The impact of the global crisis on local governments

October 6, 2022
  1. The importance of actionable intelligence in uncertain times

Our present has been burdened by a set of unprecedented uncertainties and challenges. The Covid19 pandemic and its aftermath, the crisis in Ukraine, the severe impact of climate change, and the socio-economic shifts are having a devastating effect on peoples and communities. The latest Human Development Report (HDR), an exercise that measures a nations’ heath, education, and standard of living, has reported a global decline of the index for two years in a row. The decline that we are noting comes for the first time in the 32 years since UNDP has been calculating this index, and it has reversed much of the progress towards the Sustainable Development Goals.

The communities and people in North Macedonia also feel the trickle-down effects of this ‘new uncertainty complex’ and face local and regional development unique challenges as well. That is why it is important that we have an open discussion about assessing the impact of these crises and outline the path forward that will help us overcome the status quo. The policy recommendations outlined in the HDR report focus on the need to have smart investments, encourage innovation across society and ensure that the social protection measures protect people and their wellbeing.

In challenging times like these everyone has a vital role to play. UNDP’s role in times of uncertainties is outlined in the latest Strategic Plan. The organization recognizes that to tackle the interconnected challenges and multidimensional risks, we will need systemic solutions, while betting on multilateral cooperation. UNDP’s six signature solutions include: reducing poverty and inequalities, building resilience in our communities, protecting the environment, energy, gender equality and good governance. We also try to look at these solutions as interconnected, and in demand of an integrated approach, that we try to enable through:  innovation, digitalization, and development financing. UNDP’s country office in Skopje, follows this strategic plan, and has a menu of projects and activities aligned and complementary to this plan.

We also believe that working with our partners and supporters, we can offer actionable intelligence to help tackle some of the challenges our communities are facing. Precisely for this reason, we decided to pursue research, an impact assessment of the crisis in Ukraine on the functioning of local governments in North Macedonia. We wanted to learn how severe the impact of the multi-dimensional crisis on the municipalities is, and to ensure that we advocate for policies that will leave no one behind, even in times when we are having interconnected insecurities and risks. To conduct this research, we teamed up with two university professors, and a multidisciplinary team in the country office to help learn more about the situation and the challenges ahead.

  1. Key insights from the research on the impact of the Ukraine crisis on local governments

The period under investigation for this research was January until July 2022. We used the most recent data for revenue, expenditure, financing, and arrears of 81 municipalities in North Macedonia. The analysis uses budget items (three-digit level) and budget sub-items (six-digit level), where necessary. The comparison is not only with respect to 2021 – which was a pre-election period before the local elections in October 2021, but also with regard to the pre-pandemic levels (2019 as a “normal” base year) and the pandemic 2020 year (as another crisis year).

These are our key insights from our investigation:

The multidimensional crisis in 2022 worsened the environment for local governments. They faced a hostile environment of ongoing Covid-19 pandemic, Ukraine and energy crisis, higher inflation, and a security crisis in Europe. The Ukraine crisis not only put pressure on revenue, expenditure, and financing side of local budgets, but also revealed the long-term systemic weaknesses in the design of intergovernmental fiscal relations.

Strong impact of the Ukraine crisis. 72.2% of the surveyed municipalities [total of 40 municipalities were surveyed] stated that the Ukraine crisis negatively impacted the normal functioning of the municipality. The increase of cost of goods and services mainly due to higher prices of electricity, fuel prices, other heating materials, etc. had a direct impact on their financial position and ability for public service delivery.

Declining local revenue in Jan-Jul 2022. Local government revenue in the first seven months of 2022 was 1.3 billion denars lower or 5.4% less compared to Jan-Jul 2021. We observe moderate changes in the revenue composition. Tax revenues in Jan-Jul 2022 were lower by 464.6 million denars or 7.5% less compared to the same period last year. The inflow of inter-governmental transfers was also lower: 816.5 million denars less or 5.4% less compared to Jan-Jul 2021. The decline in inter-governmental transfers was to a large extent due to lower surplus (unused funds) carried forward from 2021. Grants were lower by 22.8% or 134.2 million denars, but in line with the pre-pandemic 2019 level. During the observed period, non-tax revenue and capital revenue registered a mild increase of 2.6 and 2.7%, respectively.

LG expenditure of the entire local self-government were almost at the same level in Jan-Jul 2022 compared to Jan-Jul last year. However, there were important structural changes. We observe an expansion of current expenditure, so that 1.3 billion denars more were spent in Jan-Jul 2022 compared to the same period in 2021. In the same period, a slowdown of local investments (capital expenditure by the local governments) occurred, so that 1.3 billion denars less were spent in Jan-Jul 2022 compared to the first seven months of 2021.

What were the major changes on the expenditure side in Jan-Jul 2022? There has been a massive increase of LG expenditure for communal services, heating, communications, and transport of nearly 747 million denars. And this number cannot capture the full-blown impact of the energy crisis, as some energy bills (electricity, gas supplies, wood for heating, etc.) are not yet paid. The payment of the bills is either reprogrammed in more instalments or simply put aside as municipal arrears. Erasmus-sponsored school trips were the main reasons behind the exceptionally strong rise of travel and daily expenses in Jan-Jul 2022.

Communal services, heating, communications, and transport is one of the expenditure categories that experienced very strong growth during Jan-Jul 2022. The costs were higher by nearly 747 million denars compared to Jan-Jul 2021. This was a massive and unprecedented increase in a short period. Two thirds of these costs referred to electricity bills (67.9%), followed by liquid fuels (9.0%) and water supply and sewage (4.1%). Costs for electricity bills more than doubled in the analysed period, registering a rise of more than 110%. The increase of other costs was also very strong: other heating materials (+96.7%), central heating (+51.7%), transport of people (mainly pupils) (+55.6%), other communal costs (+35.1%), fuels and oils for motor vehicles (+33%).

One of the strongest impacts of the multiple crises in 2022 on local self-government was – and still is - the significant slowdown of local investments. 62 municipalities recorded lower investment spending. A strong reduction is observed among expenditure for other construction activities (primarily, construction and reconstruction of local streets and roads) by 1.3 billion denars and repairment and current maintenance by almost 267 million denars. Capital expenditure of local governments is indeed the largest “victim” of the Ukraine (multidimensional) crisis. 35% of surveyed municipalities responded they will postpone very important investment projects.

Provision of even basic local public services is endangered. Not only local investment, but also even basic local public services are at risk of disruption. For example, treatment plants for wastewater are heavily dependent on electricity. Their managers warn that the ordinary operations are at high risk of disruption due to the high electricity bills.

Traditional cash-based fiscal indicators have not proved fully fit for purpose. The stock of municipal arrears was steadily increasing. Compared to their short historical minimum at end-March 2020, arrears of local self-government units are higher by 28.2% at end-June 2022. Arrears of local public enterprises also strongly increased by 46.5% in two years. Arrears of second-line unit users at local level are lower by 20% compared to the historical minimum, but they are still high.

The central government stepped in. Until late September 2022, solutions had to be found solely by the local self-government. On September 28th, 2022, the Government announced that it will allow primary and secondary schools to participate on the regulated electricity market. Although fiscal pressures are not expected to ease before 2024 (and the winter 2022/23 will be especially challenging), this will be some relief for the local self-government.

  1. The way forward.

More specific proposals, regarding the research findings that we’ve presented to you today, include our belief that solutions for the future should involve greater cooperation and coordination between the central government and ZELS. A redesign of the system of inter-government relations is needed, allowing for higher fiscal discipline at the local level, more revenue and expenditure autonomy, more responsive design of inter-governmental transfers, systematic long-term mechanisms, and solutions for reduction of municipal arrears and prevention of new arrears. We also highlight that the improvement of the financial position does not necessarily lead to improvement of local public service delivery.

While crisis management is a top short-term priority, addressing structural weaknesses must not be forgotten. The improvement of local public services requires energy-efficient solutions, environment-friendly municipal waste selection and management, improved human resource management in the local public sector, including continuous capacity building. Although highly important, gender-based budgeting at the local level is still in its infancy.

Fixing local finance and building buffers for combatting future crises are important prerequisites to make decentralization work.

We believe that the way forward, should follow the path outlined in the Human Development Report mentioned above, one that prioritizes #Investment #Insurance and Innovation, while at the same time changing the norms, values and beliefs that govern our social arrangements to deliver human security and tackle people’s unsettledness. From smart practical investments in renewables and preparing for risks and natural hazards, ensuring social protection mechanisms are revitalized and working for all, to supporting innovation and investing in the technological, cultural, economic and social capital of our communities.