Federalism against markets: Local struggles for power and national fiscal adjustment in Brazil

What happens when a nation places its trust in market-oriented policies, but lays those policies atop federal institutions that subordinate the market to political concerns? This question is especially important to a decentralized country like Brazil, where the states allocate 36.5 percent of public expenditure and have the opportunity and the incentive to pursue autonomous fiscal strategies. When the Brazilian central government turned to market-oriented fiscal strategies in the 1990's, state divergence from federal policies exacerbated national dependence on external capital, destabilized the economy, and undermined market-oriented adjustment. In the prior period of government-guided policies, divergence had been less common, and when it occurred, it had less serious consequences. This suggests that political institutions constructed to integrate regional interests posed special problems for market-oriented fiscal policies.;This study explores the way political and fiscal aspects of federalism intersect. Scholars tended to separate the economic focus of the fiscal federal literature from the concern with power found in the literature on the politics of federalism. Independently, both traditions argued that sub-national rivals checked central government encroachments. Scholars of political federalism praised regime-preserving results, whereas scholars of fiscal federalism emphasized market-preserving qualities. The separation between the traditions obscured the fact that regime-preserving characteristics of the federal system could undermine market-oriented initiatives.;This study joins political and fiscal federal traditions in arguing that local political struggle caused different fiscal strategies in otherwise similar states. To test this argument, the study analyzes electoral and budgetary statistics from all states of Brazil in the 1980s and 1990s. Small-N comparison of two states from the rich South and two from the poor Northeast elucidates the causal links between local struggle, budgeting, and fiscal policy. In each region, the state with a more fragmented and polarized party system incorporated more democratic practices in budgeting institutions, which reduced the autonomy of chief executives in making fiscal choices. Only states with more cohesive and centrist party systems produced market-oriented fiscal strategies. This study explores the effect of sub-national party systems on fiscal policy, the characteristics of democratic policymaking, and problems inherent to market-oriented fiscal strategy in large, developing countries.