Mozambique shows performance-based grants work for cities acting on climate change

The recent COP26 summit in Glasgow confirmed the existential threat of the climate crisis to people and the planet, and local governments are no exception in having to face that challenge. An ever-expanding urban population leads to increasing demands for more city-level services, and these municipalities also shoulder the majority of the costs needed to adapt to more frequent and severe shocks from climate change.

In addition, driven by the realization that local needs are best addressed at the local level, low- and middle-income countries have increasingly implemented decentralization reforms. This has transferred responsibilities, resources, and tax collection authority to local governments. But the lack of both financing and capacity in municipalities can compromise the potential positive effects of decentralization. While inter-governmental transfers help remedy the financing gap, some evidence suggests that they can deter local governments from collecting revenue and hurt their autonomy by creating dependence on external funding.

To assure better service delivery and improve local capacity, policy makers have started using performance-based indicators to determine allocation of transfers to local governments. Performance-based grants were introduced as a means of motivating local governments to increase capacity, while providing resources to meet growing needs. The better they perform, the more resources they can access. The methodology quickly gained acceptance, and over the past 10 years, the World Bank has financed more than $7 billion toward performance-based grant programs in low- and middle-income countries. However, so far there has been limited evidence as to whether performance-based grants actually increase capacity, especially in low-capacity environments.

A new paper assesses the influence of a performance-based grant on local revenue collection in Mozambique. The program included annual transfers of at least $40,000 and technical assistance (TA) in financial and fiscal management, as well as urban development and investment planning. Financed under the Cities and Climate Change project, the program was implemented in half of the country's municipalities, which are made up of cities and towns, between 2013 and 2018. The study is the first rigorous assessment of a performance grant program in a developing context to date. It has four main takeaways:

1. The municipal performance grants are successful in providing incentives and enabling local governments to collect more revenue, and the effect is lagged.
2. The positive effect of a performance grant is only significant after a TA program is implemented, indicating that training is key to unlock the potential of a performance-based grant program in a low-capacity environment.
3. While the effect of TA was similar for cities and towns, the effect of the grant was larger for towns, driven perhaps by the fact that grants made up a larger share of budgets in towns and therefore had a larger impact on the incentive structure.
4. Overall, for every 10 meticais (Mozambique currency) per capita received in municipal performance grants, when combined with technical assistance, revenue collection increased by 10-11 meticais per capita in cities and 24-60 meticais per capita in towns.

Thanks to the program, participating municipalities now cover a larger share of expenditures with resources that they have collected themselves, a result of improved capacity to collect revenue. So yes: Performance-based grants can empower cities and towns and with that, it is hoped, can also strengthen local voices and make spending more responsive to growing needs. The COP's outcome was an important signal of global cooperation in the right direction, but we know more can be done at global, national, and local levels. While the study was focused on one country during a limited period, the evidence is promising and supports the World Bank's continued commitment to performance-based grants to help local governments face the challenges of the future.