3 discusses central government oversight, supervision, and financial transfers. Chapter 4 provides information on local revenue mobilization in municipalities. Chapter 5 discusses municipal borrowing for investment funding. Chapter 6 provides conclusions and next steps. Unless specifically stated, ‘local government’ in this report refers to municipalities and not the central administration at the provincial level or the rural-based authorities.