The role of institutional and political factors in explaining fiscal behavior of the state governments in Malaysia

Abstract

Lately, several state governments in Malaysia have been identified as having serious difficulty in meeting their financial needs to the extent of being qualified as at the verge of bankruptcy. One of the explanations put forward is the fact that state governments have been acting irresponsibly in managing their finance. However the question that ensues is why do state governments act in such a way in the first place? Obviously, state governments are not inherently bad managers; they do not purposely choose to act irresponsibly financially and fiscally. In this paper, we will try to relate the financial difficulties faced by these state governments to the institutional and political environment currently in place in the country. Our main assumption is that the dire financial situation of some state governments in Malaysia is the direct result of the way intergovernmental system is organized within this country. To put it differently, political and institutional factors inherent within the intergovernmental system in Malaysia have create an incentive for the state governments to act irresponsibly when it comes to manage their finance. The policy implication of this paper is that any formal rules that may be introduced by the government in order to regulate fiscal relations in federations will not have a substantial impact on subnational governments' fiscal outcomes if political and institutional incentives allow and encourage circumventing these rules.