MUNICIPAL MERGERS AND ASSOCIATIONS: INTERNATIONAL EXPERIENCE AND REFORM OPTIONS FOR CROATIA 1 MAY 2022 1 This report was undertaken by the World Bank Governance Global Practice team under the project, “Croatia: Strengthening Public Sector Efficiency and Accountability in Croatia (P175259),” led by Pedro Arizti (Senior Public Sector Specialist). The report was prepared by Marko Primorac (Professor, Faculty of Economics and Business, University of Zagreb), with inputs from Jorge Martínez-Vázquez (Regents Professor of Economics at the Andrew Young School of Public Policy at Georgia State University), Pedro Arizti (Senior Public Sector Specialist), and Alexander Sirois (Analyst). The team wishes to thank the following peer reviewers for their advice and contributions: Serdar Yilmaz (Lead Public Sector Specialist), Farah Zahir (Senior Economist), Desislava Enikova Nikolova (Senior Economist), and Josip Funda (Senior Country Economist). The report was edited by Patricia Carley. Disclaimer © 2022 The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved This document is the product of work performed by World Bank staff and consultants. The findings, interpretations, and conclusions expressed in this document do not necessarily reflect the views of the Executive Directors of the World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denomination, and other information shown in any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this work is subject to copyright. The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Attribution—Please cite the work as follows: “World Bank. {YEAR OF PUBLICATION}. {TITLE}. © World Bank.” Any queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522- 2422; e-mail: pubrights@worldbank.org. Table of Contents List of Acronyms ...................................................................................................................... 2 Executive Summary ................................................................................................................. 3 1. Introduction ........................................................................................................................ 11 2. Comparative Territorial Administrative Structure and Fragmentation in Croatia ... 18 3. Capacity of Local and Regional Government Units ....................................................... 31 4. International Experience in Dealing with Municipal Fragmentation and the Lack of Capacity................................................................................................................................... 46 4.1. Major elements and content of reform in international practice ................................... 46 4.2. The implementation of reforms in international practice ............................................. 48 5. Incentive Measures for Intermunicipal Cooperation and the Creation of Commonwealths ..................................................................................................................... 63 6. Policy Options and Recommendations for Croatia ......................................................... 74 Annex 1. NRRP–C2.2. R4-I1: Further Optimization and Decentralization of LRGUs through Support for Functional Mergers ............................................................................ 83 Annex 2. National Public Administration Development Plan – Specific Objective 5. Improving the Functionality and Sustainability of Local and Regional Self-Government .................................................................................................................................................. 86 Annex 3. Vertical Structure of Government across EU Member States ........................... 88 Annex 4. Optimal Community Size and Club Theory ........................................................ 90 Annex 5. Objectives of Intermunicipal Cooperation in Various Domains ....................... 92 Annex 6. Further Optimization and Decentralization by Stimulating Functional Merging of Local Government Units .................................................................................... 94 References ............................................................................................................................... 95 List of Tables......................................................................................................................... 102 List of Figures ....................................................................................................................... 102 List of Boxes .......................................................................................................................... 103 1 List of Acronyms CoE Council of Europe EC European Commission EU EU GDP Gross Domestic Product HDZ Hrvatska Demokratska Zajednica (Croatian Democratic Union) HRK Hrvatska Kuna (Croatian Kuna) ICT Information and Communications Technology IMC Intermunicipal Cooperation IT Information Technology LGU Local Government Unit LRGU Local and Regional Government Unit MAPS Methodology for Assessing Procurement Systems MFSA Municipal Finances Self-Assessment MJPA Ministry of Justice and Public Administration MOF Ministry of Finance MRDEUF Ministry of Regional Development and EU Funds NOK Norwegian Krone (currency) NRRP National Recovery and Resilience Plan OECD Organisation for Economic Co-Operation and Development PEFA Public Expenditure and Financial Accountability PFM Public Financial Management PIMA Public Investment Management Assessment PIT Personal Income Tax PPP Public-Private Partnership SEE South East Europe SDP Socijaldemokratska Partija Hrvatske (Social-Democrat Party) TADAT Tax Administration Diagnostic Assessment Tool UNDP United Nations Development Programme UTC United Territorial Community 2 Executive Summary 1. Croatia’s high degree of municipal fragmentation has been consistently recognized as a weakness and one of the main problems of its intergovernmental fiscal system. This report examines the nature of this fragmentation, following up on the recent report, “Croatia Fiscal Decentralization,” 2 which analyzes the country’s intergovernmental fiscal transfer system and reviews the state of municipal fragmentation, its link to municipal capacity, and how other countries have dealt with this issue. 2. The report argues that the problem of fragmentation is in essence a problem of capacity. Capacity is thus identified as the main factor inextricably linked to local government fragmentation. For this analysis, capacity is understood as the administrative, managerial, revenue, and expenditure abilities that local government units (LGUs) need to have to successfully provide assigned services to citizens and firms. 3. The objective of this report is to review international experiences and lessons in the promotion of local government mergers and municipal associations to inform efforts to advance institutional reform in Croatia and address the problem of low local government capacity. The report was requested by the Ministry of Finance to provide input into the development of a program to promote intermunicipal cooperation (IMC) in the country. The report also presents insights into the incentives needed to encourage the voluntary association of LGUs for the common provision of certain functions and public services based on international practice. 4. The report is organized into six sections. After an introduction, the second section reviews the fragmented territorial administrative structure in Croatia, and the third is devoted to unpacking the concept of LGU capacity. Although they provide an overview of some important features and characteristics of LGUs in Croatia, these two chapters do not attempt to precisely measure the level of LGU fragmentation and capacity but rather to provide applicable examples from other countries in order to identify good practices in dealing with similar challenges. The fourth section focuses on relevant international experience related to municipal fragmentation and capacity deficiencies, and the fifth examines incentive measures for IMC and the creation of associations or commonwealths. The sixth and final section lays out policy options and recommendations for Croatia, prioritized along a proposed sequence for implementation. The problem 5. Fragmentation is one of the main causes of LGU incapacity. Croatia’s administrative-territorial structure is characterized by the existence of numerous relatively small local governments that generally have weak fiscal and administrative capacity. Among 2 For more information, see World Bank (2021), Report 166109. 3 other issues, this poses a significant lack of economies of scale in the delivery of many public services. Almost two-thirds of municipalities have fewer than 3,000 inhabitants; roughly 13 percent have fewer than 1,000. In 2021, 29 municipalities had a slightly larger population (between 5,000 and 10,000), while five had over 10,000 inhabitants. Cities in Croatia are also relatively small, and more than half have fewer than 10,000 inhabitants. In 2021, when the last census was taken, almost two-thirds of cities had populations under 15,000 inhabitants, and almost 20 percent of cities had fewer than 5,000. 6. Local government fragmentation is pervasive across decentralized countries around the world. This phenomenon is characterized by (i) a relatively large number of local governments with populations too small to take advantage of economies of scale in the delivery of public services, (ii) a lack of administrative capacity and specialized resources, and/or (iii) low tax bases and revenue potential. Subnational government fragmentation and the consequent lack of capacity are among the most significant policy issues in Croatia’s system of intergovernmental fiscal relations. This has had negative consequences not only for the financing system but also for the efficient supply of local public goods and services, that is, the quality and quantity of provision for their assigned functions. A significant proportion of cities and most municipalities do not appear to have the managerial, human, fiscal, technical, and organizational capacity to successfully perform all entrusted functions. 7. Many municipalities do not have their own budgetary users, and in some municipalities, all administrative services are performed by one or two employees. The administrative capacity of these LGUs is inadequate and insufficient for ordinary operational and financial management procedures. In these circumstances, it is questionable whether further decentralization can be undertaken, as municipalities, generally serving small populations with a limited number of employees and fiscal capacity, are unable to assume or perform basic public functions and provide quality public services related to their currently decentralized responsibilities. For local governments, fiscal revenues often cover only the cost of basic administrative operations. Thus, the essential problem remains that many local governments are unable to carry out basic local public functions. Furthermore, their administrative capacity is weak and cannot support local development (through, for example, strategic planning, capital investments and infrastructure development, digitalization, absorption of European Union funds, use of advanced financing models, etc.). In addition, there is little hope that even with increased efforts in training and capacity building these conditions will change any time soon. 8. Solutions are needed to tackle fragmentation and with it, deficiencies in local capacity. Since fragmentation is one of the main drivers of low LGU capacity, it is important to facilitate subnational government cooperation and the creation of associations and joint projects at the municipality level, among counties, and between cities and municipalities. This may allow for a greater concentration of financing capacity, specialized expertise, and overall administrative efficiency. Although a lack of administrative capacity can be treated in many ways, functional and real mergers of LGUs might turn out to be the fastest and the most 4 effective remedy. Of the many different benefits of such initiatives, the specialization of employees currently performing many different tasks in small LGUs may certainly be among the most important. 9. There have been previous attempts to implement reform in Croatia. Over the years, there have been many attempts by different working groups to come up with an optimal architecture for the subnational sector and the relevant paths to reducing the number of LGUs. However, success has been limited. The main reasons behind the negative perception of territorial-administrative reform do not differ much from those in other countries: local officials are afraid of losing their jobs, local citizens are afraid of losing their “autonomy” and “identity,” and local political representatives are afraid of losing their popular support. The potential threat of political unrest related to any territorial-administrative reform also makes the reform less attractive to the central government. 10. An opportunity to move ahead with this needed restructuring may be opening in Croatia. Challenges created by the COVID-19 pandemic, the relative stability of the country’s current central administration, and the absence of scheduled elections for the next three years (parliamentary, presidential, or local) have created the favorable preconditions necessary for the government to finally implement reforms long postponed for political reasons, sometimes including an apparent lack of popular support. These reforms could include addressing the fragmentation of local governments that persistently results in weak fiscal and administrative capacity. 11. To cope with fragmentation and capacity deficiencies, the government is developing a centrally designed program to incentivize the merger or association of local governments for the provision of services. The government is looking to propose several possible financing models for the joint performance of tasks, considering the scope of LGUs laid down by law and the stated needs involved. At the same time, the potential for the actual merger of LGUs will be evaluated and financially encouraged (incentivized). The legislative framework will be amended and a financial support mechanism put in place to foster a functional and/or actual merger. Croatia has already decided to embark on a process of promoting voluntary functional and real LGU mergers to overcome the many challenges related to the fragmentation and low administrative, human resource, and fiscal capacity in many small (and especially rural) LGUs. Key messages from international experience 12. International experience has shown that when it comes to fragmentation and options for dealing with it, there is no “one-size-fits-all” recipe. Levels of fiscal decentralization, LGUs’ fiscal capacity, their autonomy and scope, the quality of locally provided services, and the existence of cooperation mechanisms all determine how serious the problem of fragmentation might be. These characteristics also influence decisions on incentive 5 plans and the design of reform measures in general. In addition to country-specific considerations, political factors also play a role. Finally, it is important to note that many countries are still experimenting with these issues, and there is no hard evidence in many cases on whether some relatively recent changes have produced the desired outcomes. In fact, there is very little hard quantitative evidence of the effects of different reform paths based on objective metrics of success or failure. This is particularly true with regard to the quality of services provided. To fill in this gap in the existing empirical literature, more research will be needed to clarify the question of service quality and to analyze, on an experimental basis, how that quality may improve through associations and voluntary mergers relative to forced mergers. 13. Despite the significant reform variations across countries, some consistent evidence is emerging on the impact of municipal mergers. This includes evidence that: (i) cost savings are primarily limited to general administrative expenditures (wages, office supplies, and so on), though the savings are not always apparent because the merged unit tends to adopt the higher standard costs of the merging units; (ii) few changes in the quality of local services are perceptible; and (iii) there is often some diminished quality of local democracy and representation. On this last issue, several studies point to amalgamation reforms that have resulted in a trade-off between efficiency and democracy. Despite its relevance to justifying forced local amalgamation programs, the empirical evidence on the existence of economies of scale in the provision of local public goods and services remains elusive. Nevertheless, IMC in several areas of public policy, such as citizen security, tourism, and management of water resources, has yielded, at least implicitly, positive effects. There is also evidence of cost savings in the provision of certain services, for example, in waste management. On the other hand, some studies have found levels of effectiveness that were lower than hoped, and others have questioned the effectiveness of collaboration and associations as the means to address low capacity or as a way to overcome initial inequities and to fiscally balance local governments. 14. When it comes to the political attractiveness of various reform paths, international experience suggests that promoting associations may in some cases be more effective than forcing mergers. This is mainly because it takes time for the potential benefits of the former reform path to be achieved and become evident. If the government does not initiate such reform at the beginning of its mandate (which is very unlikely in the best of circumstances), it is questionable whether the potential benefits will become obvious before the next elections. At the same time, negative short-term consequences are frequently immediately evident (and usually anticipated even before the reform has been implemented). With this in mind, when governments decide to deal with fragmentation through a reform effort, it becomes apparent that forced mergers are politically more sensitive (and challenging) than voluntary mergers and increased cooperation among LGUs. Still, it should be noted that even though fragmentation problems have long been recognized, countries have been implementing reforms for years and are still experimenting with different reform paths and instruments. As in any reform of that importance and size, political context is paramount, and not all cases are the same. 6 15. Financial incentives often play a key role in successful reforms. These most often include providing unconditional current grants, capital grants, debt relief, and incentives within the equalization system and within the tax sharing scheme, though many of these options undermine Tinbergen’s “one goal-one instrument” rule in policy implementation. Positive incentives can also consist of prioritizing jointly financed projects as opposed to those proposed by a single municipality. 16. A simple and effective formula to stimulate mergers and IMC is to grant priority financial treatment to investment projects and/or the provision of public services that come from merged or cooperating LGUs. However, this approach is too general and even problematic when resources are insufficient to finance all the projects requested. A more explicit way to support LGU mergers and cooperation would be the creation of a line of subsidies (or subsidized credits) specifically destined to finance projects proposed by merged or cooperating LGUs. Alternatively, a system of conditional transfers could be created whose “coverage rate” would be higher for projects that result from IMC. Another way to stimulate cooperation may be to create (or transfer) financial instruments available only to the pooled authorities (e.g., specific taxes). Or regional or central levels of government could opt for strategies that discourage local non-cooperation. In particular, they could increase local budgetary tension by reducing the subsidies received by municipalities, or block part of their potential resources as long as cooperation agreements do not take place. In any case, it is worth mentioning that the empirical literature finds little evidence of the efficacy of adverse budgetary conditions (negative incentives) on the decision to implement local cooperation agreements. 17. The time frame for providing incentive grants, as well as the methods for calculating the installments, should be explicit so that LGUs can calculate the potential benefits and the central government can have an idea of the implied budgetary costs. Another, more prudent option would be defining the available amount of the incentive fund for territorial and functional consolidation and identifying incentives in proportion to the population but ultimately still subject to the available pool of funds. 18. Criteria must be explicit, fixed in the law, and known in advance. The advantage of the formula-based incentive grant is that it is transparent from the outset and not negotiable. To avoid the cynical “gaming” of incentives, combined with a “once-in-stay-in” stipulation, incentives can be staggered and “back-loaded” so that most of the funds are transferred to LGUs well after they have demonstrated successful joint operation. In addition to these positive “carrot” measures, third-party coercion and incentives can also be extended to include negative “stick” policies. Threats of compulsory structural reform, including forced mergers, could thus be used as a catalyst to encourage small LGUs to establish shared service entities. Legal obligations binding all LGUs to these arrangements, together with periodic monitoring of these entities, would assist in preventing the creation of sham joint ventures that exist only on the surface. 7 19. The emerging trends observed across countries in recent years on financial and functional incentives to stimulate voluntary mergers and cooperation can be summarized as follows: • There is no “one-size-fits-all” solution to providing financial and functional incentives for voluntary mergers and cooperation. • Most countries rely on transferring additional responsibilities (and financing) to merged or cooperating LGUs. • Observing different reform paths and incentives employed and having in mind Croatian specifics, at this stage, additional capital grants for infrastructure projects would seem to be the most appropriate and viable solution. • Functional incentives for voluntary mergers and cooperation could, for the time being, be of an indirect nature, that is, merged or cooperating LGUs could (due to increased fiscal capacity) take over some or all of the newly decentralized functions, such as health care, education, social welfare, and fire protection services. It has to be noted that LGUs currently get an increased share of the personal income tax, a shared tax divided by counties and LGUs (cities and municipalities), for each newly decentralized function they assume. • Local government associations and voluntary mergers can also lead to increased financial capacity and resources to provide higher-quality public services to the local population. Recommendations 20. Based on the review of international experience, the government of Croatia has several relevant options, instruments, and actions for promoting voluntary mergers and cooperation among LGUs. There are specific recommendations, organized by term (short and medium) and type (strategic/institutional and operational). The top short-term recommendations include two strategic and two operational recommendations that are shown in the figure below (priority recommendations are noted in bold). 8 Figure ES1. Main Recommendation by Priority and Type Source: World Bank team and staff elaboration. 21. Focusing on the creation of local government associations or on voluntary mergers for the joint delivery of services that require some minimum efficient scale is usually much more appropriate and effective than legislating forced mergers, and also politically less sensitive. It is apparent that this reform would have to unfold gradually over the coming years. Therefore, the government should start implementing a reform of limited scope as a first step. For example, reform measures can be proposed for only those functions that have the greatest prospect for joint provision. This should be accompanied by the design of an explicit strategy for a reform program that can be deployed steadily over the next several years. Despite the numerous potential options available, it appears at this stage that the financial instruments aimed at the targeted incentivization of voluntary associations and mergers should be based on capital grants to LGUs that opt for cooperation. These grants should be conditional on the realization of infrastructure projects in the domain/sector where LGUs cooperate. 22. However, international experience shows that the successful implementation of reforms is possible using other instruments, such as debt relief (as in the case of Belgium in 2016). If the government decides to use other such instruments to incentivize mergers and associations, the implementation criteria must be carefully designed to prevent moral hazard and other adverse outcomes in the future. Another instrument that could be considered is grants for recurrent expenditures. In this case, a clear time limit would have to be determined for those current transfers. The setting of clear and transparent criteria for disbursing grants has the advantage of plainly defining the rules of the game for the national government to effectively deploy funds to willing LGUs. 9 23. Additionally, the government should consider developing simple metrics and demonstrable benchmarks for the monitoring and evaluation of these programs. The data collected during that process will be instrumental in assessing the effectiveness of the reforms and retrofitting reform design. Some examples of those indicators include the cost of specific services before and after the association/merger of municipalities; local inhabitants’ surveys on the perceived quality of certain services; or the volume of regional development investment (before and after the reforms). 24. The top priority recommendations for the government’s consideration based on the level of importance and urgency include the following: • Focus on creating local government associations or voluntary mergers for the joint delivery of services that require some minimum efficient scale and much less on instituting forced mergers. • Design an explicit strategy for the reform program that can be deployed gradually over the next several years. • Develop financial instruments aimed at the targeted incentivization of voluntary associations and mergers. • Develop criteria for allocating financial incentives. 25. Other recommendations include: • Consider developing (at least a simple) metric and set demonstrable benchmarks for prolonged monitoring and evaluation. • Simplify the legal and administrative process for establishing municipal associations. • Provide national support for the initial operation of the associations. • Raise awareness of the benefits of functional and real mergers, including (indirect) functional incentives to merge through increased fiscal capacity. • Design and deploy a centrally driven capacity program to support small and medium- sized LGUs (e.g., those with fewer than 10,000 inhabitants). • Establish sound and transparent evaluation and monitoring mechanisms. • Develop mechanisms for vertical and horizontal institutional cooperation. • Ensure compliance with the existing legislative framework. 10 1. Introduction 26. Croatia is a country with a high degree of municipal fragmentation, which has been consistently recognized as a weakness and one of the main problems of its intergovernmental fiscal system. This report examines the nature of this fragmentation, following up on the recent report, “Croatia Fiscal Decentralization,” 3 which analyzes the country’s intergovernmental fiscal transfer system and reviews the state of municipal fragmentation, its link to municipal capacity, and how other countries have dealt with this issue. The report argues that the problem of fragmentation is in essence not one of size (beyond some minimum level) but more of capacity. The report thus identifies local capacity as the underlying factor inextricably linked to fragmentation. For the purposes of this report, local capacity is understood as the managerial, revenue, and expenditure abilities that local government units (LGUs) need to have to successfully provide statutorily assigned services to citizens and firms. 27. The objective of this report is to review international experiences in local government mergers and municipal associations in order to support institutional reform in Croatia that addresses the problem of low local government capacity. The report was requested by the Ministry of Finance to provide input into the development of a program to promote intermunicipal cooperation (IMC) in Croatia. 4 In addition to the identification of relevant international practice in this field, the report presents some insights into the kinds of incentives that are needed to encourage the voluntary association of several local governments for the common provision of certain functions and public services. 28. The report is organized into six sections that together provide an overview of the challenges Croatia faces, the relevant international experience, and possible policy options for the country. Following the introduction, the second section reviews the territorial administrative structure and fragmentation in Croatia, and the third is devoted to unpacking the current capacity of local and regional government units (LRGUs). Although these two chapters provide an overview of some important features and characteristics of LRGUs, they do not attempt to precisely measure the level of LRGU fragmentation and capacity but rather to describe a selection of relevant country examples in order to identify good practices in dealing with similar challenges. The fourth section focuses on pertinent international experience related to municipal fragmentation and capacity deficiencies. The fifth focuses on incentive measures for IMC and the creation of associations or commonwealths, and the final sixth section lays out policy options and recommendations for Croatia, prioritized along a proposed sequence for implementation. Background 3 For more information, see World Bank (2021). 4 IMC is the relationship between two or more municipalities that agree to work together on any of the tasks assigned to them in order to gain mutual benefits. 11 29. Croatia’s fragmented territorial-administrative structure has been diagnosed as one of the most prominent challenges faced by the fiscal decentralization system (Ott and Bajo 2001; Jurlina Alibegović 2010; Koprić 2015; Đulabić and Čepo 2017). Recently, Buljan Deskar-Škrbić, and Švaljek (2021) found that roughly 30 percent of local units in Croatia can be labeled as “too small” to realize potential economies of scale in service delivery. At the same time, these authors also noted how forced amalgamations and mergers could be politically challenging because of the strong opposition to full-scale reform of the local government system. Over the years, there have been many unsuccessful attempts by different working groups to come up with the optimal architecture for the subnational sector and relevant paths to reduce the number of LGUs. The main reasons behind this overall negative perception of territorial-administrative reform do not differ much from those in other countries: local officials are afraid of losing their jobs, local citizens are afraid of losing their “autonomy” and “identity,” and local political representatives are afraid of losing their popular support. The political unrest that any mention of territorial-administrative reform threatens to produce also makes the reform less attractive to the central government. 30. However, an opportunity to move ahead with this needed restructuring may be opening in Croatia. Challenges created by the COVID-19 pandemic, the relative stability of the country’s current central administration, and the absence of scheduled elections for the next three years (parliamentary, presidential, or local) have created the favorable preconditions necessary for the government to finally implement reforms long postponed for political reasons, sometimes including an apparent lack of popular support. These reforms could no doubt include addressing the fragmentation of local governments that persistently results in weak fiscal and administrative capacity. 31. The government in Croatia is aware of the challenges faced by the current system of decentralization. In fact, it has proposed specific reform measures to tackle these problems in the Government Program for the Mandate 2020–2024 (Croatia 2020a). These measures include (i) establishing a database of financial and administrative capacities and tasks performed by LGUs and (ii) defining IMC mechanisms in order to connect the LGUs into functional units, while in the process, furthering the digitalization and transparency of public services. The National Reform Program 2020 (Croatia 2020b) also recognizes the insufficient capacity of LRGUs, which results in differences in the level and quality of public services, representing an obstacle to further successful decentralization. 32. The National Development Strategy of the Republic of Croatia 2030 (OG 13/2021) also points to the fragmentation of public administration that thwarts coordination and cooperation among various public bodies and institutions (Croatia 2021a). In addition, local administrations are often seen as lacking sufficient capacity, reflected in the difficulties that arise in using European Union (EU) funds to finance large infrastructure investments. Cooperation among LGUs, the development of institutional links, and voluntary merging will be encouraged. The need for reform has also been recognized by the European Commission 12 (EC). The details are contained in the country-specific recommendation issued in 2020 (EC 2020), which specifically states that public administrative efficiency in Croatia ranks below the EU average. This low capacity to design and implement policies and projects hampers effectiveness and has become especially apparent during the crisis in the implementation of the EU’s Structural and Investment Funds. Moreover, the high territorial fragmentation of public administration and the imbalance between responsibilities and resources at the local level contribute to the uneven public service quality across the country and the rising administrative costs. 33. The National Recovery and Resilience Plan 2021-2026 (NRRP) (Croatia 2021b) also recognizes these challenges and proposes changes in this area. It points to the unsatisfactory level of service quality among LRGUs, mainly as a result of weak administrative and fiscal capacity as well as a lack of transparency. To improve the provision of state and public administrative services, efforts will be made to further decentralize the state, encouraging the functional merging 5 of LRGUs for more sustainable local budget and project planning in order to raise the quality of life for citizens. This includes creating the preconditions needed to optimize the LRGU system by functionally integrating certain business procedures and generally modernizing public administration at the LRGU level through digitalization, interoperability, reductions in the number of local officials, and better salary and human resource management. The functional merger of LRGUs will also seek to mitigate the negative effects of territorial fragmentation on local public service provision. A more detailed diagnostic found in the NRRP is outlined in box 1.1. Box 1.1. NRRP – C2.2. R4 Functional and Sustainable Local Government The local and regional self-government system in Croatia faces the challenge of insufficient administrative and fiscal capacity to provide quality services, as well as a lack of transparency in the spending of budget funds. This leads to the fact that in many units, certain public needs are not adequately met, and citizens are not satisfied with the functioning of their local governments. The aim is to ensure high-quality and efficient public services through the functional connection of units. A system will be created to finance the joint performance of individual LGU tasks, including those related to their self-governing functions as well as other professional duties. Through cooperation, LGUs can more easily overcome the problem of insufficient capacity, improve the quality and quantity of the services provided, and make more efficient use of the available resources. Joint performance of tasks will be encouraged by the co-financing of specific activities. The criteria for determining the amount of co-financing will depend, inter alia, on the number of tasks performed jointly and will be determined by a specific law. Co-financing should result in a larger number of LGUs involved in the joint performance of tasks. An LGU will be entitled to additional funds, that is, the co-financing of expenditure, if it is involved in the joint performance of certain tasks. In that case, it would be entitled to a certain percentage of co- financing of its budget expenditure incurred for that purpose in the previous year. For each additional task, the amount of co-financing would be increased by a certain percentage (up to a certain limit). In cooperation with the Ministry of Finance (MOF), the co-financing funds will be provided in the 5 This is the merger of one or more functions of two or more local governments to satisfy stakeholder benefit and/or cost preferences. 13 equalization fund. The exact criteria for, and the manner and possibility of, co-financing the joint performance of certain tasks, as well as the status of the employees/officials who will perform the tasks for several combined units, will be determined. At the same time, although the current legislative framework provides for the possibility of the actual merging of units, the fact is that so far there has not been much interest in this. Therefore, the potential for actual LGU mergers will be evaluated, and genuine mergers will be financially encouraged (incentivized). LGUs that are actually or functionally merged will be obligated to send impact reports to the MOF, the state administrative body whose scope includes joint work, and the Ministry of Justice and Public Administration (MJPA). The submission of impact reports to the competent authorities will occur through the support system for the functional and real connectivity of LGUs. Successful implementation of an actual or functional merger, the joint performance of certain tasks, and the submission of subsequent reports will be preconditions to the allocation of additional funds, that is, co- financing. In so doing, units that decide to merge functionally in order to be eligible for co-financing will be obligated to carry out joint work/tasks for a minimum period of five years. Several possible financing models for the joint performance of tasks will be proposed, considering the scope of LGUs laid down by law and the requirements involved. The initial parameters would be: the stated needs of LGUs, the budgetary and fiscal capacity, the number of inhabitants concerned, the number of potential service users, and the durability of performing certain local services. A particular goal is that a functional or actual merger of units will have a positive impact when applying for EU grants and co-financing from EU funds. In order to support units that decide to merge in actuality or for functional purposes, an interdepartmental working group will also be established consisting of experts from state administration bodies. In addition to supporting these reform activities, one of the tasks of the working group will be to evaluate the merger process in order to clearly identify its financial and other effects and to monitor the outcome, thereby ensuring the establishment of a well-designed and efficient LRGU system. The legislative framework will be amended, and a financial support mechanism put in place to foster a functional or actual merger, while ensuring sufficient resources in the state budget to financially encourage the actual merger of at least 20 percent of LGUs, or a functional merger of at least 40 percent, during the period up to 2026. In so doing, functionally merged LGUs will retain the same budget available to them before the merger for a period of at least two years, and incentives will also cover one- off merger costs and provide additional funds based on the savings achieved over the ensuing five years. In addition, incentives for actual mergers will include one-off capital transfers over five years that LGUs will use specifically for infrastructure projects. The criteria and the value of incentives will be determined by the government, with greater fiscal incentives for actual mergers and those for functional mergers dependent on the number and type of joint (merged) functions provided. After the adoption of the government’s decision, a public invitation will be issued to the LGUs for expressions of interest in a voluntary functional or actual merger. Source: Croatia (2021b). 34. As part of the NRRP, investments are planned that will support the functional and/or real merging of LGUs, with the aim of establishing a comprehensive system of support for the functional and actual connections of units based on criteria to incentivize (financially encourage) this process (see Annex 1). Moreover, appropriate legislative activities will be initiated, including amendments to the Law on Financing of Local and Regional Self- Government Units and the Law on Civil Servants and Employees in Local and Regional Self- Government. If the units opt for the actual (real) merger, consequent amendments to the Law on the Territories of Counties, Cities and Municipalities in Croatia will be necessary, as well as possible amendments to the Law on Local and Regional Self-Government. 14 35. The Act on the Execution of the State Budget of the Republic of Croatia for 2022 (OG 140/21) in Article 32 stipulates that LGUs should receive grants in the name of incentives for voluntary functional or actual mergers during 2022 from section 025 – Ministry of Finance (MOF), up to the amount provided for that purpose in the Budget (HRK 100 million in 2022). The government will decide on the criteria for disbursing the grants referred to above at the proposal of the MOF in cooperation with the Ministry of Justice and Public Administration (MJPA). According to Article 67, the deadline for deciding on the criteria for disbursing grants to LGUs as an incentive for a voluntary functional or actual merger is 90 days from the day the Act enters into force. In the Proposal of the State Budget of the Republic of Croatia for 2022 and the projections for 2023 and 2024, HRK 100 million has been set aside for these incentives. The government will outline the parameters, with higher fiscal incentives for voluntary actual mergers and those for functional mergers dependent on the number and type of functions intended. 36. According to the NRRP: “The joint performance of tasks will be encouraged by co- financing of the expenditure for specific activities. The criteria for determining the amount of co-financing will depend, inter alia, on the number of tasks performed jointly and will be determined by a specific law. In cooperation with the MOF, the co-financing funds will be provided in the equalization fund. Units that decide to merge functionally, in order to be eligible for co-financing, will be obliged to carry out joint work/tasks for a minimum period of 5 years.” 37. The government is looking to propose several possible financing models for the joint performance of tasks, considering the scope of LGUs laid down by law and the stated needs involved. The initial parameters would be the stated needs of LGUs, their budgetary and fiscal capacity, the number of inhabitants, the number of potential users of services, and the time frame involved in performing certain local services. One clear objective is that a functional or actual merger of units will have a positive impact when awarding EU grants and co-financing from EU funds. 38. At the same time, the potential for the actual merger of LGUs will be evaluated and financially incentivized. The legislative framework will be amended, and a financial support mechanism put in place to foster a functional and/or actual merger. This will occur while ensuring that there are sufficient resources in the state budget to financially encourage the actual merger of at least 20 percent of LGUs and a functional merger of at least 40 percent of LGUs during the period up to 2026. In so doing, functionally merged LGUs will retain the same budget available to them before the merger for a period of at least two years, and incentives will also cover one-off merger costs and provide additional funds based on the savings achieved over the ensuing five years. In addition, incentives for actual LGU mergers will include one-off capital transfers over the five years that LGUs will use specifically for infrastructure projects. The criteria and the nature of the incentives will be determined by a government decision, with greater fiscal incentives for actual mergers and incentives for 15 functional mergers dependent on the number and type of joint (merged) functions provided. After the adoption of the government decision, the call for an expression of interest in a voluntary functional or actual merger will be published in the Official Gazette. 39. The National Public Administration Development Plan for the period from 2022 to 2027 (Croatia 2022a) and Action plan for the implementation of the National Public Administration Development Plan for the period from 2022 to 2024 (Croatia 2022b) also recognized that at the local level, there is often insufficient administrative and human capacity to perform tasks within the scope of self-government. More specifically, difficulties frequently arise in the process of using European funds to finance large investments. The lack of financial potential is also a challenge, particularly for LGUs in rural areas. In order to reduce and rationalize the costs of LRGUs, the number of local officials was revised by adopting the Law on Amendments to the Law on Local and Regional Self-Government in December 2020. In the local elections held in May 2021, 568 deputies were elected (instead of the previous 671 deputies), as well as 103 deputy municipal heads, city mayors, and county prefects. At the same time, the number of members of representative bodies was reduced by 870, that is, instead of the previous 8,254 counselors, only 7,384 members of municipal and city councils and county assemblies were elected. It should be noted that one of the amendments also requires that all LRGUs publish, on paper or online, all spent public funds in a way that is accessible and easily searchable. Regarding the encouragement of voluntary functional and actual merging of local units, it should also be noted that specific objective 5 is devoted to improving the functionality and sustainability of local and regional self-government (see Annex 2). 40. These restructuring efforts come in very challenging times. The COVID-19 pandemic has caused direct economic effects that have put immediate pressure on local government budgets, predominantly financed through the personal income tax (PIT) and surtax. Indirectly, through disturbances in global supply chains as well as geopolitical and geo- economic turbulence but also as a result of government interventions and recovery plans, the rate of inflation is rising, as are expectations of future inflation. Energy prices have already risen significantly, and utility prices are also expected to rise in the short term. Moreover, according to public forecasts, significant price increases are expected in the water supply sector. This context might turn out to be quite decisive for the success of the envisaged reforms in the structure of local government. 41. In 2021, the government created legal preconditions for the merging of smaller local water supply companies with those in larger cities. However, the initiative is currently being hampered as many small city and town mayors claim that the initiative has the hidden objective of covering the larger companies’ losses by imposing higher costs on users in their jurisdictions. Although the objective was to secure a safer and more reliable drinking water supply system, and ultimately lower prices for consumers, the smaller cities are considering calling referendums as a form of resistance to avoid incorporation. The outcome of these efforts could have a significant impact on the success of the government’s general agenda to promote 16 voluntary functional and real mergers of LGUs. Once again, as was learned during the unsuccessful introduction of the recurring property tax, a clear and effective communication campaign, the transparent presentation of the expected results and effects (impact analyses), and the inclusion of all relevant stakeholders, especially those from the local level, could prove to be critical to ensuring the success of this new reform effort. 42. To reiterate, the primary goal of this report is to review international experiences and lessons in local government mergers and municipal associations to inform related reforms in Croatia. More specifically, the analysis puts a particular emphasis on providing useful information on possible incentives to promote the voluntary association of several local governments for the common provision of certain functions and public services. Croatia has decided to embark on the process of promoting voluntary functional and real mergers of LGUs to overcome the many challenges related to the fragmentation and low administrative, human resource, and fiscal capacity in many small, and especially rural, LGUs. Based on that analysis and taking into consideration the local context in Croatia, the report proposes some meaningful and feasible recommendations for the government’s consideration. The report is therefore not focused on the causes and consequences of administrative fragmentation and/or the lack of capacity. The government has in fact already decided to introduce incentive measures for functional and real mergers to address the main problem, identified as lack of local capacity, linked to municipal fragmentation. The report instead focuses on the criteria for designing incentive mechanisms and the overall ingredients and sequencing of a successful reform process. 43. Although the government has already decided on the design and certain characteristics of the preliminary reforms, the objectives outlined cannot be accomplished in the short term. The current HRK 100 million fund will not be sufficient to provide strong enough incentives to the desired number of units, and the reform will need a significant amount of time to fully unfold. International experience shows that it can take up to 10 years for reforms to show the desired effects. Along the way, countries tend to evaluate the impact of the measures introduced thus far and to adjust the key ingredients of the reform based on the results achieved in each phase. With this in mind, the report does not limit itself to the short-term measures envisaged by the government, but provides a more comprehensive overview of the different models and methods available, as well as the instruments and criteria needed to apply them. The report should therefore be seen primarily as a guide and a source of information for the government to inform and support the implementation of the reform program. 17 2. Comparative Territorial Administrative Structure and Fragmentation in Croatia 44. Croatia has a rich history of administrative-territorial reform. These changes were often based on predominantly political, instead of economic, criteria (Čavrak 2009). Croatia is a unitary country, currently administratively divided into 21 regional (county level) and 556 LGUs (table 2.1). The 21 counties (including the 770,000-inhabitant city of Zagreb, which has county status) constitute the second, or intermediate, level of subnational government, that is, regional self-government. Cities (127, mainly urban, altogether comprising 2.8 million people) and municipalities (428, mainly rural, comprising 1.1 million people) represent the first level of subnational government, that is, local self-government. 45. Municipalities are established along the territory of more populated places that represent a natural economic and social entity and are linked by the common interests of the population. A city may be an LGU, which is a county seat of government, or any town with more than 10,000 inhabitants, representing an urban, historic, natural, economic, or social entity. A county is a unit of regional self-government whose territory represents a natural, historic, transport, economic, or social self-governing entity. Table 2.1. The Vertical Structure of the Croatian Public Sector Units per Units per Tier Units Units Population Tier Million 1,000 (1992) (2021) (2021), in million Citizens km2 Central 1 1 - - - government 3.9 Counties 21 21 II 3.9 5.4 0.4 Cities 70 128 2.8 45.5 2.2 I Municipalities 419 428 1.1 390.2 7.6 Cities and 489 556 I 143.0 9.8 municipalities 3.9 Source: Authors calculations, based on 2021 census data from Croatian Bureau of Statistics. Note: In 1992, in addition to the above-mentioned lower tiers of government, there were formally two districts (Glina and Knin) with a special self-governing status. However, although the law provides for their existence due to the occupation of these areas and political turmoil during the Homeland War, the districts never came to life. The number of administrative units of a certain level of government per million inhabitants (for cities and municipalities) is calculated as the ratio of the number of administrative units of a certain type (cities or municipalities) and the number of inhabitants living in that type of unit (not total population), while the number of units per thousand square kilometers for each category is calculated as the ratio of the number of local units (cities or municipalities) and the total area of the Republic of Croatia. 46. Counties, cities, and municipalities regulate their internal organization, structure, and operations through statutes and bylaws. LRGUs have a representative and executive body. The representative bodies take the form of municipal councils, city councils, and county assemblies. In Zagreb, as a special status unit—a city with county status—the representative body is the City Assembly. Members of the representative bodies are elected in local elections 18 by secret ballot. Local elections with a proportional electoral system are held every four years, 6 whereby the candidates have to pass a threshold of 5 percent to qualify. Although there is a strong domination of two political parties, HDZ (Hrvatska Demokratska Zajednica (in English, the Croatian Democratic Union) and SDP (Socijaldemokratska Partija Hrvatske, the Social- Democratic Party), local elections are pluralistic, with many small regional parties and independent local candidates running for county, city, or municipal offices. The executive body is the municipal chief, the city mayor, and the county prefect, which, since 2009, have been directly elected by secret ballot. The chairperson recommends members of the executive authority of the LRGU to the representative body, which selects them by a majority vote. Sessions of the LRGUs’ representative bodies are open to the public. Territorial fragmentation 47. Croatia’s administrative-territorial structure is characterized by numerous relatively small local governments that generally have weak fiscal and administrative capacity. Among other issues, this poses a significant hindrance to achieving economies of scale in the delivery of many public services. Almost two-thirds of municipalities have fewer than 3,000 inhabitants; roughly 13 percent have fewer than 1,000. In 2021, 29 municipalities had a slightly larger population (between 5,000 and 10,000), while five had over 10,000 inhabitants (see table 2.2). Table 2.2. Population of Municipalities in 2021 Cumul. % Cumul. % Munici- % % Population Munici- Population palities Municipalities Population palities < 1,001 55 40,509 12.9 12.9 3.7 3.7 1,001 – 1,500 64 81,073 15.0 27.8 7.4 11.1 1,501 – 2,000 83 144,857 19.4 47.2 13.2 24.2 2,001 – 2,500 58 128,878 13.6 60.7 11.7 36.0 2,501 – 3,000 47 128,957 11.0 71.7 11.7 47.7 3,001 – 3,500 33 107,982 7.7 79.4 9.8 57.5 3,501 – 4,000 23 85,903 5.4 84.8 7.8 65.3 4,001 – 4,500 15 63,579 3.5 88.3 5.8 71.1 4,501 – 5,000 16 75,595 3.7 92.1 6.9 78.0 5,001 – 6,000 16 87,063 3.7 95.8 7.9 85.9 6,001 – 10,000 13 95,903 3.0 98.8 8.7 94.6 10,001 – 15,000 4 43,004 0.9 99.8 3.9 98.5 > 15,000 1 16,015 0.2 100.0 1.5 100.0 428 1,099,318 100.0 100.0 Source: Authors, based on 2021 census data from the Croatian Bureau of Statistics. 48. As noted above, city status requires that the LGU be located in the county seat or that it have more than 10,000 inhabitants and represent an urban, historic, natural, economic, 6 The first local elections in Croatia were held in February 1993. 19 and/or social entity. However, cities in Croatia are relatively small, and more than half have fewer than 10,000 inhabitants. In 2021, when the last census was taken, almost two-thirds of cities had populations under 15,000 inhabitants, and almost 20 percent of cities had fewer than 5,000. However, eight cities had more than 50,000 inhabitants, of which four had more than 100,000 (see table 2.3). Table 2.3. Population of Cities in 2021 Cumulative Cumulative % Cities Population % Cities % % cities Population Population < 5,001 25 85,155 19.5 19.5 3.1 3.1 5,001 – 10,000 44 313,528 34.4 53.9 11.2 14.3 10,001 – 15,000 26 313,727 20.3 74.2 11.2 25.5 15,001 – 20,000 7 126,282 5.5 79.7 4.5 30.1 20,001 – 25,000 7 162,424 5.5 85.2 5.8 35.9 25,001 – 30,000 2 55,932 1.6 86.7 2.0 37.9 30,001 – 40,000 4 142,922 3.1 89.8 5.1 43.0 40,001 – 50,000 5 218,038 3.9 93.8 7.8 50.8 50,001 – 60,000 2 102,450 1.6 95.3 3.7 54.5 60,001 – 70,000 1 61,198 0.8 96.1 2.2 56.7 70,001 – 80,000 1 70,829 0.8 96.9 2.5 59.2 100,001 – 200,000 3 366,782 2.3 99.2 13.2 72.4 > 200,000 1 769,944 0.8 100.0 27.6 100.0 Total 128 2,789,211 100.0 100.0 Source: Authors, based on 2021 census data from the Croatian Bureau of Statistics. 49. The process of fiscal and administrative decentralization among EU member states began at different times and proceeded with uneven intensity, though in many cases it has long historical roots. The different paces of decentralization reform have been generally due to the varying social and political contexts. Often, the process of fiscal decentralization has been determined largely by the nature of the administrative arrangements. Although the number of local units does not directly affect the dimensions of fiscal decentralization, given a population size, the number of units naturally determines their average size. At the same time, administrative regulations indirectly affect the type of public goods and services provided at the local level—in other words, the form and intensity of fiscal decentralization. 50. The best indicator of the structure of the subnational sector is the number of lower tiers or levels of government and the number of administrative (subnational) units at each level or tier. The vertical structure of government in the majority of EU countries consists of several tiers (table 2.4). 7 However, usually countries with smaller territories, such as Cyprus, Estonia, Ireland, Latvia, Lithuania, Luxembourg, Malta, and Slovenia, have only one 7 For details and country specifics (notes), see Annex 3. 20 subnational level. Several countries, including Belgium, Germany, Spain, France, Poland, and the United Kingdom, have three subnational tiers of government. The majority of (13) EU countries, including Croatia, have two subnational tiers (local and regional). Table 2.4. Number of Subnational Governments in 2018 Local Level Intermediary Regional or Total Level State Level Federations and Quasi-Federations Austria 2,096 9 2,105 Belgium 581 10 6 597 Germany 11,014 401 16 11,431 Spain 8,131 50 17 8,198 Unitary Countries Bulgaria 265 265 Croatia 556 21 577 Cyprus 380 380 Czech Republic 6,258 14 6,272 Denmark 98 5 103 Estonia 79 79 Finland 311 1 312 France 34,970 101 18 35,089 Greece 325 13 338 Hungary 3,178 19 3,197 Ireland 31 31 Italy 7,926 20 7,946 Latvia 119 119 Lithuania 60 60 Luxembourg 102 102 Malta 68 68 Netherlands 355 12 367 Poland 2,477 380 16 2,873 Portugal 308 2 310 Romania 3,181 42 3,223 Slovak Republic 2,929 8 2,937 Slovenia 212 212 Sweden 290 21 311 United Kingdom 382 35 3 420 EU 28 86,682 977 263 87,922 Source: OECD (2018b). 51. The number of LGUs at the lowest tiers of government in EU countries has generally declined (table 2.5). From the beginning of the second half of the 20th century until 2018, the total number of LGUs decreased by almost 41,000 (more than 30 percent). For the new EU member states, historical data on the number of local units are incomplete. Therefore, the reference (initial) year for some new EU member states used in the analysis differs and ranges in a fairly wide interval from 1950 to 1999. In absolute terms, the number of LGUs decreased the most in Germany (over 14,000), and in relative terms in Denmark, Greece, and 21 Lithuania (over 90 percent). The number of LGUs in some countries has increased; the largest absolute increase was recorded in Romania, with almost 3,000 new local units. The highest relative increase is recorded in Cyprus, where the number of LGUs increased from 32 in 1998 to 380 in 2018. Along with Romania and Cyprus, Croatia is also one of the few EU countries where the number of LGUs increased in the observed period. Table 2.5. Number of Local Units at the Lowest Tier of Government in EU Member States T0 T1 Absolute Relative Change Number of Number of Change (in %) Year Year LGUs LGUs Austria 1950 3,999 2018 2,096 -1,903 -47.59% Belgium 1949 2,669 2018 581 -2,088 -78.23% Bulgaria 1950 2,178 2018 265 -1.913 -87.83% Croatia 1950 58 2018 556 498 858.62% Cyprus 1998 32 2018 380 348 1.087.50% Czech Republic 1950 11,459 2018 6,258 -5,201 -45.39% Denmark 1950 1,387 2018 98 -1,289 -92.93% Estonia 1999 253 2018 79 -174 -68.77% Finland 1955 547 2018 311 -236 -43.14% France 1945 38,814 2018 34,970 -3,844 -9.90% Germany 1950 25,930 2018 11,014 -14,916 -57.52% Greece 1950 5,959 2018 325 -5,634 -94.55% Hungary 1950 3,217 2018 3,178 -39 -1.21% Ireland 1950 110 2018 31 -79 -71.82% Italy 1950 7,781 2018 7,926 145 1.86% Latvia 1998 560 2018 119 -441 -78.75% Lithuania 1959 642 2018 60 -582 -90.65% Luxembourg 1950 127 2018 102 -25 -19.69% Malta 1992 67 2018 68 1 1.49% Netherlands 1950 1,015 2018 355 -660 -65.02% Poland 1992 2,459 2018 2,477 18 0.73% Portugal 1950 303 2018 308 5 1.65% Romania 1950 366 2018 3,181 2,815 769.13% Slovak Republic 1950 3,359 2018 2,929 -430 -12.80% Slovenia 1952 380 2018 212 -168 -44.21% Spain 1950 9,214 2018 8,131 -1,083 -11.75% Sweden 1950 2,281 2018 290 -1,991 -87.29% UK 1950 2,140 2018 382 -1,758 -82.15% Sources: Calculation and systematization of authors, based on CoE (1995) and (1997b) for Spain; CoE (1995) and (1997a) for Bulgaria; CoE (1998) for France; CoE (1999a) and (2005) for Cyprus; CoE (1999b) for Germany; CoE (1999c) for Ireland; CoE (1999d) for Slovakia; CoE (2000a) for Austria; CoE (2000b) for Poland; CoE (2000c) for United Kingdom; CoE (2001) for Greece; CoE (2004) for Hungary; CoE (2006a) for Belgium; CoE (2006b) for Latvia; CoE (2006c) for Lithuania; CoE (2006d) for Malta; CoE (2006e) for Portugal; CoE (2007a) for Luxembourg; CoE (2007b) for Slovenia; CoE (2007c) for Sweden; CoE (2008b) for Denmark; CoE (2008c) for Italy; CoE (2008d) for Netherlands; CoE (2009a) for Finland; CoE 22 (2009b) for Romania; CoE (2010) for Czech Republic; and CoE (2011a) for Estonia, as well as DCL and CEMR (2012) and OECD (2018b). 52. There is no consensus among EU member states on the desired level of territorial- administrative decentralization. The number of LGUs is generally declining, although the possibility of identifying clearer trends is difficult as a good number of countries have recently implemented local sector reforms (see Blöchliger and Vammalle 2012). Various countries are, due to their specific history and context, at different stages of decentralization, so the number of LGUs differs, as do the trends. In addition, the number of lower levels of government is also not uniform, and neither, accordingly, are the powers and responsibilities of subnational units of each level of government. In some, typically more developed, countries, there are also associations (commonwealths) of local units that are not formally in the vertical structure as a separate level of government. These associations or commonwealths are established with the aim of performing certain public functions more efficiently. However, different approaches to territorial-administrative decentralization in the various countries tend to stem from different needs and different historical heritages. 53. The number of local units should, in principle, depend on the number of inhabitants and the area of the state, but also on the level of economic development, which indirectly determines the standard of public goods and services at the local level. In any case, the first two characteristics (population and area) should be crucial. A larger area should also require more LGUs, given that local public services cannot be adequately and efficiently provided in too large a geographical area. On the other hand, too many LGUs can be cost- inefficient due to the accumulation of administration costs and the inability to exploit economies of scale in the provision of public services. Of course, a larger number of LGUs also means on average fewer inhabitants living in those areas. Excessive fragmentation due to the proliferation of local government units can cause weak local entities with low administrative and fiscal capacity and, in its extreme, prevent the realization of fiscal decentralization objectives. 23 Figure 2.1. Relation between the Number of LGUs and Population in 2018 among EU Countries 100 90 80 Population (in millions) 70 60 50 y = 0.0023x + 10.275 R² = 0.4076 40 30 20 10 0 0 2,000 4,000 6,000 8,000 10,000 12,000 Number of LGUs Source: Authors’ calculations, based on OECD (2018b) and Eurostat data. Note: France does not appear in figures as the maximum value on the horizontal axis is set to 12,000, and the number of LGUs in France is almost 35,000. However, it is not excluded from the sample, so the regression coefficient and coefficient of determination are calculated for a dataset that includes all EU member states. 54. As expected, figures 2.1. and 2.2. below confirm that the number of LGUs is positively correlated with the population and area of a country. However, these figures are only illustrative gross correlations, because there are probably many other significant factors affecting the number of LGUs that cannot be analyzed here. 8 Figure 2.2. Relation between the Number of LGUs and Area in 2018 800 700 Area (in thousands of km2) 600 500 400 300 200 y = 0.0172x + 106.23 100 R² = 0.4847 0 0 2,000 4,000 6,000 8,000 10,000 12,000 Number of LGUs Source: Authors’ calculations, based on OECD (2018b) and Eurostat data. Note: France does not appear in figures as the maximum value on the horizontal axis is set to 12,000, and the number of LGUs in France is almost 35,000. However, it is not excluded from the sample, so the regression coefficient and coefficient of determination are calculated for a dataset that includes all EU member states. 8 Lago-Peñas and Martinez-Vazquez (2013) provide a more detailed elaboration of some of these factors. 24 55. Although Croatia is considered a very fragmented country, there are many EU countries with higher degrees of fragmentation. This means that they have more LGUs, both in relation to the number of inhabitants and the land area (table 2.6). In terms of the number of LGUs per 100,000 inhabitants, Croatia compares to Germany and Italy, whereas Austria, Spain, Cyprus, the Czech Republic, France, Hungary, Luxembourg, Malta, Romania, and Slovakia have a greater degree of fragmentation than Croatia. Croatia’s number of 13.5 (LGUs per 100,000 inhabitants) is also lower than the EU28 average, which is 16.9. When it comes to the average LGU area (land in square kilometers over the number of LGUs), Croatia does even better. With an average LGU area of 102 square kilometers, larger LGUs (on average) exist only in Bulgaria, Denmark, Estonia, Finland, Greece, Ireland, Latvia, Lithuania, Netherlands, Poland, Portugal, Sweden, and the United Kingdom. 9 The EU28 average is 52 square kilometers per LGU. Table 2.6. Fragmentation in EU Countries (2018–19) Degree of Fragmentation Average LGU Average Inhabitants (average number Area (km2)* Size (number of LGU Area (thousands)** of LGUs per inhabitants) (km2) 100,000 inhabitants) Federations and Quasi-Federations Austria 83,878 8,822 4,209 23.8 40 Belgium 30,666 11,399 19,620 5.1 53 Germany 357,569 82,792 7,517 13.3 32 Spain 505,983 46,658 5,738 17.4 62 Unitary Countries Bulgaria 110,996 7,050 26,604 3.8 419 Croatia 56,594 4,105 7,383 13.5 102 Cyprus 5,695 864 2,274 44.0 15 Czechia 78,871 10,610 1,695 59.0 13 Denmark 42,925 5,781 58,990 1.7 438 Estonia 45,336 1,319 16,696 6.0 574 Finland 338,411 5,513 17,727 5.6 1,088 France 1 638,475 66,926 1,914 52.3 18 Greece 131,694 10,741 33,049 3.0 405 Hungary 93,012 9,778 3,077 32.5 29 Ireland 69,947 4,830 155,806 0.6 2,256 Italy 302,073 60,484 7,631 13.1 38 Latvia 64,586 1,934 16,252 6.2 543 Lithuania 65,284 2,809 46,817 2.1 1,088 Luxembourg 2,595 602 5,902 16.9 25 Malta 316 476 7,000 14.3 5 Netherlands 37,378 17,181 48,397 2.1 105 Poland 311,928 37,977 15,332 6.5 126 9 Data are presented for the years 2018–19 when the United Kingdom was still part of the EU. 25 Portugal 92,227 10,291 33,412 3.0 299 Romania 238,398 19,531 6,140 16.3 75 Slovakia 49,035 5,443 1,858 53.8 17 Slovenia 20,273 2,067 9,750 10.3 96 Sweden 447,424 10,120 34,897 2.9 1,543 United 244,424 66,274 173,492 0.6 640 Kingdom EU 28 4,465,993 512,379 5,911 16.9 52 Source: Authors’ calculations, based on OECD (2018b) and Eurostat data. Notes: *Total surface area, including land area and inland waters (lakes, rivers, etc.). Eurostat data as of 2016. **OECD and EU national accounts database (main aggregates). Total area and population include the five French outermost regions. 56. These findings are also reflected in the structure of municipalities by population size (table 2.7). The majority (more than 50 percent) of municipalities in Austria, Germany, Spain, Cyprus, the Czech Republic, France, Hungary, and Slovakia have fewer than 2,000 inhabitants, whereas this applies to only 29 percent of Croatian municipalities. However, there are countries, such as Denmark, Ireland, Lithuania, Netherlands, and the United Kingdom, in which more than half of the municipalities have more than 20,000 inhabitants. Table 2.7. Structure of Municipalities by Population Size (% of all municipalities) Fewer than 2,000 2,000–4,999 5,000–19,999 20,000 or More Inhabitants Inhabitants Inhabitants Inhabitants Federations and Quasi-Federations Austria 55 33 11 1 Belgium 1 11 62 26 Germany 54 20 20 6 Spain 72 12 11 5 Unitary Countries Bulgaria 3 17 54 26 Croatia 29 42 24 5 Cyprus 83 9 6 2 Czech Republic 89 7 3 1 Denmark 1 2 5 92 Estonia 5 16 70 9 Finland 15 30 38 18 France 85 9 5 1 Greece 8 7 35 50 Hungary 77 15 7 2 Ireland 0 0 0 100 Italy 44 26 24 7 Latvia 5 35 40 19 Lithuania 0 3 27 70 Luxembourg 26 44 25 4 Malta 15 40 40 6 Netherlands 1 1 21 77 Poland 1 25 60 14 Portugal 1 14 46 40 Romania 23 53 21 3 26 Slovak Republic 84 11 4 2 Slovenia 13 39 40 8 Sweden 0 5 52 42 United Kingdom 0 0 2 98 EU28 28 19 27 26 Source: OECD (2018b). 57. It is also interesting to see how Croatia compares, in terms of fragmentation, with countries from the Southeast Europe (SEE) region. In table 2.8, it can be seen that SEE countries are, in general, less fragmented. Only Moldova and Romania have smaller LGUs than Croatia in terms of population size (number of inhabitants), whereas average LGU size by area (in square kilometers) is lower in Slovenia. Table 2.8. Subnational Governments in SEE Countries in 2019 Degree of Fragmentation (average no. of Number Average LGU Average LGUs per of Number Size (no. of LGU Size, 100,000 Levels Second- Country of LGUs inhabitants) in sq. km inhabitants) of Gov. Tier Units Albania 61 47,054 471 2.13 2 12 B&H 144 24,417 356 4.10 3 11 Bulgaria 265 26,038 416 3.84 1 Croatia 556 7,383 102 13.54 2 20 Kosovo 38 46,935 287 2.13 1 North Macedonia 81 25,621 317 3.90 1 Moldova 898 3,950 38 253.16 3 32 Montenegro 25 24,894 552 4.02 1 Romania 3,181 6,103 75 16.39 2 42 Serbia 145 48,286 609 2.07 2 24 Slovenia 212 9,749 95 10.26 1 Turkey 1,398 59,481 583 1.68 3 793 Source: Authors, based on NALAS (2020). 58. The evidence presented above confirms that Croatia is not an outlier when it comes to local government fragmentation, both compared to other EU countries as well as those from the SEE region. However, it should be noted that this brief overview of different indicators of fragmentation presented in the tables above could be misleading, and the figures should be interpreted with caution. Although ratios of the number of LGUs per capita or per unit of area can be revealing, the question of fragmentation is really a one of financial, fiscal, and administrative capacity. 10 Regardless of the size of LGUs in terms of population or area, if they have enough capacity to provide public services and promote local development and growth, 10 The problem of identifying the optimal number of LGUs can be approached from the alternative perspective by identifying the optimal size of a single LGU. For a more theoretical view on the optimal community size and club theory, see Annex 4. 27 their size does not really fundamentally matter, even though the actual costs of public service provision may still be affected by economies of scale. However, the important point here is that in Croatia, many small LGUs do not have such capacity, and a significant share of their current expenditure goes to employee salaries, thus raising a question as to their usefulness to their residents (table 2.9). These units do not appear to have sufficient capacity to perform basic public service delivery, and their growth and development potential is severely lacking. More specifically, their administrative capacity is weak and cannot support local development (through, for example, strategic planning, capital investments and development of infrastructure, digitalization, absorption of EU funds, use of advanced financing models, etc.). For an impression of the scope of activities currently performed by LGUs in Croatia, see box 2.1. Table 2.9. Expenditure for Employees in Croatian LGUs in 2019 Operating Expenditure for Expenditure for Expenditure Employees Employees/ per capita per capita Operating Expenditure Maximum 13,890.2 4,933.3 53.8% Minimum 961.4 106.0 4.5% Average 3,341.2 592.2 18.0% Median 2,783.8 476.6 15.6% Standard deviation 1,898.2 437.2 8.7% Coefficient of variation 56.8% 73.8% 48.2% No. of units with a ratio >50% 2 No. of units with a ratio >45% 7 No. of units with a ratio >40% 16 Source: Authors, based on MOF data. Box 2.1. Functions Assigned to Subnational Government Units in Croatia Croatia’s LRGUs, independent of their own income sufficiency, are authorized to adopt general acts for their independent internal organization and that of their administrative bodies and are given the opportunity to cooperate at the national and international levels. Municipalities and cities perform tasks of local importance, and counties perform tasks of regional significance that otherwise are not assigned to state (central government) bodies. This potentially provides a very wide scope for the assignment of expenditure or functional responsibilities. County governments carry out matters of regional significance, particularly those related to education, health care, physical and town planning, economic development, traffic and transportation infrastructure, and the planning and development of the network of education, health care, welfare, and cultural establishments. Cities and municipalities, in their self-governing area of competence, administer matters of local significance through which the needs of citizens are met directly and that are not by the constitution or law assigned to state bodies. Specifically, they are responsible for carrying out the following services: housing, physical and town planning, communal economy matters, childcare, welfare, primary health care, preschool and elementary school education, culture, physical recreation and sports, protection and improvement of the environment, and civilian and fire protection. Solely from comparing the functions of cities and municipalities stipulated in the law to those of counties, it is clear there is an overlap as certain functions are managed at both the local and the regional levels. 28 All municipalities and cities may also administer matters delegated downwards from their own county’s self-government jurisdiction, if the county government provides the necessary funds. The process of fiscal decentralization (since 2001) has enabled LRGUs to take on authority (from the central government) for the provision and financing of a significant number of decentralized functions, including health care, education, social welfare, and fire protection services. The assignment of newly decentralized functions (responsibilities) to LGUs has not been mandatory but rather voluntary. This has led to an asymmetric assignment, with different cities and municipalities in charge of different services and some regional government (counties) still in charge of providing many services that in other areas or counties have been effectively decentralized to cities and municipalities. Only a minority of cities (around one quarter) with higher fiscal capacity have taken on all of these optional functions. A significantly higher number of cities and municipalities (roughly half of all LGUs) have assumed responsibility for firefighting services, while other decentralized functions have largely remained under the jurisdiction of the 20 county governments. LRGUs that took over the decentralized functions were provided with funding through an additional share of the personal income tax (PIT) and through equalization grants specifically for this purpose (this is further discussed below). Where the LGUs have not taken over the newly (optional) decentralized functions, the tasks are performed by their respective counties, which also receive an additional share of PIT for each function they provide in each LGU. Thus, there has been a de facto upward delegation of responsibilities by cities and municipalities that decided not to take on certain types of services. Perhaps the most important policy implication of this asymmetric assignment is that Croatia has indeed found a very effective way (if not necessarily the most correct one) of dealing with the lack of administrative capacity of fragmented local governments as discussed in this chapter (although, of course, not all cases of the de facto upward delegation may be due to fragmentation and lack of administrative capacity). Three tasks that are often assigned to local governments and that in Croatia can be considered rather centralized are: the provision of health services, energy supply, and business development support. Greater LGU autonomy can, nevertheless, be found in connection with housing and public utilities, preschool education, and cultural, sports, and religious activities. LGUs often entrust the provision of a certain segment of public services (utilities) to special legal entities (utility companies) that they mainly control through ownership. Utility services include the supply of drinking water, drainage and wastewater treatment, gas supply, heat supply, public transport, trash pickup, disposal of municipal waste, maintenance of public areas, upkeep of unclassified roads, retail markets, maintenance of cemeteries and crematoria, funeral services, chimney sweeping, and public lighting. These services may be provided by a company, public institution, or service department established by an LGU, as well as a legal and natural person on the basis of a concession contract or a contract on the entrustment of utility services. Funds for performing utility services are provided from the price of services, utility fees, the budget of the LGU, and other sources according to special regulations. Local utility companies provide most municipal services in Croatia (including water, sewerage, irrigation, infrastructure, energy, and sanitation). Housing and public utilities are, in addition to recreation, culture, and religion, exclusive functions of LGUs at the lowest tier of government. Source: World Bank (2021), Report 166109. 59. Currently, there is no legislation in Croatia that promotes, incentivizes, or mandates the association of several LGUs to enable them to gain administrative capacity and reach a minimum scale and thereby provide services more efficiently. However, current legislation does enable two or more LGUs to associate in the provision of public services, though this has been promoted solely for applications and joint-preparation of EU-funded projects. To do this, LGUs may establish a joint body, administrative department or service, or company, or they may jointly organize their operations in accordance with special laws. The mutual relations of LGUs in the joint organization of tasks within the scope of their self- 29 government are regulated by a special agreement in accordance with the law and their statutes and general acts. 60. Horizontal (intermunicipal) cooperation between LGUs, to perform certain joint tasks is not widespread in Croatia. The basic problem is that most municipalities lack sufficient budgets to finance development projects. This most adversely affects the development of rural areas, which make up about 90 percent of the territory. An additional problem is the lack of cooperation between cities and municipalities through joint administrative departments and service cooperation agreements. This cooperation should be encouraged by refining the legal framework for cooperation among LGUs, preparing standardized cooperation agreements, promoting good practices, and providing financial incentives. 30 3. Capacity of Local and Regional Government Units 61. The issue of capacity is multidimensional. It can refer to fiscal or financial capacity or administrative (human resource) capacity, but also the capacity to absorb EU funds, including planning and implementing infrastructure investment spending. There are many reasons for the lack of capacity among LRGUs, such as bloated levels of staffing and inadequate qualification of key personnel, as well as difficulties in attracting qualified staff. Among the major causes for these issues, most prominent are local government fragmentation and suboptimal size, inadequate assignment of expenditure responsibilities, and a lack of adequate training and/or required formal skills standards. This section unpacks in further detail the concept of capacity as it pertains to Croatia. 62. Although there is considerable anecdotal evidence on the lack of capacity among LGUs in Croatia, particularly those that are suboptimally sized, there is practically no hard quantitative evidence and analysis of it. To give a sense of the various dimensions involved, some concrete measures of the most important features of LGU capacity are provided, including fiscal (measured as per capita revenue components), service provision (measured as per capita expenditure for the most important public services provided on a subnational level), and administrative (measured by the number of employees and the expenditure for their salaries). The lack of any of these measures of capacity can result in significant deficiencies in access to basic public services. Fiscal capacity and fiscal needs 63. A comparison of minimum and maximum values, as well as coefficients of variation and Gini coefficients, shows significant disparities in per capita revenue and expenditure, particularly at the municipal level (table 3.1.). Fiscal capacity has been equalized through equalization transfers, but fiscal needs and the expenditure levels available to accommodate those needs are questionable. Therefore, a more comprehensive analysis of service delivery on the subnational level is performed below. Table 3.1. Fiscal Capacity and Fiscal Needs of LRGUs in 2018 (1) + (2) + Own (3) + Other Expenditures Shared Equalization Revenues Transfers Revenues Transfers (1) (2) (3) (4) (5) Counties Min, HRK 156.8 352.5 503.5 999.8 1,049.4 Max, HRK 489.2 956.2 956.2 2,941.7 2,757.0 Range (max-min), HRK 332.4 603.7 452.7 1,941.8 1,707.6 Average, HRK 323.4 595.6 660.2 1,392.8 1,382.2 Median, HRK 329.2 569.5 628.2 1,275.6 1,288.2 Standard deviation, HRK 83.8 156.9 113.3 421.4 376.9 31 Coefficient of variation 25.9% 26.3% 17.2% 30.3% 27.3% Gini coefficient 0.142 0.138 0.088 0.126 0.114 Cities Min, HRK 469.5 972.0 2,364.8 2,405.4 2,029.9 Max, HRK 9,538.8 10,912.2 11,042.2 12,031.3 14,053.9 Range (max-min), HRK 9,069.3 9,940.2 8,677.4 9,625.9 12,023.9 Average, HRK 2,440.0 3,803.1 4,571.0 5,401.4 5,316.2 Median, HRK 1,584.4 2,887.4 3,817.9 4,821.5 4,695.0 Standard deviation, HRK 2,096.6 2,469.5 2,115.6 2,213.5 2,502.8 Coefficient of variation 85.9% 64.9% 46.3% 41.0% 47.1% Gini coefficient 0.429 0.336 0.233 0.218 0.247 Municipalities Min, HRK 104.5 464.5 1,543.7 1,726.0 1,495.4 Max, HRK 13,934.2 15,855.1 15,855.1 26,749.9 29,477.4 Range (max-min), HRK 13,829.7 15,390.6 14,311.4 25,023.9 27,981.9 Average, HRK 1,955.0 2,815.3 3,738.7 4,839.9 4,741.0 Median, HRK 991.5 1,792.0 2,872.4 3,847.6 3,758.1 Standard deviation, HRK 2,313.3 2,616.7 2,310.6 2,995.4 3,167.8 Coefficient of variation 118.3% 92.9% 61.8% 61.9% 66.8% Gini coefficient 0.523 0.425 0.277 0.281 0.303 Source: Authors. 64. Since 2001, LRGUs have had the opportunity to take on authority for the provision and financing of newly decentralized functions, including health care, education, social welfare, and fire protection services. LGUs willing to take on these voluntary assignments must prove that they have sufficient fiscal capacity to perform them. For those that do not assume these decentralized functions, provision is performed by counties. This has resulted in an asymmetric assignment of expenditure responsibilities, where some counties end up in charge of providing many services that in other counties have been effectively decentralized. This asymmetric assignment has turned out to be a very effective way (if not necessarily the most optimal one) of dealing with the ongoing lack of administrative capacity of many small, fragmented local governments. 65. Only a minority of cities (around one quarter) with higher fiscal capacity have taken on these optional functional assignments. Meanwhile, most of these functions have been taken over by counties and the city of Zagreb (table 3.2). Primary education has been decentralized to the 35 cities with the strongest fiscal capacity, and firefighting—public fire departments—has also experienced widespread decentralization. Public fire departments are usually co-owned by LGUs (cities and municipalities) in different proportions and with different numbers of co-founders (e.g., the Zagorje public fire department is co-owned by 23 LGUs—six cities and 17 municipalities). In another way to look at it, there has been a de facto upward delegation among those cities and municipalities that decided not to take on certain types of services. 32 Table 3.2. Decentralization of Particular Public Functions in 2020 Function Decentralized to Primary education 20 counties and the city of Zagreb, as well as 35 other cities with stronger fiscal capacity Secondary education 20 counties and the city of Zagreb Social care/social welfare centers 20 counties and the city of Zagreb Homes for the elderly and infirm *17 counties and the city of Zagreb Health care 20 counties and the city of Zagreb Firefighting–public fire departments 76 public fire departments co-owned by LGUs Source: Decisions on Minimum Financial Standards for Individual Public Functions (NN 128/2019). Note: *In three counties (Virovitičko-podravska, Zagrebačka, and Krapinsko-zagorska), there are no homes for the elderly and infirm founded by the state or the LRGUs. 66. It is evident that at the present time, the majority of cities and practically all municipalities have insufficient fiscal capacity to assume new decentralized functions. Moreover, some LGUs have inadequate capacity to provide even the basic (core) functions. To get a sense of the existing capacity to perform public services at different levels of government, first the per capita expenditure of LRGUs was analyzed according to the functional classification. The functional dimension of expenditures reveals clear disparities among LRGUs (table 3.3). It is surprising that the minimum value for all functional expenditure components for LGUs is zero, though this is usual for certain naturally centralized functions (such as defense). However, it is difficult to believe that in some LGUs, there is no expenditure for such functions as general public services, economic affairs, or housing and community affairs. It is possible that there are problems in recording these values (functional classification of expenditures) in certain LGUs, which again points to the issue of weak administrative capacity. 11 The disparities in the distribution of functional expenditure responsibilities are less pronounced at the regional (county) level. Table 3.3. Summary Statistics of LRGUs’ Functional Expenditure Components per Capita in 2018 (HRK) Standard Coefficient Max Min Average Median Deviation of Variation Local Government Units (cities and municipalities) GPS 15,242.7 0.0 1,180.8 935.8 1,066.2 90.3% DEF 211.5 0.0 2.5 0.0 12.9 507.9% POS 2,056.4 0.0 125.6 90.5 140.7 112.0% EA 28,563.0 0.0 936.0 615.1 1,551.9 165.8% ENV 4,575.0 0.0 234.1 85.1 447.5 191.2% HC 9,449.6 0.0 1,184.4 885.2 1,172.9 99.0% HLT 408.4 0.0 18.4 2.5 36.0 195.0% RCR 6,007.4 0.0 381.3 246.3 529.4 138.8% EDU 6,431.5 0.0 281.4 184.8 425.0 151.0% SP 10,840.2 0.0 221.1 134.8 500.0 226.1% Total 29,477.4 1,465.9 4,565.6 3,699.2 2,944.1 64.5% 11 This possibility also calls for attention to interpreting the results and relying on the existing data to perform in- depth analyses. The important caveat is the quality of the data that are now available. 33 Regional Government Units (counties) GPS 353.7 125.7 207.9 186.4 65.6 31.6% DEF 1.0 0.0 0.1 0.0 0.3 261.9% POS 147.0 3.5 17.5 9.4 30.9 176.1% EA 1,503.5 61.4 238.7 127.8 339.9 142.4% ENV 41.5 0.0 13.5 12.4 11.4 84.4% HC 105.7 0.0 22.9 13.1 29.0 126.7% HLT 145.1 5.5 39.9 30.8 36.3 90.9% RCR 122.5 8.7 47.0 38.3 30.3 64.4% EDU 397.9 32.6 197.6 204.2 99.7 50.4% SP 74.5 29.2 47.5 43.7 13.9 29.3% Total 2,061.2 511.1 832.6 793.3 337.4 40.5% Source: Authors’ calculation, based on data from the Report on Revenues and Expenditures, Receipts and Expenses (Form PR- RAS) for 2018. Note: GPS: general public services, DEF: defense, POS: public order and safety, EA: economic affairs, ENV: environment, HC: housing and community, HLT: health, RCR: recreation, culture, and religion, EDU: education, and SP: social protection. 67. In order to create a clearer image of capacity for service provision at the subnational level, a separate analysis needs to be conducted for each service within the general functions presented above. With this aim, first, functional expenditures for counties, cities, and municipalities are decomposed to find the most significant expenditure items, and then summary statistics are calculated for these identified functions. Table 3.4 shows the most significant functional expenditure categories for counties, including: general public services, health, primary and secondary education, and social protection. The share of expenditure for these functions in the total functional expenditure of counties reaches almost 53 percent. Table 3.4. Expenditure for Selected Functions for Counties in 2018 (as a % of total) General Primary Secondary Social Public Health Education Education Protection Services Share in total 26.1 4.1 8.0 8.5 6.1 Cumulative share 26.1 30.2 38.2 46.7 52.8 Source: Authors’ calculation, based on data from the Report on Expenditure according to Functional Classification (Form RAS- functional) for 2018. 68. Considering their relative importance and also the fact that their cumulative share in total functional expenditure exceeds 50 percent, these five functions were analyzed to determine the capacity for service provision across counties. As a reminder, health care, primary and secondary education, and social protection are among the newly decentralized functions (together with firefighting, which is, in terms of decentralization, relevant for LGUs) that were predominantly assumed by counties. Comparison of minimum and maximum values, as well as the coefficients of variation and Gini coefficients, reveal significant disparities among counties in per capita expenditure for three out of the five functions: health care and primary and secondary education (table 3.5). 34 Table 3.5. Summary Statistics of Per Capita Expenditure for Selected Functions of Counties in 2018 (in HRK) General Primary Secondary Social Public Health Education Education Protection Services Max 353.7 145.1 143.9 220.5 74.5 Min 125.7 5.5 0.0 0.0 29.2 Average 207.9 39.9 49.5 71.8 47.5 Median 186.4 30.8 38.2 68.7 43.7 Standard deviation 65.6 36.3 45.2 69.2 13.9 Coefficient of variation 31.6% 90.9% 91.2% 96.3% 29.3% Gini coefficient 0.168 0.431 0.497 0.521 0.158 Source: Authors’ calculation, based on data from the Report on Expenditure according to Functional Classification (Form RAS- functional) for 2018. 69. Given their natural competences, LGUs (cities and municipalities) provide a very different set of services. The most significant functions in terms of functional expenditure for cities and municipalities are general public services, firefighting, road traffic, waste management, community development, streetlights, health care, recreation and sports, culture, preschool education, primary education, secondary education, and social protection. Expenditures for these functions in 2018 made up more than 73 percent of total functional expenditure for cities and more than 71 percent for municipalities (table 3.6). Table 3.6. Expenditure for Selected Functions of LGUs in 2018 (as a % of total) Cities Municipalities Share in Share in total Cumulative share Cumulative share total General public services 23.6 23.6 25.1 25.1 Firefighting 1.5 25.1 2.7 27.9 Road traffic 6.9 31.9 9.2 37.1 Waste management 2.7 34.7 2.1 39.2 Community development 10.6 45.2 11.8 51.0 Streetlights 2.3 47.6 3.7 54.6 Health 1.3 48.9 0.5 55.1 Recreation and sports 6.4 55.3 2.7 57.8 Culture 3.3 58.6 2.6 60.3 Preschool education 2.1 60.7 4.1 64.4 Primary education 4.9 65.6 1.4 65.9 Secondary education 2.1 67.7 0.4 66.2 Social protection 5.6 73.3 5.0 71.2 Source: Authors’ calculation, based on data from the Report on Expenditure according to Functional Classification (Form RAS-functional) for 2018. 70. Summary statistics of per capita expenditure for each of the functions depicted in table 3.6 for cities are presented in table 3.7. Significant disparities are present for all functions, and very low numbers are recorded in certain municipalities for particular functions. More precisely, the minimum value for the majority of functions was zero—either a result of 35 the low capacity to deliver services or low administrative capacity to record expenditure levels adequately. The highest Gini coefficient is recorded for waste management (0.74), primary education (0.77), and secondary education (0.85). One main reason for such large Gini values recorded for primary education is that some cities have assumed this decentralized function and therefore have (a priori) higher expenditure, but they also receive additional financing (PIT share and equalization grants for decentralized functions) for having assumed it. This is relevant also for firefighting services, although the Gini coefficient for firefighting is much smaller than for primary education. Table 3.7. Summary Statistics of Per Capita Expenditure for Selected Functions of Cities in 2018 (in HRK) Standard Coefficient of Gini Max Min Average Median Deviation Variation Coefficient GPS 10,370.13 186.41 1,082.54 863.68 1,000.31 0.92 0.32 FF 418.61 0.00 95.07 62.15 92.42 0.97 0.48 RT 2,393.84 0.00 401.28 322.04 454.64 1.13 0.56 WM 2,089.36 0.00 143.20 42.02 307.99 2.15 0.74 CD 4,480.03 0.00 519.55 234.97 693.88 1.34 0.63 SL 1,592.96 0.00 154.64 128.14 168.39 1.09 0.44 HLT 204.83 0.00 24.95 8.10 36.80 1.48 0.68 RS 1,353.31 0.00 236.25 162.10 242.09 1.02 0.45 CL 2,996.58 0.00 154.27 80.68 294.79 1.91 0.63 PREE 1,065.91 0.00 84.52 50.38 122.88 1.45 0.62 PRIE 3,059.82 0.00 109.67 32.60 321.14 2.93 0.77 SECE 506.40 0.00 11.96 0.00 47.76 3.99 0.85 SP 866.56 0.00 199.61 154.68 145.30 0.73 0.36 Source: Authors’ calculation, based on the data from the Report on Expenditure according to Functional Classification (Form RAS-functional) for 2018. Note: GPS: general public services, FF: firefighting, RT: road traffic, WM: waste management, CD: community development, SL: street lights, HLT: health, RS: recreation and sport, CL: culture, PREE: preschool education, PRIE: primary education, SECE: secondary education, and SP: social protection. 71. The Gini coefficients presented in table 3.8 confirm significant disparities in service delivery for municipalities. The most pronounced disparities are observed in per capita expenditure for waste management (0.85) and secondary education (0.81), but very large Gini coefficients are recorded also for health care (0.77), culture (0.77), and community development (0.73). The comparison of minimum and maximum values confirms the existence of small municipalities that are unable to perform basic services, whereas the maximum per capita values for municipalities are, for many functions, at even higher levels than for cities (with the exception of waste management and primary and secondary education). Table 3.8. Summary Statistics of Per Capita Expenditure for Selected Functions of Municipalities (2018; HRK) Standard Coefficient of Gini Max Min Average Median Deviation Variation Coefficient GPS 15,242.75 0.00 1,210.30 978.76 1,085.52 0.90 0.36 FF 2,038.27 0.00 124.80 91.22 143.52 1.15 0.47 36 RT 9,148.88 0.00 476.06 226.20 821.28 1.73 0.67 WM 2,013.74 0.00 89.65 5.07 248.62 2.77 0.85 CD 8,889.66 0.00 533.39 152.55 995.92 1.87 0.73 SL 3,061.17 0.00 174.92 107.95 240.40 1.37 0.57 HLT 408.36 0.00 16.21 0.00 35.00 2.16 0.77 RS 1,645.77 0.00 109.01 62.58 165.75 1.52 0.59 CL 5,968.96 0.00 124.16 36.00 439.87 3.54 0.77 PREE 3,199.89 0.00 172.37 81.84 264.46 1.53 0.64 PRIE 1,366.24 0.00 48.63 24.35 98.95 2.03 0.67 SECE 314.24 0.00 15.57 0.00 33.66 2.16 0.81 SP 10,840.23 0.00 226.21 126.43 563.77 2.49 0.54 Source: Authors’ calculation, based on the data from the Report on Expenditure according to Functional Classification (Form RAS-functional) for 2018. Note: GPS: general public services, FF: firefighting, RT: road traffic, WM: waste management, CD: community development, SL: street lights, HLT: health, RS: recreation and sport, CL: culture, PREE: preschool education, PRIE: primary education, SECE: secondary education, and SP: social protection. 72. It is also interesting to note that the minimum per capita expenditure for all observed functions is zero. This likely confirms the fact that certain municipalities do not have the financial capacity to perform one or more of the observed functions, though as already mentioned, this result can also be due to inadequate administrative capacity for recording the transactions according to functional classification. To further investigate this notion, employed labor force capacity in LRGUs is assessed. Labor force–related capacity 73. The number of employees in LRGU bodies continuously increased from 8,500 in 1995 to 18,700 in 2018 (figure 3.1). In the case of municipalities, the number of employees in 2018 was 2.6 times higher than in 1995 (increased in the observed period from 2,131 to 5,462), in cities 2 times (from 5,422 to 10,840), and in counties 2.5 times (from 944 to 2,355). 37 Figure 3.1. Number of Employees in Bodies from 1995 to 2018 20,000 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Municipalities Cities Counties Source: Authors’ calculation based on data from the Report on Revenues and Expenditures, Receipts and Expenses (Form PR- RAS) for the years 1995–2018. 74. In addition to local employees of administrative and professional bodies, employees of LGRU budgetary and extra-budgetary users are also involved in the provision of public goods and services at the local level. 12 The total number of employees, including those with users, increased from 10,672 in 1995 to 26,922 in 2014 (figure 3.2). In this period, the number of employees in municipalities increased 1.4 times (from 1,060 to 1,536), in cities 2.4 times (from 9,306 to 22,616), and in counties 9.1 times (from 306 to 2,770). The largest relative increase in the number of total employees is recorded in counties starting in 2001 with the process of fiscal decentralization, when LRGUs were given the opportunity to assume the provision and financing of decentralized functions. 12 Budgetary users are state bodies, institutions, councils of minority self-government, budgetary funds, and sub- local self-governments whose expenditures for employees and/or material expenditures are secured from the LRGUs’ budget. LRGU budgetary users are those founded by LRGUs, predominantly (more than 50 percent) financed from LRGU budgets and listed in the register of budgetary users. These may be, for example, employees of museums, theatres, kindergartens, schools, social care institutions, and/or health institutions founded and majority owned by LRGUs. Extra-budgetary users of LRGU budgets are extra-budgetary funds, companies, and other legal entities in which LRGUs have a decisive influence on management, or for which contributions and/or earmarked revenue are one of the financing sources, and which are listed in the register of extra-budgetary users. 38 Figure 3.2. Number of Employees with Users from 1995 to 2018 30,000 25,000 20,000 15,000 10,000 5,000 0 Municipalities Cities Counties Source: Authors’ calculation, based on the data from the Report on Revenues and Expenditures, Receipts and Expenses (Form PR-RAS) for the years 1995–2018. Note: Data for 2001 not available. Box 3.1. Administrative Capacity and Recording Omissions in Subnational Workforce Statistics Since 2015, transfers of funds to budgetary users for salaries from budget sources are not recorded in the accounts of sub-category 311 Salaries (gross), but in sub-category 367 Transfers to budgetary users from the competent budget for financing of regular activities. The manner of presenting data on the average number of employees of LRGUs in Form: PR-RAS (Level 22 reports) also changed. In their financial statement (level 22), LRGUs are supposed to fill in data relating to the average number of employees (based on the balance at the beginning and end of the reporting period and based on hours worked), but they do not fill in data relating to the average number of employees with users (based on the balance at the beginning and end of the reporting period and on hours worked). For this reason, the number of employees suddenly decreased in 2015. However, it is evident that some LRGUs still report this number despite detailed instructions from the MOF on how reporting should be performed. A more detailed analysis of reported data reveals that 446 out of a total of 576 LRGUs did not report the number of employees with users in 2018, whereas as many as 130 LRGUs reported positive numbers. As opposed to the financial data provided in those reports, where LRGUs face different controls while filling in the data to ensure the precision of the reporting, the number of employees is entered into analytical (statistical) data without controls, enabling LRGUs to fill in the data according to their own provisional and rough understanding and interpretation of the instructions. This is just more evidence that administrative capacity in many LRGUs in Croatia is weak. 75. LRGUs are autonomous in determining the number of administrative departments and the number of employees as long as they comply with provisions determining the maximum value of the wage bill. 13 The number of employees in LRGUs therefore depends 13 For financial sustainability, more important than the pure number of employees is the wage bill. According to the Law on Salaries in Local and Regional Self-Government (OG 28/2010), the mass of funds for salaries (i.e., the wage bill) of employees in LRGUs may not be more than 20 percent of the operating revenue of the unit generated 39 only on fiscal capacity and the political will of the representative body. The Law on Local and Regional Self-Government determines the number of deputies and members of the representative bodies according to the number of citizens, whereas other decisions are made autonomously by LRGUs. 76. Total expenditure for employees increased from HRK 527 million in 1995 to HRK 4.9 billion in 2014 (figure 3.3). For municipalities, the total amount increased 4.9 times (from HRK 108 to 527 million), for cities 7.8 times (from HRK 476 to 3.7 billion), and for counties 18.1 times (from HRK 33 to 603 million). An increasing trend has significantly intensified from 2001, in parallel with the fiscal decentralization process. The sharp decline in 2015 and onward can be attributed to the methodological changes described in box 3.1. Figure 3.3. Total Number Of Employees in Bodies and with Users from 1995 to 2018 45,000 6,000 40,000 5,000 35,000 30,000 4,000 25,000 3,000 20,000 15,000 2,000 10,000 1,000 5,000 0 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Municipalities Cities Counties Expenditure for employees (in million HRK) Source: Authors’ calculation based, on data from the Report on Revenues and Expenditures, Receipts And Expenses (Form PR-RAS) for the years 1995–2018. 77. The number of employees per LRGU differs significantly, and it seems that the only criteria for this number is the fiscal capacity of the LRGU. It is generally positive that LRGUs exercise their autonomy in making such decisions, as the different strategies they implement in this regard contribute to the positive effects and overall efficiency of decentralization. Figure 3.4 presents the number of employees in counties in 2018. 14 Although all counties should have assumed similar functions, the number of employees ranges from 44 in Požeško-slavonska to 255 in Splitsko-dalmatinska, with an average of 118. The city of Zagreb is excluded from the analyses here as it is an outlier because of its dual status (county in the previous year, minus revenue from domestic and foreign grants and donations (except for grants for civil servants taken over under a special law), revenue from special contracts (co-financing of citizens for sub-local self-governments), and revenue derived from the additional share of PIT and equalization grants for decentralized functions. 14 Comparisons in nominal terms are provided first, but later comparisons are also normalized by population. 40 and city) and due to the fact that because of its large size it distorts the image of the sector (in 2018 Zagreb had almost 3,000 employees). Figure 3.4. Number of Employees in Counties in 2018 300 300 250 250 200 200 150 150 Average 100 100 50 50 0 0 Source: Authors’ calculation, based on data from the Report on Revenues and Expenditures, Receipts and Expenses (Form PR- RAS) for 2018. 78. Similarly, the number of employees in cities ranges from zero reported in Ludbreg to 494 in Rijeka (figure 3.5). Most cities have up to 50 employees (79 out of 126), 25 have between 50 and 99 employees, and 22 have more than 99 employees. Figure 3.5. Cities by Number of Employees (without Zagreb) in 2018 45 40 35 30 25 20 15 10 5 0 up to 25 25-49 50-74 75-99 more than 99 Source: Authors’ calculation, based on data from the Report on Revenues and Expenditures, Receipts and Expenses (Form PR- RAS) for 2018. 41 79. The number of employees in municipalities ranges from zero (reported in several municipalities) to 72 employees in Čeminac (figure 3.6). However, most municipalities have up to 10 employees (215 out of 429), 157 municipalities have between 10 and 24 employees, and 57 municipalities have 25 employees or more. As many as 68 municipalities have fewer than five employees; of these, 41 have fewer than 4, 17 fewer than three; six fewer than two, and five fewer than one. Figure 3.6. Municipalities by Number of Employees in 2018 160 140 120 100 80 60 40 20 0 up to 5 5-9 10-14 15-19 20-24 more than 24 Source: Authors’ calculation, based on data from the Report on Revenues and Expenditures, Receipts and Expenses (Form PR- RAS) for 2018. 80. Therefore, the remainder of the analysis in this chapter observes the number of employees also in relative terms, distinguishing between three groups of LGUs: municipalities, cities, and large cities. 15 In 2018 large cities employed 6,708 people (36 percent of all LRGU employees) and spent more than HRK 1 billion on this expenditure, which is more than 42 percent of the total amount for all LRGUs (table 3.9). Given their status, scope of responsibilities, and dominant share in the structure of total number of employees and total expenditure, it is worth exploring how the number of employees in large cities differs from other observed groups of LGUs (other cities and municipalities). For the aforementioned reasons, Zagreb is excluded from the analysis as an outlier. Table 3.9. Number of and Expenditure for Employees in Large Cities and County Seats in 2018 County Employed Employed/ Expenditure Expenditure per City Seat in Bodies 1,000 citiz. (in HRK m) capita (in HRK) 15 The Law on Amendments to the Law on Local and Regional Self-Government (Official Gazette, 129/05) of 2005 stipulates the status of large cities for all those units of local self-government that are also economic, financial, cultural, health, transport, and scientific centers of development of the wider environment and that have more than 35,000 inhabitants. Large cities and cities representing county seats (hereinafter referred to as large cities) have been entrusted with additional tasks (compared to other cities), including: maintenance of public roads, the issuance of construction and location permits, and other acts related to the construction and implementation of spatial planning documents. 42 Bjelovar Yes 81 2.0 14.9 370.7 Čakovec Yes 49 1.8 11.2 415.0 Dubrovnik Yes 253 5.9 43.0 1,008.2 Gospić Yes 84 6.6 8.6 677.8 Karlovac Yes 136 2.4 18.3 328.2 Kaštela No 185 4.8 20.4 526.9 Koprivnica Yes 100 3.2 11.7 377.7 Krapina Yes 24 1.9 3.4 273.2 Osijek Yes 220 2.0 32.7 302.3 Pazin Yes 42 4.9 5.5 632.6 Požega Yes 121 4.6 9.8 373.8 Pula No 178 3.1 26.4 459.5 Rijeka Yes 494 3.8 66.1 514.1 Samobor No 81 2.2 14.1 374.1 Sisak Yes 118 2.5 13.8 288.2 Slavonski Brod Yes 94 1.6 12.6 212.5 Split Yes 448 2.5 66.7 374.4 Šibenik Yes 178 3.8 17.7 381.1 Varaždin Yes 115 2.4 18.0 383.4 Velika Gorica No 168 2.6 20.9 328.5 Vinkovci No 140 4.0 15.2 430.6 Virovitica Yes 87 4.1 9.5 444.0 Vukovar Yes 143 5.2 14.1 510.4 Zadar Yes 202 2.7 27.2 361.9 Zagreb Yes 2,967 3.8 522.3 661.1 Total 6,708 3.3 1,024 507.3 Source: Authors’ calculation, based on data from the Report on Revenues and Expenditures, Receipts and Expenses (Form PR-RAS) for 2018. 81. To get an impression of the differences in relative terms, table 3.10 presents summary statistics for employees in different categories of LGUs observed in nominal (absolute) terms but also per 1,000 inhabitants. The numbers reveal a surprisingly high number of employees per 1,000 inhabitants in municipalities. The highest number reported for municipalities is 32.9 for Lovas, for large cities 6.6 (Gospić), and for other cities 13.6 (Imotski). Median values mostly confirm the fact that in relative terms (per 1,000 inhabitants), municipalities employ slightly fewer employees than cities in general but many more than large cities. This may imply that the number of employees depends on the number of inhabitants and consequently on the fiscal capacity of LRGUs. However, when a certain level of employment is reached, the number of employees does not necessarily increase proportionally to the increase in the size of the population. In other words, there are likely fixed costs in terms of number of employees for certain functions, and therefore the number is not expected to increase as significantly after some minimum threshold. 43 Table 3.10. Descriptive Statistics of LGU Employees in in 2018 Municipalities Cities Large Cities Other Cities Minimum 0.0 0.0 24.0 0.0 Number of employees Maximum 72.0 494.0 494.0 151.0 Average 12.8 62.2 155.9 40.2 Median 9.0 34.0 128.5 29.0 Minimum 0.0 0.0 1.6 0.0 Employees per 1,000 Maximum 32.9 13.6 6.6 13.6 citizens Average 5.5 4.2 3.4 4.4 Median 3.5 3.6 2.9 3.7 Source: Authors’ calculation, based on data from the Report on Revenues and Expenditures, Receipts and Expenses (Form PR- RAS) for 2018. 82. Many municipalities do not have their own budgetary users, and in some municipalities, all administrative services are performed by one or two employees. The administrative capacity of these LGUs is inadequate and insufficient for ordinary operational and financial management procedures. In such circumstances, it is questionable whether further decentralization can be undertaken, given municipalities that, with a small number of employees, a small population, and limited fiscal capacity, are unable to assume or perform public functions and provide quality public services. 83. The consequences of the lack of administrative capacity go beyond service delivery. Insufficient administrative capacity and poor co-financing potential have also hampered the absorption of EU funds. To cope with the problem of co-financing, the Ministry of Regional Development and EU Funds (MRDEUF) provides direct administrative assistance for the co- financing of the implementation of EU projects both at the local and regional levels. However, strengthened administrative (human resource) capacity does not ensure the continuous inflow of high-quality projects into the pipeline. Significant efforts to increase the absorption capacity of LRGUs are urgently needed, as subnational government should, through the EU funds, be a significant (if not the main) driver of capital investments in Croatia. Although the problem of the lack administrative capacity can be treated in many ways, functional and real mergers of LGUs might turn out to be the fastest and the most effective remedy. Out of many different benefits of such initiatives, the specialization of employees currently performing many different tasks in many small LGUs would certainly be among the most important. 84. To summarize: • The issue of capacity is multidimensional. It can refer to many different aspects of LGU operations and performance and can have different roots. Among the most prominent and certainly most important for Croatia are fiscal, service provision, and administrative capacity. 44 • Certain LGUs have significant deficiencies in some or all of the observed dimensions. Many municipalities in Croatia do not have their own budgetary users, and in some municipalities, all administrative services are performed by one or two employees. • The majority of cities and practically all municipalities have insufficient fiscal capacity to assume new decentralized functions. Moreover, some LGUs, with a small number of employees, a small population, and limited fiscal capacity, are unable to assume or perform public functions and provide even the basic (core) public services. • The lack of capacity affects local service delivery. Lack of capacity, partly driven by fragmentation, significantly influences the provision of public goods and services and the capacity for absorbing EU funds, including capacity for planning and implementing infrastructure investment spending. • Countries around the globe have undertaken various steps to deal with the problems of capacity. In many cases, they have sought to achieve sufficient capacity through territorial integration of small units into bigger ones or through resource sharing and shared service provision. Some of these possible solutions and ways of implementing them are described in the following sections. 45 4. International Experience in Dealing with Municipal Fragmentation and the Lack of Capacity 86. Although the existence of a large number of relatively small municipalities in some countries, such as France, Italy, Spain, or Switzerland, has historical roots, in other countries, the problem is more recent. For example, in 1992, the Law on the Territories of Counties, Cities and Municipalities divided Croatia into 21 counties, including the city of Zagreb, 69 cities, and 421 municipalities and abolished the existing 114 municipalities of the former state. The number of LRGUs in Croatia increased to a total of 556 LGUs (cities and municipalities) by 2020, while the number of counties did not change. Similarly, Hungary’s more than 3,000 municipalities were created during the 1990s. Other Eastern European countries, however, such as Bulgaria, did not experience similar increases during the transition period. In countries outside Europe, such as Indonesia and Peru, the fast increase in the number of municipalities can be traced to significant incentives for municipal fragmentation hidden in the system of transfers, granting minimum equal amounts to all municipalities. 87. The various empirical studies carried out in many countries show that the vast majority of public services provided at the local level require on average a minimum optimal scale of 10,000 inhabitants, though that varies depending on the type of service. 16 For a small number of public services (e.g., urban transport and brownfields), the optimal minimum population can reach up to 100,000 inhabitants, but for others (e.g., elementary education), it can be as low as 5,000. The problem of municipal fragmentation in many countries typically does not lie so much in the average size of local governments, but in the fact that in many cases, as in Croatia, this average value obscures the fact that there is a significant percentage of suboptimal-sized municipalities, which, in addition to having smaller populations, tend to be lacking in terms of administrative and fiscal capacity. 88. This section provides selective and relevant country examples to show (i) what countries have done (the major elements and content of the reforms), and (ii) how they have done it (process and steps used), including information on possible frameworks that can be used by the government of Croatia to organize and structure related reforms. 4.1. Major elements and content of reform in international practice 89. Countries have employed various solutions to these problems with uneven success. Approaches have ranged from shared service provision to merger or amalgamation, with many intermediate solutions. To gain a clear picture of the different approaches to tackling the issue of fragmentation, the Local Government Association of Queensland, a local association in the state of Queensland, Australia, created to serve the 77 state’s councils, has developed an 16 See, for example, Lago-Peñas and Martinez-Vazquez (2013). 46 extended taxonomy of possible models that provide a good summary of the main possible options: • merger/amalgamation, where two or more entities are consolidated into a single larger local authority • significant boundary change, in which the spatial area of municipal jurisdictions is altered, but existing government structures are left intact • resource sharing through service agreements, in which one local authority undertakes specific functions for other local councils, such as in regional waste management • resource sharing through joint enterprise, in which municipalities combine in given areas of service provision to accrue scale advantage, as in regional development initiatives • shared service provision through the establishment of system-wide entities, as in procurement initiatives (LGAQ 2005) 90. These reform options are not a finite list of all possible models. There are, for example, other models in which LGUs share all functions but retain their political independence (such as joint administration). However, this taxonomy helps to differentiate between two distinct concepts: one where the number of LGUs is reduced, and the other where an LGU’s structure is intact but cooperation is promoted and service provision is transformed. International experience shows that although some countries have opted for mergers, others maintain high levels of fragmentation with alternative approaches that yield positive outcomes. Box 4.1. Village Amalgamation in Ukraine In Ukraine, communities may initiate a voluntary amalgamation process if their territory is (1) contiguous, (2) located within one region (oblast), and (3) has certain historical, natural, ethnic, cultural, or other unifying characteristics. The process may be initiated by community members or local authorities but is subject to public consultation and approval by each of the local councils affected. Amalgamation plans may also be subject to local referendums and must be approved by the oblast council. To encourage amalgamation, every oblast is required to draft a “perspective plan” for creating effective territorial communities, to be approved by the respective oblast council and Ukraine’s Cabinet of Ministers. Perspective plans are to be developed according to a methodology proposed by the Ministry of Regional Development and approved by a cabinet resolution in April 2015. As originally conceived, the plans would identify the largest villages or raion (district)-subordinated cities within each raion. These would be declared centers of the new amalgamated communities. All hromadas, or municipalities, within 25 kilometers of that center would then be targeted for amalgamation with it. If no center could be identified, the hromada with the most children within a cluster of hromadas would be the designated center. Source: World Bank (2017). 91. One of the main options for municipal fragmentation is to promote, through incentives, the voluntary merger or amalgamation of smaller municipalities. International experience indicates that this approach has generally enjoyed little success, though there are 47 exceptions (see box 4.1 for the recent experience in Ukraine). To promote voluntary mergers, programs could include introducing or strengthening incentives for the association of small municipalities for more efficient provision of public services. However, European countries, such as France, Spain, or Italy, that have historically experienced high levels of local fragmentation have for many years tested this path with minimal results, even when significant tax advantages were offered. One reason is the political economy of this process. Locally elected officials tend to be reluctant to lose their jobs and positions, while residents – often for valid reasons – fear the loss of representation and accountability associated with becoming part of a larger municipality that may be based in distant places. In short, the lesson that can be drawn from international experience is that the voluntary merger of municipalities is not usually an effective solution. 92. Connecting municipal reforms to institutional changes may also make the process smoother. An important example of this approach relies on the combination of both territorial and decentralization reforms, meaning the transfer of new responsibilities and financial resources to merged municipalities. The two components appear to be two sides of the same coin, territorial reform being partly driven by the decentralization reform (Swianiewicz, Gendźwił, and Zardi 2017). 93. Another option might be to legally force the municipalities of suboptimal scale to merge. There are a number of countries that have implemented this measure in recent decades, including the United Kingdom and most of the Nordic countries, such as Denmark, Sweden, and Finland, and more recently, in the wake of the Great Recession, countries such as Greece, Italy, and Turkey. These measures are sometimes implemented at once or in two stages, first through a voluntary merger or fusion period, followed by a final forced unification. Although these forced mergers have been accepted in many of these countries as a solution to historical problems, often the results are not always positive. In some countries, the formation of larger jurisdictions raised the management costs of the new entities, partly due to a lack of job consolidation and partly to the adoption of higher wages and standards than before consolidation. Forced mergers can also limit the use of the advantages of decentralization, not only the greater degree of representation and accountability that decentralization often provides but also the better orientation of public services to the various preferences in the different jurisdictions, thus generally improving social welfare. In short, even if politically feasible, forced mergers must be weighed from an individualized cost-benefit perspective to ensure that savings materialize in the management of public services. 4.2. The implementation of reforms in international practice 94. The process of planning a territorial reform of this caliber should in principle start by identifying the sequence, steps, and elements for success. Based on experience, examples of this kind of strategizing are available and should support the government of Croatia in preparing a strategic plan. In practice, however, local conditions require notable design 48 adaptations and implementation changes. This section provides guidance on a possible strategy, highlighting the process used in several relevant country cases. 95. The ideal process has been documented through various international experiences. Broadly, a systematic approach to territorial reform could follow the steps detailed in figure 4.1, which lays down 15 stages in the process of preparing and implementing the reform. Ideally the process would be presented as chronological steps, but in reality, many of these steps are strongly interlinked or often have to be implemented in parallel. Moreover, it is sometimes necessary to take a few steps back and return to the previous stages. Figure 4.1. Territorial Reform Implementation Process Source: Authors, based on Swianiewicz, Gendźwił, and Zardi (2017). 96. The process of planning requires that applied reform elements across countries be considered. Some key ingredients that could help the government of Croatia to plan and implement successful reform are systematized in figure 4.2. 49 Figure 4.2. Key ingredients for Successful Territorial Reform Source: Authors, according to Swianiewicz, Gendźwił, and Zardi (2017). Merger/amalgamation 97. During the period from 1990 to 2014, many EU countries reduced the number of municipalities. Table 4.1 shows the relative changes in the number of municipalities by country—in some cases minimal, in others striking reductions. The process used was not uniform across countries, and this section highlights only some relevant cases. Table 4.1. Relative Change in the Number of Municipalities in EU Countries (1990=100) 1990 1994 1998 2002 2006 2010 2014 Austria 100 101 101 101 101 101 101 Belgium 100 100 100 100 100 100 100 Bulgaria 100 91.4 93.9 94.6 94.6 94.6 94.6 Croatia 100 290 317 320 323 323 323 Cyprus 100 100 100 100 99.7 99.7 100 Czech Republic 100 152 152 153 152 152 153 Denmark 100 100 100 100 98.2 35.6 35.6 Estonia 100 99.6 96.9 94.5 89 88.6 83.5 50 Finland 100 98.9 98.3 97.4 93.7 74.3 69,6 France 100 99.9 100 100 100 100 100 Germany 100 99.6 88.8 83.2 76.5 74.4 69.1 Greece 100 99.9 17.4 17.4 17.5 17.5 5.49 Hungary 100* 102 102 102 103 103 103 Ireland 100 101 101 101 101 101 27.4 Italy 100 100 100 100 100 100 99.7 Latvia 100 99.1 98.8 95.6 92 20.6 20.8 Lithuania 100 100 100 103 103 103 103 Luxembourg 100 100 100 100 98.3 98.3 89.8 Malta 100 100 101 101 101 101 101 Netherlands 100 94.6 81.5 73.8 68.2 64.1 60 Poland 100 104 104 105 104 104 104 Portugal 100 100 101 101 101 101 101 Romania 100 100 100 101 108 108 108 Slovakia 100 101 102 102 102 102 102 Slovenia 100 255 327 329 356 356 360 Spain 100 100 100 100 100 109 100 Sweden 100 101 101 102 102 102 102 Source: Authors, based on Swianiewicz, Gendźwił, and Zardi (2017). Note: * (1989). 98. Several countries underwent serious reforms and achieved drastic results. The cases of Greece, Latvia, Estonia, and Norway are particularly interesting. 99. Greece is one of the countries that has clearly implemented territorial amalgamation reform (Swianiewicz, Gendźwił, and Zardi 2017). The process in Greece had two phases: the first in 1998 and the second, more radical phase in 2011. The cumulative change of the two reform waves reduced the number of local governments by a factor of almost 20. The Greek (2011) territorial reform was marked by implementing a 10,000-inhabitant population threshold. This population criterion was mixed with functional and geographical criteria, which provided exceptions for some categories of municipalities: • The additional criterion was a “one island – one municipality” rule, with an exception made for a few of the largest islands. • For metropolitan (densely populated) areas the minimum population size was even higher (25,000). • The strict population criterion was not applied to sparsely populated mountain areas. 100. Latvia embarked upon an effort to encourage smaller jurisdictions to amalgamate in 1998 with the passage of the Law on Administrative Territorial Reform (Dillinger, Zeikate, and Draugelis 2003; Swianiewicz, Gendźwił, and Zardi 2017). The law defines the aim of the reform: “to establish administrative territories with local (and regional) authorities able to develop economically and provide quality services to inhabitants.” The law created a council to coordinate this effort, the Territorial Reform Council, comprised of representatives from the Union of Local and Regional Governments and the central government. The Department of 51 Local Government Affairs under the Minister for State and Municipal Reform was designated to spearhead the effort. Territorial reform was to be based on: (i) the long-term development prospects of the municipality area; (ii) the relation between the number of inhabitants and the size of the area, with indices of economic development; (iii) the revenue base; (iv) the level of infrastructure required to perform municipal functions; (v) demographic characteristics; (vi) economic, geographical, and historical unity; (vii) accessibility of municipal services; and (viii) other conditions. 101. However, this first phase of Latvian territorial reform was not as successful (see table 3.1.) as the one implemented in 2009, when Latvia reduced the number of municipalities from 550 to 119. One of the main justifications for the reform was the increase in local governments’ capacity to deliver a wider range of public services (Vilka and Seimuskane 2012). The merger of municipalities was accompanied by the transfer of public transport functions from districts to municipalities. The share of municipal spending in GDP increased from 9 percent in 2005 to 12 percent in 2010 (but later dropped back to 9.2 percent in 2015). The experience shows that building a broad consensus on territorial reforms is sometimes very difficult or even impossible. Despite its success, the association of local governments supported only voluntary mergers of local governments and eventually, 32 old municipalities appealed to the Constitutional Court in a bid to stop the reform. 102. More recently, Estonia has also undergone a successful territorial reform. The process is described in box 4.2. In 2016, Estonia passed the Administrative Reform Act. This Act provides the bases and procedures for changing the administrative-territorial organization of rural municipalities and cities in order to: increase the capacity of local governments to offer high-quality public services, use regional prerequisites for development, increase competitiveness, and ensure more consistent regional development. To achieve the reform objectives, preference was to be given to the formation of local governments with more than 11,000 residents (the recommended size of a local government). The methods of tackling the administrative-territorial reorganization were: • the formation of a new local government, as a result of the merger of two or more local governments • an increase in the size of one local government, by way of merging with one or several local governments with common borders 103. In the process, borders of merging or joining local governments could be altered by assigning one or several settlement units or another territorial area belonging to one local government to another government. The Estonian MOF was responsible for organizing the implementation of the administrative reform. Local governments were to be able to ensure the professional capability necessary for organizing the functions arising from the law and to provide quality public services to all of their residents in accordance with the purpose of the reform, provided that the government have at least 5,000 residents (the minimum size of a local government). A local government that did not meet the minimum size criterion according to the 52 population register and had (i) not submitted a proposal to local government council concerning the start of negotiations for territorial reorganization, (ii) not received a respective proposal from another local government council, or (iii) refused to start negotiations with another such council, was to submit a proposal to start negotiations with other local government councils by October 1, 2016 at the latest. Local governments merged on the initiative of their councils. The government initiated administrative-territorial reorganization on February 15, 2017, as well as the alteration of the borders of those local governments that did not meet the criterion for the minimum size. The MOF submitted a draft regulation to the local government councils concerned regarding the reorganization and alteration of administrative borders in order to provide an opinion, which had to be submitted by May 15, 2017. 104. The newly formed local government was able to use the insignia of a merging rural municipality or city agreed in the merger contract or agreement until the statutes of the new local government could be established. A merger contract and agreement entered into force on the date the council election results were announced, which were valid until the results of the next local government council election. If the post of an official within a new administrative agency formed as a result of the reform process was eliminated, another place of employment or post corresponding to their education, work experience, knowledge, and skills, was, where possible, to be offered, with functions similar to the former post. In the event that the current post of an official was eliminated and they were offered a place of employment, the official was to be paid unemployment compensation. The chairman of the local government council, rural municipality mayor, and city mayor, upon the termination of his or her authority, was to be paid compensation in the form of a lump sum (six or 12 times the average monthly salary, depending on the time spent in the position). Compensation was not paid in the event that the council elected the person for the post of rural municipality mayor, city mayor, or chairman of the council for a new term. Box 4.2. The Process of Territorial Reform in Estonia Timetable of the Reform Phase I of the reform initiative: until January 1, 2017 (voluntary mergers) • November 19, 2015 - Government decision to approve reform concept, criteria, and time plan • January 7, 2016 - Administrative reform act entered into force • October 1, 2016 - Municipalities that did not comply with the criteria set in the law to start negotiations • January 1, 2017 - The deadline for submitting merger application to the county governor • January 2, 2017 - Government decision on voluntary mergers Phase II of the reform: January 1–July 15, 2017 (government-initiated mergers) • February 15, 2017 - The government to make a merger proposal to the municipalities that did not meet the criteria • May 15, 2017 - Municipalities respond to the merger proposal • July 15, 2017 - Final government decision on the merger Source: Administrative Reform Act of Estonia (2016). 53 105. The territorial reform process must be planned systematically and comprehensively in order to cover everything needed for successful implementation. Table 4.2 shows the time frame of the reform process in Norway that started in 2014. Table 4.2. Stages of Amalgamation Reform in Norway Nr. Stage Date 1. Report to the parliament on local government reform May 14, 2014 2. Local negotiation processes 2014–2016 3. Report to the parliament on new tasks for larger local governments March 20, 2015 4. Public hearing on revised income system for local government sector December 16, 2015 5. First deadline for local decisions February 1, 2016 6. Second/final deadline for local decisions June 30, 2016 7. Recommendation reports from county governors submitted to central October 2016 government 8. Proposal to the parliament on new local government structure April 5, 2017 9. Decision of the parliament on new local government structure June 8, 2017 10. First round of amalgamations January 1, 2018 11. Second round of amalgamations January 1, 2020 Source: Authors, based on Klausen (2017), as cited in Swianiewicz, Gendźwił, and Zardi (2017). 106. Municipal amalgamation reforms have been advocated as ways to improve efficiency, reduce costs, and enhance capacity in local government service provision (Tavares 2018). However, empirical evidence and metrics on the effects of such reforms are scarce. Tavares (2018) provides a synthesis of the empirical literature published over the past 20 years, organizing the effects of amalgamations into three categories: economic efficiency and cost savings, managerial implications, and democratic outcomes. Despite the significant variation across countries and reforms, some regularities emerge: cost savings are primarily limited to general administration expenditures (wages, office supplies, and so on), there are few changes in the quality of local services, and the quality of local democracy tends to diminish. Indeed, several studies point to amalgamation reforms that result in a trade-off between efficiency and democracy. Finally, despite its relevance to forced local amalgamation programs and related policies, Gómez-Reino, Lago-Peñas, and Martinez-Vazquez (2021) claim that empirical evidence on the existence of economies of scale in the provision of local public goods and services remains elusive. Their analysis confirms the presence of moderately increasing to constant returns to scale in the provision of local services across traditional local service sectors, such as education, water and sanitation, and garbage collection. 107. The effects of municipal mergers and associations on quality of services have not been sufficiently researched. However, Tavares (2018) reviews the results of several prominent studies. A study conducted in the Netherlands by Allers and Geertsema (2016) showed no change in the quality of public services as the result of amalgamations. Similarly, Reingewertz (2012) found no evidence that the level of services provided to residents of amalgamated municipalities in Israel had declined. However, in Switzerland, early work by 54 Steiner (2003) suggested that in five merged municipalities, performance quality generally improved, but amalgamations seldom eased the municipal budget situation. Much more recent and detailed work by Steiner and Kaiser (2017) in Switzerland indicates partial support for the hypothesis of a positive effect of mergers on public service delivery, professionalization of staff, and municipal autonomy, and an inconclusive effect on municipal finances. Intermunicipal cooperation 108. Amalgamation is not the only way of dealing with problems of fragmentation. IMC offers an interesting alternative in cases when municipalities are too small to individually provide public services at an efficient cost level but are reluctant to form a municipal amalgamation to benefit from economies of scale. Forming a body consisting of multiple municipalities with a specific focus provides a way to reduce costs on service provision while maintaining municipal sovereignty in other areas (Struk and Bakoš 2021). 109. IMC involves several local authorities or municipalities, in proximity to one another, that join forces to develop and manage public services, amenities, and infrastructure, improve service delivery to better respond to user needs, and bolster local development. Switzerland, for example, has a system of both compulsory and incentive-based cooperation; some cantons can legally compel municipalities to cooperate in a specific field of competence, but they often resort to financial incentives (CoE 2008a). The creation of intermunicipal associations or commonwealths of local governments is based on developing special districts 17 for the intermunicipal provision of large-scale services, or alternatively, enabling some services that require a large minimum size to contract between small and larger contiguous municipalities or to contract those services with a privatized company (which occurs, for example, in countries like Australia, Canada, or the United States). 18 The appeal is that through this type of cooperation, smaller local governments are allowed access to specialized technologies, equipment, and personnel (Martínez-Vázquez and Gómez-Reino 2008). However, inefficiencies, such as creating duplication, can also arise to the extent that local governments might continue to provide services in the same competitive area. This could occur, for example, when participating municipalities do not reduce their employee staffing due to legal restrictions or bureaucratic inertia. 110. Typically, the law on municipalities or some other legislation introduces the possibility of creating commonwealths as an intermunicipal associative form. 19 In Croatia, 17 The creation of special districts can be considered a specialized version of the more general commonwealth solution, one that is commonly used in some regions of North America, such as with the creation of special water and sewage districts. 18 For example, in the United States, small towns often hire larger local governments or create “special districts” for certain services. 19 In a broader sense, IMC could include not only the joint provision of public services by several local governments but also the possible recruitment of one subnational government by another to provide a public service in its territory in exchange for a pre-established payment. The presence of this form of legislation is not a 55 cooperation between local and regional units is proving to be one of the foundations for improving the state of local self-government. Cooperation is achieved through the joint ownership of utility companies (e.g., garbage collection or water supply companies, etc.) or in an ad hoc manner, without any written agreement, meaning that there is no mechanism for monitoring and recording its existence or functionality. Thus, cooperation mechanisms already exist but are often informal or based on unreliable political agreements. It is therefore necessary for Croatia to establish a sound institutional foundation to strengthen existing cooperation efforts. Figure 4.3. provides an indicative framework of three phases and 15 steps that could serve as a guideline to setting up IMC projects. Figure 4.3. Key Steps in Setting up IMC Projects Source: Authors, according to CoE, UNDP, and LGI (2010) 111. One of the obstacles to fully establishing formal IMC in Croatia is the weak capacity of LRGUs to take initiative, and the fact that the central government has never truly insisted on the unification of local or regional public services across subnational units. The legal requirements can sometimes also be demanding, for example, requiring popular consultation. Another major drawback to the formation of commonwealths is that there is no guarantee of the stability and continuity of the new institutional arrangement. It may also be that the institutional framework is inflexible and unclear, or that the costs of reaching agreements are guarantee of success, however. For example, in Latin America, in countries such as Argentina, Guatemala, and Peru, commonwealths are recognized but have not flourished; Bolivia is an exception, where there are about 100 commonwealths that receive financial support and preferential treatment in public planning and investment systems by the central government. 56 very high (for reasons of communication, negotiation, coordination, or monitoring and evaluation). International experience in the use of commonwealths as a solution to local fragmentation is varied, with important lessons to be learned. Among these lessons, the various incentives and rules for the creation and proper functioning of commonwealths can be highlighted (box 4.3). Box 4.3. Rules and Incentives for the Creation and Proper Functioning of Municipal Commonwealths 1. Establish, through national legislation, simple and flexible channels for the creation of incentives. 2. Since small municipalities have fewer financial, human, and technical resources, require that the central government and municipal associations provide these municipalities with the necessary support and technical advice. In this regard, it would be desirable to ensure that local governments have the required training on the various possibilities for collaboration, such as through the establishment of a specialized center for advice on local cooperation within the orbit of the central government. 3. Introduce ways to reduce communication and transaction costs to reach agreements and to monitor their proper execution. This can be achieved, for example, with the provision of standardized model agreements. 4. Consider the introduction of positive financial incentives, for example, (i) providing priority financial treatment to investment projects and/or public services that come from commonwealths; (ii) creating a line of subsidies (or subsidized credits) specifically aimed at financing projects proposed by commonwealth governments, or (iii) creating a system of conditional transfers whose “coverage rate” is higher for projects from commonwealths. 5. When private providers are considered, look for ways to promote competition between the concessionaires used by the commonwealths. Source: World Bank (2021). 112. In international settings, unless the law says differently, all the functions performed by municipalities can be performed jointly through an IMC arrangement. In general, municipalities perform three kinds of direct functions: (i) issuing regulations; (ii) providing community and utility services, and (iii) commissioning the building of infrastructure. To support the operation of these direct functions, municipalities also carry out some indirect functions (CoE, UNDP, and LGI 2010). See table 4.3 for a more detailed overview of municipal functions and Annex 5 for possible objectives of IMC in various domains (public functions). Table 4.3. Classification of Municipal Functions Category Functions - Development planning; urban planning; construction permits - Environmental protection Regulatory functions - Commercial and health regulations - Traffic management 57 - Economic development (trade fairs, enterprise zones, tourism, rural development) - Education and school facilities - Social services (family care, social work, social housing) Community services and - Health centers and sanitation their infrastructure - Cultural services, facilities, and events (theaters, festivals, libraries, sports activities) - Communal police; fire service; rescue/civil protection - Registers (civil status, population, property/cadastre); certifications - Water supply and distribution; sewerage - Waste management (collection, disposal, treatment/recycling) Public utilities and - Urban heating; energy supply their infrastructure - Public transport; roads and lighting; car parks - Public gardens and green areas - Human resources management and development - Procurement of goods and services, legal advice Indirect functions - Budgeting; tax collection; accountancy and bookkeeping; internal audit - Maintenance of buildings and equipment; catering and cleaning - Electronic data processing Source: CoE, UNDP, and LGI (2010). 113. The most common form of cooperation is for the provision of services whose production is capital intensive, such as waste collection and treatment and water supply and channeling. However, municipalities sometimes cooperate also in performing indirect functions, especially where the administrative capacity for providing some of those functions are weak or nonexistent (see box 4.4). Regional economic development is another frequent goal. In Europe, there is a wide variety of experience, including in Portugal, France, and Spain, which promote the formation of commonwealths by means of precise and developed national legislation. In France, financial incentives to promote cooperation have long been provided, but a law was introduced in 2008 that required all municipalities of a certain size to find contiguous border partners with which to associate. In Spain, there are no substantial financial incentives or mandates, but there is a flexible legal framework that allows municipalities to adapt to new formats and objectives with ease. Box 4.4. Areas of Competence of Intermunicipal Cooperation Bodies The areas of competence of IMC bodies are selected either by the municipalities themselves or by the state. The criteria for selection must be: cost-effectiveness, service quality, proximity, economic and social concerns, etc. The choice may be influenced by practical needs or by a more complicated policy, particularly if it is a central government decision. The key areas of intermunicipal competence concern management of water, waste, traffic and transport, planning, lighting, emergency services, environmental protection, tourism, economic and social development, sports amenities, medical services, social security and public order (sometimes), and public security. Energy and education may also be managed by intermunicipal bodies. There is no necessary limit to the list of transferred competences. There may, however, be state prerogatives that cannot be transferred to the local level, and so for instance, functions of authority cannot be delegated to the intermunicipal bodies. Moreover, intermunicipal bodies must, in principle, remain within the 58 municipal area of competence and respect the competences of the other state levels. The following country examples are notable: In Norway, among areas of administrative and technical competence are (figures from 2008): waste collection (75 percent), procurement (46 percent), firefighting (45 percent), information and communications technology (42 percent), and water services (15 percent). Beginning in 2007, new areas of competence in which many municipalities cooperate are social welfare institutions for children (28 percent) and agriculture (35 percent). In France intermunicipal bodies have wide areas of competence: spatial planning, economic development, housing, environmental protection, road infrastructure, urban policy, crime prevention, and cultural, sports and educational amenities. According to a 2002 survey by the French Association of Mayors, the public services whose management is most often assigned to intermunicipal bodies are transport, sanitation, and waste processing. Water and waste services are also managed at the intermunicipal level, although to a lesser extent (60 percent, with 40 percent managed by the municipalities). Social welfare and school meals are still matters for the municipalities, in the context of municipal social welfare centers, but intermunicipal centers are now developing. In Sweden, IMC is considered cost-effective and efficient in the fields of the environment, planning, building, and civil engineering, as well as various other technical fields. It generates advantages of scale that can reinforce organizational capacities. Nonetheless, it is apparently considered less efficient to cooperate in the fields of social assistance or individual care, as these must be provided in situ where the beneficiaries live. There are no advantages of scale here and the high cost of the transaction does not change even where the management sector is broader. Thus, the competent authorities have to decide whether their aim is cost-effectiveness or priority service provision and possibly find compromise solutions. Source: CoE (2008a). 114. Research and academia indicate positive outcomes for LGU cooperation. Yurisch, Soto, and Fuenzalida (2019) review the literature devoted to reductions in service costs for participants in cases of the collective implementation of programs at an intermunicipal scale. They refer, for example, to the study by Amaral and Blatt (2011), which provides evidence of beneficial effects from the procurement of medicines by a municipal consortia. Wolfschütz (2020) uses data on municipalities in four West German states—Lower Saxony, Hesse, Rhineland Palatinate, and Bavaria—during the years 2008–2015 and confirms that over time, IMC has a positive effect on local economic performance and local business development resources are spent more productively in cooperating municipalities. Studies to assess the final results of collaboration and positive impacts on the target population refer mostly to areas of public policy, such as citizen security (Salazar, Polendo, and Ibarra 2011), tourism (Pereira, Barreto, and Pittock 2009), and management of water resources (Montero et al. 2006). These studies conclude, at least implicitly, that local government associations and collaboration have positive effects (Yurisch, Soto, and Fuenzalida 2019). 20 20 Struk and Bakoš (2021) quantify the cost benefits of utilizing IMC in the field of municipal solid waste management using data from a 10-year period from municipalities in the South Moravian region in the Czech Republic, where high municipal fragmentation results in many dominantly small municipalities that often are not able to provide public services at reasonable costs. Their results suggest that municipalities participating in IMC focused on waste management experienced annual cost savings of approximately 13.5 percent for the provision of this service throughout the examined period of 2010–2019 when compared to municipalities that did not cooperate. 59 115. However, not all studies confirm a beneficial effect from IMCs. For example, Frère, Leprince, and Paty (2014) assessed the effects of intermunicipal fiscal cooperation on municipal spending based on the French experience and show that it had no significant impact on the level of municipal public spending. Similarly, some studies found levels of effectiveness that were lower than hoped for (e.g., Prosenewicz and Lippi 2012), while others questioned associations and collaboration as the means to address low capacity or to overcome initial inequities and to fiscally balance local governments. Despite the proliferation of studies in this area, however, few explicitly measure effectiveness (Yurisch, Soto, and Fuenzalida 2019). Other possibilities 116. Some countries have addressed the issue by creating several tiers of local governments that are assigned, at least in principle, expenditure responsibilities congruent with their size and administrative capabilities. Adopting an asymmetric allocation of spending functions contingent upon the size and capacity of each level of government is far from an ideal solution to the issue of local government fragmentation, though the approach has been implemented in countries like Peru, South Africa, and Spain. This approach has already been implemented in part in Croatia with the distinction between cities and municipalities at the local level and the de facto upward delegation of services by cities and municipalities to their respective county governments. 117. Finally, an alternative option is to allow and facilitate (temporary) upward delegation of certain local public functions to a higher (intermediate) level of government. For example, in some parts of Spain, small municipalities delegate some of their functions to the provincial subregional “diputaciones” 21 or municipal associations “mancomunidades” (see box 4.5). In other cases, the delegation of functional responsibility is horizontal, from a smaller jurisdiction to an adjoining larger one. For example, in the United States, small municipalities may contract for refuse collection or fire protection services with larger neighboring jurisdictions. Box 4.5. Municipal Associations (Mancomunidades) in Bizkaia The province of Bizkaia is one of three historical territories of the Basque Country, one of the autonomous communities in Spain. Bizkaia has a population of over 1.1 million habitants in 112 municipalities, most of them small and with limited capacity to carry out all their assigned functions and These long-term results show how beneficial IMC can be in reducing service costs. In addition to the direct financial benefits, municipal representatives stated that IMC often brings other qualitative and non-financial benefits, such as better service quality, the possibility of sharing infrastructure, and relief from administrative and managerial burdens through the utilization of professional management, which was especially appreciated by the smallest municipalities with limited administrative staff. 21 Diputaciones, or provincial councils, are the administrator and governing body of a province of Spain, an intermediate institution between the municipal and regional governments (comunidades autónomas) and part of the local government system there. 60 to fulfill all their duties on their own. The degree of fragmentation is high at approximately 10 LGUs per 100,000 inhabitants, and fairly similar to Croatia’s (see table 2.6). Legal and regulatory framework. The Spanish Constitution already contemplates the possibility of forming municipal associations (mancomunidades) under article 141.3, and the law (Law 7/1985, April 2, 1985) recognizes the associations as local entities in the same way as municipalities and provinces. These associations are further regulated under a law that established that: municipalities have the right to associate for the common execution of works and services determined within their competence; these associations have legal personality and capacity to fulfill their specific purposes; and they are governed by their own statutes (estatutos). The statutes must regulate the territorial scope of the entity as well as its purpose and competence, governing bodies and resources, term of duration, and other functions necessary for its operation. The governing bodies will be representative of the joint municipalities. The procedure for approving the statutes of the associations is determined by legislation of the autonomous communities, in the case of Bizkaia, the Basque Country autonomous community. Thus, Regional Law 3/1995 (March 30, 1995) regulates in more detail the supra-municipal entities of Bizkaia by establishing the procedure for their constitution and dissolution, the minimum content of their statutes, and their minimum operating standards, among other key aspects. Creation. The 15 associations that exist in Bizkaia were created under the aforementioned legal and regulatory framework. The formation has been gradual, and associations are still being created. The most recent was established in 2021, the Nerbioi-Ibaizabal Services Association. The creation agreement is municipal competence, and the specific administrative process is clearly detailed in articles 10–16 of Regional Law 3/1995. An absolute majority of the members of the City Council is required to adopt an agreement to establish a commonwealth together with other municipalities for the joint provision of the services considered. Services provided. Generally, associations manage the services that municipalities in isolation do not have the capacity to manage or that are cheaper to manage jointly based on a criterion of scale, even if the capacity exists. The usual services that are pooled are social services and solid waste management, but the associations manage many other services that include environmental protection, overall waste collection, public lighting, equality programs, social services, cultural and language promotion, employment, and even abandoned animals. Incentives. Incentives for the promotion of associations are not expressly mentioned under the Constitution, but the Regional Law establishes in its article 1.5 that the Diputación Foral de Bizkaia (provincial government) will promote the creation of associations for a more rational and economic provision of services. In some case, the Diputación Foral de Bizkaia has developed specific subsidy programs for prioritizing projects from the associations (e.g., solid waste management) and in many cases, projects and programs by these associations are prioritized for co-financing. The Diputación Foral de Bizkaia provides technical assistance to the municipalities to form and manage these associations. Management. Associations are managed through their governing bodies, generally consisting of a president, governing board, and general assembly, all of them councilors or mayors of the joint municipalities. In the largest ones, there is usually a manager in addition to the elected officials and the compulsory secretary-controller as in any municipality. The personnel are public employees, civil servants, or workers appointed after passing an official competitive process. All municipalities provide contributions to the associations to pay general, fixed, and personnel expenses and to finance the joint 61 services. These contributions are proportional to the size of each municipality or its population so that they finance the service to the extent that they benefit from it. The associations report back to their governing board, formed by the municipalities. Source: Diputacion Foral de Bizkaia, Bizkaia Foru Aldundia, https://web.bizkaia.eus/es/inicio. 62 5. Incentive Measures for Intermunicipal Cooperation and the Creation of Commonwealths 118. Successful IMC seems to be highly correlated with the definition of robust incentives. It is very telling that wherever useful examples of cooperation or voluntary mergers are found, they have been supported by a strong set of incentives provided by national or, in European countries, EU policies. The nature of these incentives is such that sometimes it is open to debate as to whether cooperation is still bottom-up and voluntary or imposed by external actors. It has been the case in France and Finland, the two European countries most often quoted as positive examples of IMC. To some extent, the same is true of the recent development of intermunicipal bodies in Hungary, the Czech Republic, or Slovakia (Swianiewicz 2010). 119. Hulst and van Montfort (2007) distinguish three major types of IMC incentives. These are: financial, in which, most typically, IMC is supported by various kinds of grants; functional, in which certain functions may be delegated to local governments under the condition that they create an intermunicipal institution; and obligatory, in which required standards are set or statutory obligations are formulated to ensure cooperation (leaving, however, local discretion as to the details related to the area, practical arrangements, and level of cooperation). 120. IMC does not have to be completely voluntary and based on incentives. This process can (like mergers/amalgamations) also be imposed by the central government. However, this model would be perhaps the least useful in the Central and Eastern European context, which has a continuing problem of setting too many unrealistic rules and standards. These regulations are often not followed, as this would exceed the capacity of local governments, and at the same time they seriously damage local autonomy. Thus, producing more rules to stimulate IMC would most likely be both ineffective and harmful to the entire system of local government. Therefore, in the remainder of this document, financial and functional incentives will be the predominant focus. 121. In the case of voluntary mergers, clear incentives of a financial or functional nature should be provided by the central government, offering wider autonomy or additional powers to those undertaking the change. Incentives or compensation can be, for instance, in relation to existing debt, further investment, geographical disadvantages, and so forth. Incentivized voluntary (or semi-voluntary) mergers can be found in Finland, the Netherlands, Norway, Denmark, and the German state of Saxony Anhalt. In some cases, if the voluntary stage fails, the next step is a compulsory merger (Swianiewicz, Gendźwił, and Zardi 2017). Financial incentives 122. Financial incentives play a critical role in stimulating voluntary mergers. Table 5.1 summarizes the experience of a number countries with this kind of incentive. Although there is 63 a wide variety of examples of how to implement financial incentives, this section highlights the cases of the Flemish government, Norway, Ukraine, Estonia, Slovenia, Belgium, and Switzerland. Table 5.1. Financial Incentives Aimed at Stimulating Voluntary Mergers Country (year) Incentive measures The Flemish government takes over the debts of the municipalities that decide to amalgamate by the deadline. The maximum amount of debt relief is €500 per inhabitant, Belgium (2016) with a maximum amount of €20 million per amalgamation and to the extent that the maximum amount of €200 million in the Flemish budget is not exceeded. Municipalities can still amalgamate after the deadline, but without these incentives. Local governments formed as a result of the alteration of administrative-territorial Estonia (2016) organization initiated by local government councils were to be paid a merger grant (see box 4.1 for details). • The so-called reform grant – between 5 million and 30 million NOK (€0.5–3.3 million), according to the population of the new municipality • A grant that is meant to cover costs in the amalgamation process and that varies between 20 and 65 million NOK (€2.2–7.1 million) • The most important is the long-term incentive, which the government offers for a Norway (2017) period of 20 years. During the first 15 years, the new municipality receives an annual block grant from the state equal to what the amalgamated municipalities would have received without the amalgamation. Since small municipalities have higher costs per capita, they currently receive a higher per capita block grant. If the new, bigger municipality succeeds in reducing per capita administrative costs, it will be able to spend over the average on service production during the transition period. After 15 years, the plan is gradually to reduce these incentives. The state provides financial incentives for the establishment of joint intermunicipal Slovenia (2005) administrative bodies, such that it covers one-half of their operating costs. These bodies may or may not have a legal personality. The cantonal supports to LGUs’ voluntary amalgamation take three forms: • a general indicative plan for a voluntary amalgamation policy in the canton; Switzerland (2000) • technical and administrative support to LGUs that engage in an amalgamation process; and • direct unconditional block grants paid to the new amalgamated commune (see box 4.2) for details. • Increased revenues: the new hromada may take over revenues that were earlier assigned to the raion-level government (in particular, the share in revenues from PIT assigned earlier to the raion). Ukraine • Specific grants from the central government that may be used for development (2015) projects in the new hromada. This incentive makes the reform relatively costly for the state budget and it is not clear how sustainable these grants may be in the future. • Inclusion of transfers from the state budget in a more transparent formula-based scheme, instead of the poorly regulated and highly subjective mechanisms at the regional and raion level. Source: Authors, based on Swianiewicz, Gendźwił, and Zardi (2017), Swianiewicz (2011), and Dafflon (2013). 123. The Flemish government takes over the debts of the municipalities that decide to amalgamate. The per capita amount is predetermined, with a ceiling set per amalgamation and a total maximum expenditure for the budget. The government has also enabled and encouraged municipalities to engage in critical self-assessments of their governance capacity and to reach their own informed conclusions by developing a monitoring system as a joint effort of the 64 Flemish Agency for Internal Affairs (a government body) and the Policy Research Centre (a government-financed academic research center). The Agency has assisted Flemish LGUs in developing an amalgamation roadmap, simulating a financial profile for the amalgamated LGU via a simulation dashboard, and conducting impact studies. As a result, 15 LGUs have merged into seven, reducing their average population size to 21,000, though a quarter of the LGU population remains below 10,000 (EC 2021). 124. Norway introduced incentives via several different types of grants: i) the reform grant, according to the population of the new municipality; ii) a grant for covering costs in the amalgamation process; and iii) the long-term incentive, offered for a period of 20 years. 125. In Slovenia, the state provided financial incentives for the establishment of joint intermunicipal administrative bodies by covering one-half of their operating costs. These bodies may or may not have a legal personality. The result is 52 joint municipal administration bodies for 212 municipalities. 126. In Ukraine, the mergers have been incentivized, among other instruments, through specific grants from the central government, with the funds used for development projects. It is worth mentioning that in parallel with the law on voluntary amalgamation, Ukraine has implemented a law that aims at strengthening IMC. These two ways of dealing with territorial fragmentation are seen as complementary rather than alternative. Together with territorial and functional changes, the Ukrainian reform also refurbished the system of intergovernmental financial relations. Changing tax sharing arrangements has been particularly beneficial for cities of oblast significance—their real revenues increased by 14 percent during the 2014–16 period. Also, consolidated hromada, or municipalities, have gained financial support in the form of investment grants that have allowed them to allocate close to 30 percent of their total expenditure to capital investments. Overall, the reforms have led to a significant shift of power from an upper to a lower tier of government. As a result, from 2015 to April 2017, almost 2,000 tiny local governments were merged into over 400 new, enlarged jurisdictions, meaning that the overall number of basic-tier LGUs has been reduced by over 1,500. Thus far, the reform has covered almost 20 percent of Ukrainian territory, and the eventual number of new local governments will probably be higher than initially anticipated (Swianiewicz, Gendźwił, and Zardi 2017). Box 5.1. Financial Incentives for Merged Local Government Units in Estonia Merger grants. Local governments formed as a result of the alteration of administrative-territorial organization initiated by local government councils were to be paid a merger grant. The rate of the merger grant was €50 per resident of the merged local government. The minimum merger grant for a merged local government was €150,000 and the maximum €400,000. In the event that the number of residents in a local government formed as a result of a merger was: 1) smaller than 3,000, the merger grant was calculated for each merged local government according to the minimum amount of the grant. 65 2) equal to or greater than 5,000, the merger grant was calculated for each merged local government per resident at twice the rate or double the minimum or maximum amount of the merger grant. 3) equal to or greater than 3,000 but smaller than 5,000, the merger grant was calculated for each merged local government according to the number of residents in the local government formed as a result of the merger. The basis for calculating a merger grant, increasing in a linear fashion, was the rate of the grant per resident, which was increased after the 3,000th resident of a local government formed as a result of a merger by 2.5 cents per each additional resident, but to no greater amount than twice the rate of the grant per resident (capped at €100 per resident). The total amount of the merger grant calculated for a merged local government increased in a linear fashion in the same proportion as the rate increase of the merger grant calculated per resident (in total not less than €300,000 and not more than €800,000 per new municipality). If the number of residents in a local government formed as a result of a merger was equal to or greater than 11,000, or if a local government the size of a county was formed with a number of residents that was smaller than 11,000, an additional grant in the amount of €500,000 was calculated. Budgetary subsidies were kept at the same level for at least eight years. If a territorial area was assigned from one local government to another, the merger grant was calculated per resident thereof if: 1) a territorial area of another local government was assigned to a local government formed as a result of a merger 2) a territorial area of another local government was assigned to a local government that did not meet the criterion for the minimum size of a local government and that did not participate in the merger, provided that the local government from which a territorial area was excluded merged with some local government. In that case, the rate of the merger grant per resident was doubled. Procedure for paying a merger grant. The merger grant calculated for each merged local government and territorial area assigned thereto was summarized and paid to the local government formed in the course of a merger. At least one-fourth of the merger grants were transferred to a local government formed in the course of a merger by the end of 2017 at the latest, another half of the grants by June 2018, and the rest of the amount in the first quarter of 2019 at the latest. Using a merger grant. Resources of the merger grant were prescribed in the state budget. A rural municipal or city government, within one month following the announcement of council election results of a local government formed in the course of a merger, was to submit an application to the MOF for an allocation of the merger grant, in which it explained how using the grant was in keeping with the Promotion of Local Government Merger Act. A merger grant could be used to cover the following costs: 1) conducting research, analyses, and consultations related to the merger 2) ascertaining the opinion of the residents of the rural municipality or city 3) taking actions related to the change of the name and status of the local government 4) reorganizing local government administrative agencies, or agencies administered by them, including payment of the compensation prescribed by law (such as payment of single compensation to the chairman of the council of a relevant local government or a rural municipal or city mayor upon termination of his or her authority) 5) covering expenses related to the provision of public services 6) financing the investments prescribed by the development plan or agreed upon in the merger agreement 66 7) meeting financial obligations arising from a loan agreement arranged in the merger agreement or other type of obligation 8) co-financing projects from EU structural funds For municipalities that merged on a central government initiative, there were no incentives, but direct expenses stemming from the merger process were covered (initially capped at €100,000, but this limit was found unconstitutional by the country’s supreme court). Source: Administrative Reform Act (2016). 127. Switzerland also offers examples of incentive measures for voluntary mergers. In the early 2000s, the canton of Fribourg experienced an unprecedented wave of voluntary municipal mergers. More than half of all municipalities (135) started a merger process, and many ultimately (105) merged successfully. The number of municipalities dropped from 245 at the end of 1999 to 168 by the end of 2006: 77 municipalities disappeared from the cantonal map. With the aim of encouraging municipal mergers during a limited period of time (2000– 06), the parliament of the canton passed a decree in 1999 introducing lump sum payments for merging municipalities. More precisely, each municipality that merged received CHF 400 per inhabitant weighted by its financial capacity. A fund was created to finance these payments. Local governments had to contribute 30 percent to this fund; the remaining 70 percent was paid by the canton. Together with the transparent way of calculating the lump sum payment and the pressure exerted by the time-based limitation, this substantial contribution on the part of the municipalities might have constituted an additional incentive. Merging then meant getting the lost money back with a little “bonus.” This incentive structure allowed for the rare event of a large-scale territorial reform that was not based on compulsion (Strebel 2018). Box 5.2. Financial Incentives for Amalgamated Communes in Switzerland The cantonal supports to LGUs’ voluntary amalgamation take three forms: (i) a general indicative plan for a voluntary amalgamation policy in the canton; (ii) technical and administrative support to LGUs that engage in an amalgamation process; and (iii) direct unconditional block grants paid to the new amalgamated commune. These block grants are usually the main cantonal policy incentive. There are two ways for calculating the cantonal financial aid: ad hoc in five cantons (Aargau, Graubünden, Luzern, Sankt-Gall, and Ticino) and formula based in all the other cantons. Ad hoc financial support means that there are variables enumerated in the cantonal law on the encouragement of LGU amalgamation that require calculations or estimations (normally by the canton) to obtain the amount to be paid. The incitement consists of (i) calculating the financial and structural disabilities that exist between the poorest or the less-developed LGUs in the amalgamation and a benchmark detailed in the law, and (ii) compensating for the differences. The usual benchmarks are either the variable average for the LGUs engaged in the amalgamation or the “best” position for each variable. It is never some sort of “cantonal average” for the relevant variables. Thus, the financial aid is relative to the group of LGU candidates for amalgamation within a delimited territory. The most common variables are: (a) public indebtedness per capita; (b) tax effort (considering the surtax on direct taxation and sometimes also user charges); (c) differences in the infrastructure and equipment 67 of the communes; and (d) exceptional needs, considering that certain investments are necessary for the viability of the new commune, whose costs cannot be left to the new LGU after amalgamation. Formula-based incentive grants can be expressed with the following general formula: 1 = [ × ∑ =1 ] × × , where IG = incentive grant, CHF = the amount of grant per capita, H = the number of residents, i = LGU candidate to amalgamation, n = the number of LGUs in the referred amalgamation, IFC = indicator of financial capacity, and m = encouragement factor that increases with n. Most cantonal formulas are lump sum and use only the two first terms within the brackets in the equation above. Actually, the amount per capita varies from 100 to 600 CHF. Three cantons (Neuchâtel and Jura, Fribourg between 2000 and 2005) are weighting the population number with an inverse index of financial (tax) capacity. Tax capacity indices are generally used in revenue equalization. The assertion in the formula is that “rich” LGUs participating in the amalgamation process should not receive the full per capita incentive grant because their financial position is already comfortable. This variable has been debated in many cantons and abandoned because it mixes equalization with the amalgamation policy, something that goes against the Tinbergen “one goal-one instrument” rule in policy implementation. According to Tinbergen, the number of achievable policy goals cannot exceed the number of policy instruments. The inverse argument can also be found: equalization objectives can be so generous that there is no incentive for beneficiary LGUs to find efficient solutions in horizontal cooperation or amalgamation. It could also induce wealthier LGUs not to engage in amalgamation because the aid received is judged insufficient. Finally, the variable m tries to influence the size of the new LGU in increasing the per capita grant in function of the number of communes finally merged. Here, the incentive from the cantonal point of view is to obtain in each amalgamation the more LGUs. For example, m can be 1.1, 1.2, 1.3 or higher, depending on the number of communes (three, four, five, or more). The advantage of the formula-based incentive grant is that it is transparent from the outset and not negotiable. Source: Authors, based on Dafflon (2013). 128. In summary, countries have taken various paths in conducting their territorial reforms. Although there have been ample use and variety of fiscal instruments to stimulate mergers and associations worldwide, there is no consensus on which instruments (financial incentives) have proven most efficient and effective. However, observing different reform paths and incentives employed, and having in mind Croatia’s context, at this stage, additional capital grants for infrastructure projects would seem to be the most appropriate and viable solution. Functional incentives 129. Several countries have experience in the deployment of functional incentives, which can also play a critical role in stimulating mergers. Table 5.2 summarizes the functional incentives for mergers and cooperation utilized across the countries. There is a wide variety of examples of how to implement these incentives and this section highlights the cases of Denmark, the Netherlands, Ireland, Norway, and Ukraine. 68 Table 5.2. Functional Incentives Aimed at Stimulating Voluntary Mergers Country (year) Incentive Measure Denmark The abolition of counties and the reallocation of a share of their responsibilities to the (2007) municipalities provided incentives for municipal mergers. Large responsibilities were transferred to municipalities in the areas of social care, with the requirement that they consolidate (or collaborate) to perform their new mandatory Netherlands social functions adequately. The first decentralization process in 2007 showed that small (2015) municipalities did not have the managerial, administrative, and financial capacity to deal with these new responsibilities, and several small municipalities needed to reorganize themselves on a more suitable scale. Local authorities were given an expanded role in economic development, but the Ireland determination of new boundaries was left to the central government. The mergers (2014) occurred on the back of a review of municipal needs and capacity relative to population size. Transfers of additional responsibilities from the counties (e.g., secondary education and Norway public transport) and the central government to municipalities will occur only if they (2014–2017) merge into larger units. These units should be based on functional areas with sufficient capacity and competence to manage these new tasks. Ukraine Possibility of taking over several important functions related to education, health care, (2015) and social assistance that had earlier been assigned to the raion (regional) level. Source: Authors, based on Swianiewicz, Gendźwił, and Zardi (2017). 130. In Denmark, the abolition of counties and the reallocation of a share of their responsibilities to municipalities provided incentives for municipal mergers. This was Denmark’s third wave of agglomeration, following voluntary and involuntary mergers in the 1970s and early 2000s. Between 2007 and 2012, the country was able to reduce the number of LRGUs from 271 to 98. The process could be characterized as “semi-voluntary,” with a clear timetable and expected results. The implication was that if free negotiations were not successful, then decisions might be taken out of local hands. There was just one “hard” criterion, which was that the new municipality should contain at least 20,000 inhabitants, although 30,000 was the recommended target size. Municipalities below the threshold could avoid amalgamation by concluding a cooperation agreement with neighboring municipalities on service provision to reach the population target. Seven of the 33 non-amalgamated municipalities fell into this category and entered into binding partnerships, of which five were islands. Moreover, there was also the “soft” criterion of cohesion—the municipalities should have existing ties through patterns of trade and commuting and a sense of belonging together, and hence some shared socioeconomic identity. Clearly, the municipalities had to have contiguous boundaries, as there could not be physical gaps between them. This soft criterion was not formalized into strict metrics, however, leaving opportunity for interpretation according to local circumstances. Where intra-LGU interests converged, the law foresaw the holding of referendums; alternatively, mediation was available and usually delegated to credible senior political figures or retired LGU officials. Financial incentives were secondary to the scheme and relied on a new financing system—whereby regions received no tax revenue directly but were financed instead from central and local levels—and the intermunicipal equalization scheme was adjusted to reflect the new municipal map and distribution of tasks to ensure a fairer balance in resources between rich and poor territories (EC 2021). 69 131. The Netherlands currently has one of the highest mean populations for municipalities in the EU, with an average of over 49,000 inhabitants. This may be explained by population density, given the country’s landmass, as well as the consecutive involuntary mergers in the 1980s. In 2015, large responsibilities were transferred to municipalities in the areas of health and social care, with the requirement that they consolidate (or collaborate) to perform their new mandatory social functions adequately. The first decentralization process in 2007 showed that small municipalities did not have the managerial, administrative, or financial capacity to deal with these new responsibilities, and several small municipalities needed to reorganize themselves on a more suitable scale (EC 2021). 132. In Ireland, local authorities were given an expanded role in economic development (Swianiewicz, Gendźwił, and Zardi 2017), but the determination of new boundaries was left to the central government. The mergers occurred on the back of a review of municipal needs and capacity relative to population size. The result merged six city and county councils into three unified local authorities. A further 80 town councils were abolished, reducing their number from 114 to 31. 133. In Norway, transfers of additional responsibilities from the counties (e.g., secondary education and public transport) and central government to municipalities occurred under the condition that they merge into larger units. Under the relevant legislation, mergers should be voluntary unless LGUs were determined to be obstructionist to changes that were necessary in light of regional consideration. During the merging phases, LGUs were barred from taking out loans or entering into long-term rental agreements as a safeguard against misappropriation and obstruction. The financial incentives included reduced equalization subsidies to small units that did not merge (“the stick”) and reform grants (“the carrot”), described further in section 5 below (Klausen, Askim, and Christensen 2021). 134. In Ukraine, LGUs were given the possibility of taking over several important functions related to education, health care, and social assistance that had been earlier assigned to the higher (raion) level. A legislative framework was developed to allow for the cooperation of territorial communities and their voluntary consolidation in order to build scale at the local level, provide higher quality and more affordable public services, and improve capacity to meet new fiscal and administrative responsibilities. As of July 2017, approximately 2,000 local self-governments had voluntarily merged to form 413 united territorial communities covering 17 percent of the national territory and representing 8 percent of the population. Besides financial incentives, an additional driver of success was the ability of the merging communities to maintain their original identities and elect a local community leader. This helped convince smaller towns, villages, and settlements to engage in the amalgamation process (OECD 2018a). 70 135. The emerging trends observed across countries in recent years on financial and functional incentives to stimulate voluntary mergers and cooperation can be summarized as follows: • There is no “one-size-fits-all” solution to providing financial and functional incentives for voluntary mergers and cooperation. • Observing different reform paths and incentives employed, and having in mind Croatia’s context, at this stage, additional capital grants for infrastructure projects would seem to be the most appropriate and viable solution. • Most countries rely on transferring additional responsibilities (and financing) to merged or cooperating LGUs. • Having in mind the architecture of the Croatian fiscal decentralization system, functional incentives for voluntary mergers and cooperation could, for the time being, be of an indirect nature, that is, merged or cooperating LGUs could (due to increased fiscal capacity) take over some or all of the newly decentralized functions, such as health care, education, social welfare, and fire protection services. It has to be noted that LGU currently get an increased share of PIT, a shared tax divided by counties and LGUs (cities and municipalities), for each newly decentralized function they assume. • Local government associations and voluntary mergers can also lead to increased financial capacity and resources to provide higher-quality public services to the local population. Designing a program of incentives 136. This section summarizes the financial incentive measures for real and functional mergers currently being proposed by the Croatian government, followed by specific proposals developed for the government’s consideration. A full discussion on policy options and recommendations for reform in Croatia is in the next and final chapter. As currently planned by the government 137. Functional mergers (planned): • The joint performance of tasks will be encouraged by co-financing the expenditure for specific activities. • The criteria for determining the amount of co-financing will depend, inter alia, on the number of tasks performed jointly and will be determined by a specific law. • The initial parameters would be the following: the stated needs of LGUs, their budgetary and fiscal capacity, the number of inhabitants, the number of potential users of services, and the time frame involved in performing certain local services. 71 • In cooperation with the MOF, the co-financing funds will be provided in the equalization fund. • Units that decide to merge functionally, in order to be eligible for co-financing, will be obliged to carry out joint work/tasks for a minimum period of five years. 138. Functionally merged LGUs will retain the same budget available to them before the merger for a period of at least two years, and incentives will also cover one-off merger costs and provide additional funds based on the savings achieved over the ensuing five years. 139. Actual mergers (planned): • Incentives for actual LGU mergers will include one-off capital transfers over the five years that LGUs will use specifically for infrastructure projects. 140. One clear objective is that a functional or actual merger of units will have a positive impact when awarding EU grants and co-financing from EU funds. The criteria and the nature of the incentives will be determined by a government decision, with greater fiscal incentives for actual mergers and incentives for functional mergers dependent on the number and type of joint (merged) functions provided. Proposal for additional options 141. Functional mergers (proposed): • Grant priority financial treatment for the provision of public services on the territory of cooperating LGUs. • Create a line of subsidies (or subsidized credits) specifically destined to finance projects proposed by cooperating LGUs. • Create a system of conditional transfers whose “coverage rate” would be higher for projects that result from IMC. • Determine tasks (specific activities) eligible for co-financing in the event of joint performance. 142. Concrete and precise co-financing criteria should be determined based on a thorough analysis of tasks that will be encouraged if provided in cooperation. These criteria should take into account the number of tasks performed jointly (the amount of co-financing should be positively correlated to the number of functions merged), budgetary and fiscal capacity (the amount of co-financing should increase as capacity decreases), the number of inhabitants and the number of potential users of services (the amount of co-financing should increase with the number of inhabitants and/or potential users), and the time frame involved in performing certain local services (the amount of co-financing should increase with the duration 72 of the program, whereby (in order to avoid the cynical “gaming” of incentives), combined with a “once-in-stay-in” stipulation, incentives can be staggered and “back-loaded” so that most of the funds are transferred to LGUs well after they have demonstrated successful joint operation. 143. Once the list of encouraged joint tasks has been determined, the government might decide, for example, to co-finance 10 percent of expenditures for these tasks. The co- financing may increase for any new function provided in cooperation by certain percentages (say 1 or 2 percent). For budgetary and fiscal capacities, as well as the number of inhabitants and the number of potential users, LGUs could be divided into several groups (cohorts), and the additional percentage of co-financing could be proposed according to their distribution among cohorts. If the fiscal space would not allow this, the coefficients could be used to “correct” the amount of co-financing. For example, if LGUs are grouped into five cohorts, the best performing cohort could have a coefficient of 0.2 (or 20 percent) and the worst performing a coefficient of 1 (or 100 percent). These coefficients would then be multiplied by the amount of co-financing determined in previous stages to determine the final level of co-financing. 144. Indicators of capacities can, as previously discussed, take many different forms. However, relying on the most basic ones, such as own revenue per capita, functional expenditure for particular functions per capita, or number of employees per 1,000 inhabitants, might prove to be the most effective. 145. Actual mergers (proposed): • Grant priority financial treatment to investment projects that come from merged LGUs. • Create a line of subsidies (or subsidized credits) specifically destined to finance projects proposed by merged LGUs. • Create a system of conditional transfers whose “coverage rate” would be higher for projects that result from IMC. • When proposing the criteria for one-off capital transfers over the five years that LGUs will use specifically for infrastructure projects, consider combining a “once-in-stay-in” stipulation with the staggering and “back-loading” of incentives so that most of the funds are transferred to LGUs well after they have demonstrated a successful actual merger. 146. The criteria for disbursing these transfers can also depend on fiscal capacity as well as the deficiency of infrastructure (infrastructural equipment per capita). This can be measured, for example, as a five-year average of expenditure for non-financial assets, but also by incorporating the expenditure used to maintain the infrastructure. These characteristics (again presented by cohorts) could help in determining the correction coefficients, whereas the basic amount of the transfers should be determined as a percentage of the previous year’s fiscal capacity or a five-year average. 73 6. Policy Options and Recommendations for Croatia 147. This final section summarizes the main points of the challenges of fragmentation, given its impact on local capacity. It also distills the main messages from international experience and proposes a number of policy reforms and recommendations, organized by type and prioritized by urgency. Challenges of fragmentation 148. Local government fragmentation is pervasive across decentralized countries. This is characterized by the relatively large number of local governments with populations too small to take advantage of economies of scale in the delivery of public services, the lack of administrative capacity and specialized resources, and/or the very low tax bases and own revenue potential. Subnational government fragmentation and consequently – the lack of capacity is one of the most significant policy issues in Croatia’s system of intergovernmental fiscal relations. This has had negative consequences not only for the financing system but also for the efficient supply of local public goods and services, that is, the quality and quantity of provision for the assigned local public functions. A good share of cities and most municipalities do not appear to have the managerial, human, fiscal, technical, and organizational capacity to successfully perform all entrusted functions. 149. For local governments, fiscal revenues often cover only the cost of operating the basic administration. Moreover, the essential problem remains that many local governments are unable to carry out basic local public functions. Furthermore, their administrative capacity is weak and cannot support local development (through, for example, strategic planning, capital investments and development of infrastructure, digitalization, absorption of EU funds, use of advanced financing models, etc.). In addition, there is little hope that these conditions will change any time soon, even with increased efforts in training and capacity building. It is therefore important to facilitate cooperation and the creation of associations and joint projects at the municipality level, among counties, and between cities and municipalities, thereby allowing for a greater concentration of financing capacity and expertise and administrative capacity. 150. Enhancing cooperation among LGUs, and between counties and LGUs, is a precondition to more balanced LGU development. Horizontal (intermunicipal) cooperation between LGUs in performing certain tasks together is not sufficiently widespread in Croatia at the present time. Joint administrative departments could also be encouraged through the finalization of a legal framework for the horizontal cooperation of LGUs, the preparation of typical cooperation agreements, and the promotion of good practices. The efficiency and cost- effectiveness of conducting tasks of local importance could be directed toward forms of intercity cooperation or IMC, such as joint administrative departments, shared development of utility companies, and other formal forms of collaboration. 74 Key messages from international experience 151. International experience has shown that when it comes to fragmentation and options for dealing with it, there is no “one-size-fits-all” recipe. Levels of fiscal decentralization, LGUs’ fiscal capacity, their autonomy and scope, the quality of locally provided services, and the existence of cooperation mechanisms all determine how serious the problem of fragmentation might be. These characteristics also influence decisions on incentive plans and the design of reform measures in general. In addition to country-specific considerations, political factors play a role. Finally, it is important to note that countries are still experimenting, and there is no hard evidence in many cases on whether some relatively recent changes have produced the desired outcomes. However, there are some lessons and emerging trends that are relevant for most countries to take into consideration. Specifically: 152. The problem of fragmentation in essence is not a problem of size (beyond some minimum level) but generally more a problem of capacity. This is understood as the managerial, revenue, and expenditure abilities that LGUs need to have to successfully provide the assigned services to citizens and firms. This capacity is often affected by the design and limitations of the overarching intergovernmental fiscal transfer system and can include aspects related to the revenue and expenditure assignments or the lack of clarity in the assignment of functions across government levels. 22 For its part, the World Bank’s global experience has shown that subnational public management strengthening is a prerequisite to improvements in service delivery in any single sector. Therefore, the most critical factor to consider is the managerial and fiscal capacity of LGUs. The average number of inhabitants or area is not as relevant as the administrative and fiscal capacity of LGUs to provide public goods and services and to perform their administrative and operational tasks. In other words, the problem of fragmentation—where it exists—does not have to be treated through comprehensive reform as long as there are mechanisms to support small and less competent LGUs. However, a minimum of scale or size must be in place to allow for the internalization of economies of scale. 153. International practice addressing local fragmentation varies, and countries are still experimenting with different reform paths and instruments. These range from forced amalgamation to voluntary amalgamation and simple local government associations for the provision of joint services. The results of the different reform avenues are far from conclusive, however. For example, forced mergers do not always deliver on lowering the costs of service provision, or voluntary amalgamations may not happen because of the lack of incentives. However, promoting local government associations is certainly politically less sensitive than forcing mergers, and it may even be more immediately effective than promoting voluntary 22 For more information, see World Bank (2021). 75 mergers. 23 Generally, however, with any reform of that importance and size, political context is paramount, and the process therefore needs to adapt to the different local constraints. 154. It is difficult to find hard quantitative evidence of the effects of different reform paths based on objective metrics of success or failure. This is particularly true with regard to the quality of services provided. To fill in this gap in the existing empirical literature, more research will be needed to clarify the question of quality of services and to analyze, on an experimental basis, how that quality may improve through associations and voluntary mergers and in comparison to forced mergers. 155. Financial incentives often play a key role in successful reforms. These most often include providing unconditional current grants, capital grants, debt relief, and incentives within the equalization system and within the tax sharing scheme, though many of these options undermine Tinbergen’s “one goal-one instrument” rule in policy implementation. Positive incentives can also consist of prioritizing jointly financed projects as opposed to those proposed by a single municipality. 156. The simplest formula to stimulate mergers and IMC is to grant priority financial treatment to investment projects and/or the provision of public services that come from merged or cooperating LGUs. However, this approach is too general and even problematic when resources are insufficient to finance all the projects requested. A more explicit way to support LGU mergers and cooperation would be the creation of a line of subsidies (or subsidized credits) specifically destined to finance projects proposed by merged or cooperating LGUs. Alternatively, a system of conditional transfers could be created whose “coverage rate” would be higher for projects that result from IMC. Another way to stimulate cooperation may be to create (or transfer) financial instruments available only to the pooled authorities (e.g., specific taxes). Or regional or central levels of government could opt for strategies that discourage local non-cooperation. They could increase local budgetary tension by reducing the subsidies received by municipalities, or block part of their potential resources as long as cooperation agreements do not take place. In any case, it is worth mentioning that the empirical literature finds little evidence of the efficacy of adverse budgetary conditions (negative incentives) on the decision to implement local cooperation agreements (Gómez et al. 2010). 157. The time frame for providing incentive grants, as well as the methods for calculating the installments, should be explicit so that LGUs can calculate potential benefits and the central government can have an idea of budgetary costs. Another, more prudent option would be defining the available amount of the incentive fund for territorial and 23 There are, however, successful examples of forced mergers as discussed in the report, such as in Greece and Turkey, among others. In the case of Turkey, the forced merger was implemented within the context of broader local government/intergovernmental reforms, which was probably the main reason why it was a successful amalgamation exercise. 76 functional consolidation and identifying incentives in proportion to the population but subject to the available pool of funds. 158. Calculation criteria must be explicit, fixed in the law, and known in advance. The advantage of the formula-based incentive grant is that it is transparent from the outset and not negotiable (Dafflon 2013). In order to avoid the cynical “gaming” of incentives, combined with a “once-in-stay-in” stipulation, incentives can be staggered and “back-loaded” so that most of the funds are transferred to LGUs well after they have demonstrated successful joint operation. In addition to these positive “carrot” measures, third-party coercion and incentives can also be extended to include negative “stick” policies. Threats of compulsory structural reform, including forced mergers, could thus be used as a catalyst to encourage small LGUs to establish shared service entities. Legal obligations binding all LGUs to these arrangements, together with periodic monitoring of these entities, would assist in preventing the creation of sham joint ventures that exist only on the surface (Dollery, Kortt, and Grant 2013). Recommendations 159. Based on the review of international experience, it can be concluded that the government of Croatia has several relevant options, instruments, and actions to address the lack of local capacity, municipal fragmentation, and enhance IMC among LGUs. This final section proposes several specific recommendations that are organized by term (short and medium) and type (strategic/institutional and operational). The top short-term recommendations include two strategic and two operational recommendations that are shown in bold in figure 6.1: 77 Figure 6.1. Main Recommendation by Priority and Type Source: Authors. Note: Priority recommendations are in bold. Short-term recommendations 160. Focus on creating local government associations or even voluntary mergers for the joint delivery of services that require some minimum efficient scale and much less on forced mergers. Voluntary associations, or even voluntary mergers, will be politically more expedient than forced mergers, and there is ample international experience that the voluntary association solution can be effective in addressing many of the problems arising from fragmentation. Building on that international experience and the apparent political challenges that may come with mergers (especially forced ones), and especially having in mind the Croatian local political and administrative landscape and past experience with this and similar reform issues (e.g., the unsuccessful introduction of the recurrent property tax), the creation of local government associations has better prospects for success. 161. Design an explicit strategy for a reform program that can be deployed gradually over the next several years. This reform will have to be unfolded gradually over the coming years. Some of the preconditions for a more comprehensive approach, such as the MJPA’s project, “Optimization of the Local and Regional Self-Government System,” are yet to be prepared. The results of this project will provide more solid analytical foundations for proposing reforms in the domain of functional mergers. According to the National Recovery and Resilience Plan (Croatia 2021b), the complete support system for voluntary functional and actual mergers, 78 including the fiscal stimulus, based on capacity analysis, categories of common functions (services), and different models of functional and actual connection, will be operational by mid- 2025. 24 Until then, a limited scope of reform can be implemented as a first step – for example, reform measures can be proposed only for those functions that have the greatest prospect for joint provision. The government could make a quick survey among LGUs to check which functions have the greatest odds for functional mergers and focus the incentive measures accordingly. Another option would be to develop a more general incentive scheme, let LGUs submit their proposals for a functional merger in any sector (function) they deem appropriate, and have the MOF evaluate the proposals and make final decisions. However, as this option risks causing considerable confusion and murkiness, the prearranged scheme would be preferable. 162. Develop financial instruments aimed at the targeted incentivization of voluntary associations and mergers. Two distinct incentive schemes must be developed: one for real and the other for functional mergers. Despite the numerous options, financial incentives should be based on capital grants to LGUs that opt for cooperation. These grants should be conditional on the realization of infrastructure projects in the domain/sector where LGUs cooperate. However, international experience shows the successful implementation of reforms also using other instruments, such as debt relief (Belgium in 2016). If the government decides to use such instruments to incentivize mergers, the implementation criteria must be carefully designed to prevent moral hazard and other adverse outcomes in the future. Current grants could also be considered, but a clear time limit would have to be determined for those current transfers. 163. Develop criteria for allocating financial incentives. Clear and transparent criteria for disbursing grants should be developed. In general, the government may provide funding (e.g., special grants) conditional upon projects being submitted jointly by two or more municipalities that are creating an association for the delivery of certain public services. If the grant is for a function that can be made more effective through IMC, such as solid waste management, it can be fully justified from an economic efficiency point of view. This kind of financial incentive may be explicit—when a joint application and the existence of an official association are formal preconditions for access to the grant. But such incentives can also be implicit, where a minimal threshold for the project size is applied to the grant (e.g., the number of people who will benefit). In several EU programs (Instrument for Pre-Accession, Cohesion Fund), funding has been available only for large projects. Access to EU funding is, for small municipalities, often only possible through IMC. Even if there is no formal threshold, rules for assessing applications may favor bigger projects and might include the number of users or the total volume of benefits among the assessment criteria. A proposal submitted by a small municipality may have no chance of passing the relevant threshold (CoE, UNDP, and LGI 2010). 24 For an overview of the stages and sub-stages of the project aimed at further optimization and decentralization by stimulating the functional merging of LGUs, see Annex 6. 79 164. The setting of clear criteria has the advantage of plainly defining the rules of the game for the national government to effectively deploy funds to willing LGUs. It can also mainstream national and supra-national priorities to the regions and municipalities, particularly those lagging in development. Subnational governments have a big role to play in climate action, and the green and digital agendas can be supported by explicitly including some of their elements in the program criteria. In this way, LGUs could more decisively mainstream climate considerations into their operations (e.g., green public financial management and procurement) or enhance the climate sensitivity of public investment by including, for example, project screening for climate and disaster risks, incorporating the social cost of carbon and climate- related uncertainty in cost-benefit analyses, or managing for climate risks in public-private partnerships. Other recommendations 165. Consider developing (at least a simple) metrics and set demonstrable benchmarks for monitoring and evaluation in the medium term. This should be done as a means of collecting data on the outcomes prior to the reform to be able to track these effects. Some appropriate indicators could include: the cost of specific services before and after the association/merger of municipalities; local inhabitants’ surveys on the perceived quality of certain services; or the volume of regional development investment (before and after). 166. Simplify the legal and administrative process for establishing municipal associations. This will require analyzing the current process, identifying areas for simplification, informing LGUs of the revised process, and providing blueprints of intermunicipal agreements as well as technical support. Examples of IMC in Croatia can already be found in several areas, including communal services. The legal basis for the establishment of joint communal services is the Decision on the Establishment of Joint Communal Services enacted by the city council. Mutual relations among LGUs regarding the organization, type of management, financing, responsibilities, and status of joint communal services is to be governed by the Agreement on Mutual Relations in Organizing Joint Communal Services, which forms an integral part of the aforementioned Decision. Although there is currently no special legislation regulating and structuring this form of cooperation, some of the existing agreements could already serve as a blueprint for the future association of other LGUs and for other purposes (for the provision of other services). Some of these current agreements are also available online and provide practices to build on. 167. Provide national support for the initial operation of the associations. Consider an initial program to cover some of the administrative costs of mergers and cooperation agreements, including studies and reports. The program could be time bound and cover the specific recurrent costs needed to start operations. 80 168. Raise awareness of the benefits of functional and real mergers, including (indirect) functional incentives to merge through increased fiscal capacity. This could, for example, allow small municipalities (or groups of merged municipalities) to take over responsibility for providing and financing newly decentralized public functions and to acquire an increased share of PIT for that purpose. Moreover, the association of LGUs in the provision of public services has been particularly promoted for the purpose of participating in EU-funded projects. In reality, this should be a pretty significant incentive, since the amounts of money received through EU funds may be considerable. However, an association is not a necessary condition for receiving EU funds, as it is already stimulated indirectly; for example, there are big “agglomeration projects” for water and sewage infrastructure financed through EU funds in which big cities and surrounding municipalities usually participate in order to harmonize with the EU’s Urban Waste Water Treatment and Drinking Water Directives. Essentially, these projects are de facto structured in a way that is appropriate and desired for promoting and incentivizing associations. 169. Design and deploy a centrally driven capacity program to support small and medium- sized LGUs (e.g., those with fewer than 10,000 inhabitants). World Bank global experience shows that the existence and robustness of cross-cutting systems to obtain fundamental capacity and levels of administration, such as planning, budgeting, budget execution, accounting, internal control, procurement, human resources, monitoring and evaluation, strategic planning, and tax administration, are critical precursors to securing adequate local service provision and basic fiscal performance. Local capacity is referred to here as managerial abilities that LGUs need to have to successfully provide the assigned services to citizens and firms and include public financial management, public procurement, tax administration, public investment, and asset management, among the most crucial. Several international frameworks adapted to the subnational setting can help guide the assessment and support of these capabilities. They include the Public Expenditure and Financial Accountability (PEFA), Public Investment Management Assessment (PIMA), Municipal Finances Self-Assessment (MFSA), the Tax Administration Diagnostic Assessment Tool (TADAT), and the Methodology for Assessing Procurement Systems (MAPS). The program should include the design of a tool to assess municipal capacity, including the capacity to adequately deliver the minimum public services, and to guide a centrally driven technical assistance program that should involve an inventory of the municipal services that are not being adequately provided, training of local staff, and the development of national IT systems, to include the software and hardware needed for capacity building and support to small/medium municipalities. The operational concept of “shared services” should be considered for this system, by which some administrative functions could be centralized regionally or nationally. 170. Establish sound and transparent evaluation and monitoring mechanisms. The government also has responsibility for monitoring and evaluating both the process of establishing IMC projects as well as their performance, where there is a national interest. Although the government cannot unreasonably intervene in the autonomy of local self- 81 government, it should be able to prevent unreasonable IMC proposals (CoE, UNDP, and LGI 2010). In addition, the government should develop and provide a legislative framework for IMC as well as blueprint agreements and technical support. The government can also facilitate training and dialogue between potential candidates for cooperation and promote and publicize the accomplishments and success stories. 171. Develop mechanisms for vertical and horizontal institutional cooperation. At the national level, the MOF, MJPA, and MRDEUF need to coordinate permanently on this issue and successfully reach out to LGUs. This could be performed as part of a formal (yet temporary) task force or commission. At the local level, there is a need for further collaboration and coordination among LGUs, and it would be especially important to strengthen cooperation and the creation of joint projects at the municipal tier. This would enable a greater concentration of financial resources as well as experts. There is significant room for pooling and jointly applying for EU projects and horizontal connectivity. One of potential solutions is for counties to take over from LGUs part of their subregional activities, especially from those units that do not have the necessary capacity (personnel and professional) to perform quality tasks, such as spatial planning and other related activities, particularly when they concern local development planning, the use of EU funds, and so on. This is an area where it would be necessary to strengthen counties’ regional development roles, and where counties as coordinators could take over technical and financially demanding tasks that most smaller municipalities and cities are unable to perform due to a lack of human and organizational capacity. 172. Ensure compliance with the existing legislative framework. This would require that LGUs have at least 10,000 inhabitants (or be a county seat) in order to obtain the status of city (almost half of the cities in Croatia have fewer than 10,000 inhabitants). Publication of the official results of the 2022 census are a good opportunity to raise this issue. 82 Annex 1. NRRP–C2.2. R4-I1: Further Optimization and Decentralization of LRGUs through Support for Functional Mergers 25 173. Insufficient administrative and fiscal capacity to provide quality services to citizens for which LRGUs are responsible was detected as a fundamental problem of the system. This can lead to citizen dissatisfaction with the quantity and quality of the services provided by their local governments. Many units also face a fundamental functional problem, which is the inability to adequately perform certain tasks and/or the inability to provide all services within their scope, as determined by law. For these reasons, a system of support for the functional and actual mergers of units will be established so that the units can, through coordinated action, provide adequate services to citizens, which is precisely their purpose. The goal is to establish a quality system for the functional and real connection of units in order to provide better and more transparent services to citizens and to strengthen LRGU capacity so that they are more efficient in performing tasks within their scope. 174. The cooperation of local units for the joint performance of tasks within their self- governing scope, as well as for other professional tasks that the units perform for their own needs, will be encouraged. The actual merging of units that have needs and express interest will also be encouraged. Through cooperation, local units can more easily overcome the problem of insufficient capacity, improve the quality and quantity of services provided, and make more efficient use of available funds and resources. At the same time, the cooperation and functional connection of units in the provision of services enables units to retain their identity (as opposed to the case of real mergers) and yet overcome possible financial, administrative, and technical constraints. By providing adequate professional assistance and establishing a system for financing the joint execution of individual tasks, possibly through an actual merger, the units will be encouraged to jointly perform tasks or actually merge. Given the complexity of public administration reform, as well as the fact that successful implementation requires the support and involvement of professionals and the general public, it will be possible to evaluate the plan during its implementation (through mid-2024). This will also include active citizen participation in implementation through online debate and digital communications, as well as a collaborative project with the academic community. These will be pilots to strengthen the participation of citizens and the interested public in shaping public administration and public service policies. 175. Further optimization and decentralization of local and regional self-government systems through support for functional integration is already being implemented in part through the European Social Fund (ESF) project, “Optimization of Local and Regional Self-Government Systems.” The plan is to develop a central database on the capacity of LRGUs by the end of 2022 that will contain a set of data for assessing and monitoring their capacity, based on which 25 This annex is based on Croatia (2021b). 83 a single IT system will be developed to support greater efficiency among LRGUs. A catalog of tasks will be prepared on the basis of the collected data that will define the categories of units with regard to the capacity and tasks performed. Accordingly, a list of recommendations on changes to LRGUs’ existing system of organizing tasks will be developed, all with the aim of improving the quality of services provided to citizens at the local level. The process of optimizing the LRGU system will continue through strengthening the culture of cooperation among local units. In further reform efforts regarding the joint performance of certain tasks, which is to say the functional association of units, the connection of units will be carried out by establishing a model of joint performance of individual tasks and encouraging units to join, which would hopefully increase the number of units involved in the different types of combined operations. 176. Models will be established through which local units will be encouraged to work (provide services) together, but also to cooperate with state services, which would primarily increase the quality of services to citizens and reduce costs. In addition, the units that decide to functionally associate will be given access to the support system for the functional connection of units that will be linked to the IT system developed through the ESF project. The IT system will enable the units to more clearly detect which tasks would be more efficient to perform jointly with other unit/units of local self-government and which units are suitable partners for the joint performance of tasks. At the same time, the collected data, the catalog of jobs, and the defined categories of units resulting from the project will serve as a basis for the adequate actual merging of units that express interest. The system should provide solid grounds for reaching a decision on which units would find it useful to actually (physically) merge. 177. The system of support for the actual and functional connection of LGUs will offer the development of a model for the functional association of units, and as part of the project activities, the employees of the units will also be trained to work in the new system. Prior to the implementation of the system, a questionnaire for local self-government will be prepared in which the units will conduct a self-assessment of the current quality and quantity of services within their scope and express interest in joint work with one or more local government units and/or an actual merger. 178. As part of these activities, guidelines/recommendations for the joint execution of individual tasks based on good EU practices will be developed. From these guidelines/recommendations, and with the help of the results obtained by the self-assessment questionnaire, units suitable for functional association and for actual merger that have expressed interest will be detected. The new system will also contain the steps necessary to realize the joint performance of certain tasks, as well as for an actual merger. In the case of functional mergers, tasks (functions) will be sorted by the types of services provided. For example, if two or more units want to provide childcare together, they will select childcare in the drop-down menu. The system will then show which units are most suitable (given the size of the unit, 84 population, number of preschool children, geographical location, finances, capacity, etc.) for a functional merger. 179. The system will then offer possible models of association, given that the units can be connected in different ways by establishing a joint governing body, joint company, or institution, or in a manner prescribed by law. The units will also be provided with support through direct communication with officials employed in state administration bodies, depending on the department to which the jointly performed task belongs (a kind of help desk for performing tasks). Thus, employees of the units that carry out the process of functional merger, as well as those who already work together, will be able to quickly and directly contact experts in each field through a platform through which online workshops and trainings will also be held. During the later implementation of the project, the units will also have insight into the good practices of other units that have already implemented a functional or actual merger. One of the modules of the system will be for submitting impact reports, which will enable units to easily report electronically to the MOF, the state administrative body within whose scope the work is performed jointly with the MJPA. 180. Citizens will also be provided with insight into the way that units perform tasks, especially in relation to the joint performance of tasks, which will ensure further digitalization and transparency. At the same time, the joint performance of tasks will strengthen the unit’s financial and human resources, which will increase its capacity to prepare and implement projects financed from EU funds. Functional merging will also contribute to the strengthening of the internal control system so that it will be easier to conduct an internal audit of the work performed by the units together. The system will also show the steps needed to achieve an actual merger, as well as the units that are suitable “partners” for this action (geographical proximity, level of development, population, etc.). 181. The building of administrative capacity for the joint execution of tasks will also be encouraged, while strengthening the capacity for absorption of EU funds. By the end of 2021, basic adjustments to the regulations will be made related to fiscal incentives for LRGUs in order to encourage them to functionally and physically associate. In so doing, greater incentives will be awarded for actual mergers. A comprehensive system of support for voluntary functional and real mergers, including fiscal incentives, based on an analysis of capacity, categories of joint tasks, and various models of functional and real connectivity, will be operational by mid- 2025. 85 Annex 2. National Public Administration Development Plan – Specific Objective 5. Improving the Functionality and Sustainability of Local and Regional Self- Government 26 182. In order to improve the functionality and sustainability of local and regional self- government, for the first time, all available data on LRGUs and the jobs they perform will be collected so that a realistic picture of the state of affairs can be obtained based on objective facts. In addition, the current capacity of units for performing the different tasks will be defined and assessed, and at the same time recommendations will be made for improving the system of organizing tasks within their scope. In this way, LRGUs will be enabled to perform tasks within their scope more efficiently, which will ultimately result in increasing the quality of public services provided to citizens and contribute to citizen satisfaction. 183. Further improvement of the functionality and sustainability of local and regional self- government will be enabled by establishing a system for financing the joint execution of individual tasks of local units—tasks within their self-governing scope as well as other professional tasks performed by units for their needs. Through cooperation and mergers, units can more easily overcome the problem of insufficient capacity, improve the quality and quantity of services provided, and make more efficient use of available funds and resources. More specifically, good cooperation between local self-government units enables the improvement of administrative division and has a positive effect on the vertical distribution of public functions and resources. The insufficient financial, administrative, and personnel capacity of certain local self-government units limits them in independently performing numerous and increasingly complex public services, as well as in reaching the necessary quality standards. 184. The cooperation of the units will enable the joint provision of public services and the joint use of resources for the benefit of all stakeholders involved. A high-quality and efficient system of local and regional self-government will be established through the functional and real association of units for the effective and transparent provision of services so that citizens have equal opportunities to get their needs and interests met, regardless of where they live. Joint execution of tasks will be encouraged by co-financing provided to units for a specific task performed jointly. The criteria for determining the amount of co-financing will depend, inter alia, on the number of tasks performed in cooperation. An individual unit will be entitled to additional funds, that is, co-financing, if it is involved in the joint performance of certain tasks. Funds for co-financing will be provided in the equalization fund and planned in the state budget for the current year with projections for the next two years, depending on the expressed and identified needs of units that decide on a functional merger. The exact criteria, manner, and possibility for co-financing the joint performance of certain tasks and the status of employees in the bodies that will perform the tasks for several local units will be determined. In order to 26 This annex is based on Croatia (2022a) and (2022b). 86 provide local self-government units with the necessary cooperation in the implementation of the process of functional and actual mergers, a system of support will be established. 185. The joint performance of local self-government units, that is, their actual merging, is therefore aimed at obtaining material resources and their economic use and promoting the units' own and common interests, meaning active joint action and policy making. Administrative capacity for project and investment management among LRGUs needs to be further strengthened through professional support and continuous investment in the competencies of both national bodies for EU funds and other public institutions and legal entities. Greater coordination and communication are also needed, as well as the mutual exchange of practices and information between the LRGUs themselves through common digital solutions. The IT system of quality management and application of the methodology for the optimization and standardization of business procedures will lead to a best process model for performing similar services and jobs, with the aim of optimizing costs, the reliability of service provision, and ultimately, customer satisfaction. 186. The medium-term priorities under the fifth specific objective are: consolidating the system of local units by combining joint provision of services and voluntary mergers; improving the system of organization of tasks within the scope of LRGUs, which will encourage units to perform better and more quality tasks within their scope; strengthening the administrative capacity of LRGUs, especially in the areas of transparency, public service delivery, and participation; and increasing the fiscal capacity of LRGUs to achieve sustainable decentralization. The outcome indicators to measure progress toward the fifth specific objective are: the share of units involved in the joint performance of local self-government activities (target value in 2027: >40 percent); and the share of revenues of municipalities, cities, and counties in GDP (target value in 2027: >10 percent). 87 Annex 3. Vertical Structure of Government across EU Member States Country Description Federations and Quasi-Federations The municipal level comprises statutory cities, towns, markets, and villages. The Austria nine Bundesländer include Vienna. The upper level consists of six federated entities (three language communities and Belgium three regions). In Flanders, 15 municipalities merged on January 1, 2019, reducing the total number of municipalities from 589 to 581. Germany The intermediary level comprises 294 rural districts and 107 district-free cities. The two “foral” autonomous communities (Basque Country and Navarra) retain more autonomy than the other regions. Local subdivisions vary according to the Spain autonomous communities. The two autonomous cities of Ceuta and Melilla are included in the number of municipalities but not in the number of provinces. Unitary Countries Municipalities are subdivided into smaller towns and villages, totaling 4,995 as of Bulgaria December 31, 2017. The number of regions includes the city of Zagreb, which has the status of both a Croatia county and a city. The municipal level comprises 128 towns and 428 municipalities. Cyprus The municipal level includes municipalities and communities. Czech The municipal level includes municipalities, towns, and statutory cities. The Republic number of regions includes Prague. The number of municipalities does not include Christiansø, which has a special Denmark status. The number of municipalities decreased from 213 to 79 (14 of which are urban and Estonia 65 rural) following administrative reform completed in October 2017. There are 19 regional councils but only one has an autonomous administration (the Finland island region of Åland); the other 18 regional entities are statutory joint municipal boards. The total number of subnational governments in each level includes those of Corsica and the outermost regions. With the 2015 regional reform, there are 13 regions instead of 22 in mainland France and five outermost regions (Martinique, Guadeloupe, Guyane, La Réunion, and Mayotte). Municipalities are undergoing France continuous consolidation since the creation of the status of “new municipality” (commune nouvelle) in 2010. Between 2010 and 2019, 2,508 municipalities joined together to create 774 new municipalities. Since 2010, the number of municipalities has decreased by 5 percent. Since the 2010–11 Kallikratis reform, municipalities have been divided into sub- Greece municipal localities (local and municipal communities). The reform also created 13 self-governing regions from the previous 54 prefectures. Hungarian “settlements” include the capital city of Budapest and its 23 districts, Hungary towns of county rank, other towns, and villages. The number of counties excludes Budapest. 88 The new municipal level established with the 2014 Local Government Act includes Ireland 31 county and city councils. The 2014 reform also created a nationally representative system of sub-county governance, the municipal districts. Since the introduction of Law n° 56/2014, effective January 2015, the intermediate level is no longer composed of directly elected governments, but rather of 14 metropolitan cities and 84 provinces, to which are added the Free Municipal Italy Consortia of Agrigento, Caltanissetta, Enna, Ragusa, Syracuse, and Trapani. Their representatives are now elected by mayors and municipal councilors. Among the 20 regions, 15 have an ordinary status and 5 have a special status (i.e., Sardinia, Sicily, Trentino-Alto Adige/Südtirol, Aosta Valley, and Friuli-Venezia Giulia). With the 2011 municipal amalgamation reform, Latvia has 119 local governments, including 110 municipalities (novads) and 9 “republican cities.” Municipalities are Latvia divided into sub-municipal divisions, including 76 towns and 497 civil parishes. In 2019, the government initiated a new territorial reform aiming at reducing the number of local governments from 119 to 35. Since January 1, 2018, the date of entry into force of the last three amalgamation Luxembourg laws, the number of municipalities has decreased from 105 to 102. Malta The municipal level is composed of local councils. The gradual decrease in the number of municipalities has continued, from 389 in January 2018 to 355 in January 2019 (there were 443 municipalities in 2007). Netherlands District Water Boards, which are considered to be decentralized local governments in national legislation, are excluded from the count reported in the table. The total number of counties (powiats) includes 314 counties and 66 cities with Poland county status. Municipalities are subdivided into 3,091 sub-municipal localities (freguesias). The Portugal regional level comprises the two autonomous regions of the Azores and Madeira. The number of regions includes the municipality of Bucharest, which also has Romania county status. The municipal level comprises 320 towns and municipalities and 2,861 communes. Sub-municipal level consists of 12,957 villages. Slovak The municipal level includes cities, rural municipalities, city districts in Bratislava Republic (17) and Košice (22), and three military districts. Among the municipalities, there are 11 urban municipalities with a special status. Slovenia There is also a structured sub-municipal level (6,035 settlements). As of January 2019, all counties have been formally transformed into regions, Sweden including the municipality of the island of Gotland. Until that date, Sweden’s regional governance structure had been asymmetric. The three devolved administrations at the regional level are Northern Ireland, Scotland, and Wales. England has 35 local governments at the intermediary level (upper tier), comprising 26 county councils, the Greater London Authority (GLA), United and 8 combined authorities. The municipal level consists of 317 local authorities in Kingdom England, 22 in Wales, 32 in Scotland, and, since April 1, 2015, 11 local councils in Northern Ireland (formerly 26). In addition, there is a structured sub-municipal level of approximately 9,500 parish councils in England, 735 community councils in Wales, and 1,200 councils in Scotland. Source: Authors, according to OECD and EC (2018). 89 Annex 4. Optimal Community Size and Club Theory 27 187. The issue of LGU financing and complex fiscal relations between the central and lower levels of government is impossible to observe without insight into the basic assumptions and reasons for establishing communities. Club theory, founded by Buchanan (1965), considers the optimal size of the community and the supply of public goods at the community level. Samuelson (1954, 387) distinguishes between two categories of goods: goods of private consumption (1 , … , ) that can be distributed among individuals (1, 2, … , , … , ) according to the equality = ∑ 1 and goods of common (collective) consumption (+1 , … , + ) that are available to all, where the use of goods by one individual does not reduce the possibility of using goods by other individuals, so that for each good of common consumption + = + at the same time for each individual i. Accordingly, Buchanan (1965, 2) points out that in the neoclassical model, in which there are only pure private goods and services, the utility function of the individual is given by = (1 , 2 , … , ), where X denotes the amount of private good available in a certain period of time to the individual i. By extending this function to public goods, which Samuelson (1954) denotes by the indices n+1,…, n+m, it can be written as = (1 , 2 , … , ; +1 , +2 , … , + ). 188. Despite the then popular views on how goods can be classified into pure private and pure public goods, Buchanan (1965, 2) points out that there are a number of possibilities between these two extremes and develops the club theory to fill the gap between them. The basic question in the theory of clubs is to determine the so-called marginal membership, that is, the optimal size of the community. The utility function of the individual does not include the size of the community as one of the variables since in the world of private goods, the optimal size is precisely the individual. Nevertheless, Buchanan includes in the utility function the variable , which denotes the number of individuals who share the good , including the i-th individual whose utility function is examined. By introducing this new variable, the function can be written as: = [�1 , 1 �, �2 , 2 �, … , �+ , + �]. 189. If the good is defined as a means of payment, and the letter u denotes partial derivatives, the marginal rate of substitution of consumption of goods and for the i-th individual can be defined as / . Accordingly, / represents the rate at which an individual is willing to give (accept) money in exchange for accepting an additional member into the existing community. The function of production costs can now be defined as: = [�1 , 1 �, �2 , 2 �, … , �+ , + �], where it should be noted that the cost function includes the variable because with the fixed costs of production (supply) of public goods (services), the price for an individual decreases by including additional users (community members). Furthermore, from the utility and cost functions it is possible to derive an expression 27 Adapted from Primorac (2013). 90 for the necessary marginal conditions of Pareto optimality with respect to the consumption of each good. Typically, the expression / = requires equality of marginal rates of / substitution in the consumption and production (or exchange) of goods and for the i-th individual. By introducing a variable denoting the size of the community, the expression can be written as / = . In other words, the optimal size of a community is achieved when / the marginal benefit that a new member brings to community members is equal to the marginal cost they bear by accepting that new individual. By combining the above expressions (conditions), the expression / = / = / is obtained, which finally represents the necessary marginal conditions of optimality. 190. By determining the value of , it is possible to classify goods as pure public or pure private goods, or to determine the degree of public- and private-ness of goods that lies between these two extremes. A good for which the equilibrium value of is extremely high can be characterized as public, while one with a low equilibrium value of can be considered mainly a private good. 191. As part of the theory of fiscal federalism, Buchanan, through the theory of rational choice, made an exceptional contribution to shedding light on the dilemma of the optimal size of the community. However, the stated theoretical assumptions are quite difficult to confirm empirically or to implement in any way in practice, first of all because individuals/society often do not behave rationally, and also because it is almost impossible to adequately assess the functions of utility and cost. However, considering the extremes in terms of community size, it is obvious that with respect to the given characteristics of the supply of public goods and the preferences of the population, there are communities that could be characterized as too small or too large. Buchanan’s theory clearly shows the influence of community size on the supply of public goods and services and emphasizes the importance of limiting excessive fragmentation in the decentralization process. 91 Annex 5. Objectives of Intermunicipal Cooperation in Various Domains Domain Possible Objectives of IMC Ensure availability of basic health care services (general medicine, health education, dental care) to all citizens within a larger area, Health care avoiding duplication of efforts and enhancing their quality (better professional skills and technologies). Develop jointly welfare services with a limited number of beneficiaries and related infrastructure (e.g., housing, elderly care); Welfare support and social harmonize social policy in a territory where many families cross assistance municipal borders, providing visible and effective support to vulnerable people. Build, manage, and maintain shared school facilities to offer a higher Education services level of education in rural areas and prevent closure of classes for lack of pupils. Harmonize environmental policy in areas of common interest by Environmental achieving political coordination and consensus on goals and management and protection measures to reach them. Find adequate locations for landfills and share their use; acquire Waste collection and trucks; build central waste disposal/treatment plants; develop joint disposal policies for solid waste management and recycling to achieve better environmental protection. Share equipment (water towers, purification stations); join in Water distribution and outsourcing procedures to strengthen negotiating capacity; join in sewerage project development to attract capital investment. Rationalize water management and the use of available water Agricultural irrigation sources to extend water distribution and improve settlement of water disputes. Harmonize strategic planning and perform joint studies on local Economic and territorial development for a larger area. Improve territorial marketing to tap development tourism potential. Support development of business incubators and markets. Harmonize cultural development policy. Share management of Cultural equipment and key sports and cultural facilities to optimize their use. Organize events festivals and cultural events to gain better press coverage and attract more visitors from other municipalities. Develop single urban plans for a larger area to rationalize other policies (housing, enterprise zones, roads) and deal effectively Urban planning with issues that cross municipal boundaries (e.g., social housing, transport). Unify planning procedures to ensure criteria for development does not favor one municipality unfairly. Management of Develop the capacity to design and manage joint projects to gain EU funds access to EU structural funds. Share policy goals and priorities in the development of the roads Construction and network, and harmonize/coordinate road construction and maintenance of roads maintenance works. Establish rational and cost-effective public transport system for Public transport larger area. 92 Harmonize traffic regulation and unify traffic equipment to improve Traffic regulation traffic management; achieve better deployment of traffic police. Maintain modern, well-equipped service able to manage in difficult Fire and rescue services conditions. Rationalize tax collection processes, develop better links with register offices and with state tax administration to improve control Tax collection procedures, increase staff specialization, and fight tax evasion; raise higher levels of local revenues. Develop purchasing power for smaller municipalities. Develop Public procurement professional legal and economic experience. Human resource Provide jointly professional human resources to raise performance management standards and levels of human resource expertise. and development Manage more effectively electoral rolls, civil status register, Administrative tasks property register, payrolls, and accountancy. Technical services Maintain and use machines and equipment. Electronic data Secure access to a modern EDP service. processing (EDP) Source: CoE, UNDP, and LGI (2010). 93 Annex 6. Further Optimization and Decentralization by Stimulating Functional Merging of Local Government Units 28 Implementation stages: • Adjusting the regulations pertaining to fiscal incentives for the voluntary integration of units (December 2021) • Activating the basic (fiscal) support mechanism for the voluntary functional and physical integration of units (March 2022) • Drafting guidelines/recommendations for joint execution of specific activities and physical merging of units based on good practice in the EU (December 2023) • Establishing an integral system of support to the functional and physical integration of units (June 2025) Substages: • Creating questionnaires for units to self-assess their current capacity for conducting activities within their scope of work and to express their needs and interests for joint execution of activities, i.e., physical merger • Identifying the state of affairs regarding the execution of activities within the units’ scope of work, using an IT system, catalog, and categories defined within the project, Optimization of the Local and Regional Self-Government System • Drafting a concept design and functional specifications of a system for supporting the physical and functional integration of units • Drafting a model for the functional integration of units and establishing additional financial incentives for physical mergers • Identifying units that would benefit from functional mergers and activities that they could execute together • Identifying units that would benefit from physical mergers • Developing and implementing a system for supporting the physical and functional integration of LGUs (advancing the architectural and program design, developing the system modules, implementing the system to the CDU’s (cro. 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Number of Local Units at the Lowest Tier of Government in EU Member States ..... 22 Table 2.6. Fragmentation in EU Countries (2018–19) ..................................................................... 25 Table 2.7. Structure of Municipalities by Population Size (% of all municipalities) .................... 26 Table 2.8. Subnational Governments in SEE Countries in 2019..................................................... 27 Table 2.9. Expenditure for Employees in Croatian LGUs in 2019 ................................................. 28 Table 3.1. Fiscal Capacity and Fiscal Needs of LRGUs in 2018...................................................... 31 Table 3.2. Decentralization of Particular Public Functions in 2020 ............................................... 33 Table 3.3. Summary Statistics of LRGUs’ Functional Expenditure Components per Capita in 2018 (HRK) .......................................................................................................................................... 33 Table 3.4. Expenditure for Selected Functions for Counties in 2018 (as a % of total) ................. 34 Table 3.5. Summary Statistics of Per Capita Expenditure for Selected Functions of Counties in 2018 (in HRK) ...................................................................................................................................... 35 Table 3.6. Expenditure for Selected Functions of LGUs in 2018 (as a % of total) ........................ 35 Table 3.7. Summary Statistics of Per Capita Expenditure for Selected Functions of Cities in 2018 (in HRK) ............................................................................................................................................... 36 Table 3.8. Summary Statistics of Per Capita Expenditure for Selected Functions of Municipalities (2018; HRK) ............................................................................................................... 36 Table 3.9. Number of and Expenditure for Employees in Large Cities and County Seats in 2018 ............................................................................................................................................................... 42 Table 3.10. Descriptive Statistics of LGU Employees in in 2018..................................................... 44 Table 4.1. Relative Change in the Number of Municipalities in EU Countries (1990=100) ......... 50 Table 4.2. Stages of Amalgamation Reform in Norway ................................................................... 54 Table 4.3. Classification of Municipal Functions ............................................................................. 57 Table 5.1. Financial Incentives Aimed at Stimulating Voluntary Mergers ................................... 64 Table 5.2. Functional Incentives Aimed at Stimulating Voluntary Mergers ................................. 69 List of Figures Figure 2.1. Relation between the Number of LGUs and Population in 2018 among EU Countries ............................................................................................................................................................... 24 Figure 2.2. Relation between the Number of LGUs and Area in 2018 ........................................... 24 Figure 3.1. Number of employees in bodies from 1995 to 2018 ....................................................... 38 Figure 3.2. Number of employees with users from 1995 to 2018..................................................... 39 Figure 3.3. Total number of employees in bodies and with users from 1995 to 2018.................... 40 Figure 3.4. Number of employees in counties in 2018 ...................................................................... 41 Figure 3.5. Cities according to the number of employees (without Zagreb) in 2018..................... 41 Figure 3.6. Municipalities according to the number of employees in 2018 .................................... 42 Figure 4.1. Territorial reform implementation process ................................................................... 49 Figure 4.2. Key ingredients for successful territorial reform .......................................................... 50 Figure 4.3. Key steps in setting up IMC projects ............................................................................. 56 102 List of Boxes Box 1.1. NRRP – C2.2. R4 Functional and Sustainable Local Government .................................. 13 Box 2.1. Functions Assigned to Subnational Government Units in Croatia .................................. 28 Box 3.1. Administrative Capacity and Recording Omissions in Subnational Workforce Statistics ............................................................................................................................................................... 39 Box 4.1. Village Amalgamation in Ukraine ....................................................................................... 47 Box 4.2. The Process of Territorial Reform in Estonia .................................................................... 53 Box 4.3. Rules and Incentives for the Creation and Proper Functioning of Municipal Commonwealths .................................................................................................................................. 57 Box 4.4. Areas of Competence of Intermunicipal Cooperation Bodies .......................................... 58 Box 4.5. Municipal Associations (Mancomunidades) in Bizkaia..................................................... 60 Box 5.1. Financial Incentives for Merged Local Government Units in Estonia ............................ 65 Box 5.2. Financial Incentives for Amalgamated Communes in Switzerland ................................. 67 103