The Effect of Fiscal Health
on Innovation in Cities
BY KSENIYA M. KHOVANOVA-RUBICONDO
S
ince the recent economy meltdown, the public
sector has undertaken a number of economic
recovery initiatives that focus on innovation.
Yet, our understanding of the role local government
finance plays in innovation is far from perfect. While
it is too early to come to conclusions about the strategies local governments are currently using to cope
with financial distress, analyzing the extent to which
fiscal conditions have shaped the innovative policy
decisions of the past might help localities in choosing the best policy approach. With this goal in mind, a
recent study of 140 mid-sized U.S. cities in eight states1
explored the effects of fiscal health on the degree to
which they implemented innovations in performance
management, using data from a survey conducted by
the Government Finance Officers Association.2 The
study considered whether or not the availability of
financial resources is a crucial factor for public-sector
innovation to occur — in other words, do cities need
financial resources to innovate, or is it financial and
economic scarcity that stimulates innovation in cities?
Are fiscally stressed cities likely to be more innovative
than fiscally healthy ones? The research ultimately
determined that fiscally healthy cities innovate more.
INNOVATION AND THE GREAT RECESSION
The link between the fiscal health of local governments and their innovations in the recent economic
crisis was visible in the way that local economic
recovery was largely based on innovations driven
by financial resources. The cities, suburbs, and rural
areas that make up metropolitan America became
more interested in innovation activities, which were
viewed as a means “to foster more productive, inclusive, and sustainable growth by better tapping the
assets and creativity.”3 Local governments tried to
stimulate their economies by increasing revenues or
drawing down reserves to maintain spending, and by
expanding or accelerating local capital projects, especially those with low long-term operating costs.
While these novel activities were mostly locally
generated and designed, the $787 billion American
Recovery and Reinvestment Act of 2009 (ARRA) led
to another set of innovative initiatives focusing on
economic recovery in American communities. These
June 2012 | Government Finance Review 13
faced with a scarcity of resources
initiatives were designed to: reflect
While it is too early to come to
will engage in maladaptive rather
long-term regional goals; cut across
than innovative behavior, becoming
jurisdictions and sectors; find ways to
conclusions about the strategies
more rigid and conservative in their
create interdepartmental programs to
local governments are currently
actions.6 Some argued that the loss of
solve wider problems in an integrated
using
to
cope
with
financial
distress,
fashion; kick off investment by using
spare resources reduces the potential
private-sector partnerships creatively;
for fiscally stressed local governments
analyzing the extent to which
and maximize performance by using
to innovate.7 Public finance literature
fiscal conditions have shaped the
information management and benchalso emphasized the importance of
innovative policy decisions of the
marking. The ARRA was regarded as
monetary resources such as rainy day
an investment in the fundamental elefunds or fund balances for maintainpast might help localities in choosing
ments that lead to prosperity — that is,
ing a balanced budget and preserving
the
best
policy
approach.
innovations — that would allow local
financial flexibility,8 and larger fund
leaders to maximize the recovery of
balances were thought to allow state
their communities strategically using
governments to survive fiscal stress.9
4
ARRA resources. But how does this
These studies indicate that governlogic work in practice? Are U.S. cities really dependent on
ments with larger fund balances might have more financial
resources to create innovations?
flexibility in their innovative decisions.
Until recently, relevant studies presented sharply divided
perspectives on the relationship between fiscal health (often
referred to as “fiscal stress”) and innovation. One point of
view emphasized the importance of environmental change
and performance gaps as stimuli that increase innovative
behavior.5 Thus, an organization is more likely to innovate in a rapidly changing environment than in a steady
one. Another viewpoint argued that public organizations
THE ANALYTICAL MODEL
The study of 140 mid-sized cities in eight states used the
analytical model presented below (Exhibit 1) to test how
the variation in cities’ abilities to meet their financial and
service obligations, availability of budgetary fiscal slack
(ready access to cash or debt financing), home rule, level of
fiscal autonomy, type of leadership, and size of their govern-
Exhibit 1: The Effect of City Fiscal Health on Its Innovation
Tax and
Expenditure
Limitations
Financial Slack
Home Rule
Innovation
Scope of Performance
Management
Implementation
Fiscal Health
Revenue Wealth/
Spending Needs
Form of
Government
14 Government Finance Review | June 2012
Size of
Government
SCOPE OF INNOVATION INDEX
The innovation study is comparatively new, and no established definition of innovation exists today. Innovation is a
practice that is perceived as new or different by the organization that implements it, regardless of whether or not the
practice is objectively new.14 This practice creates value for
the jurisdiction.
ment affect the degree of performance management innovation implementation.10 This research also introduced two
new measures: the Index of Fiscal Health and Index of
Innovation Scope.11
FISCAL HEALTH INDEX
It has been largely recognized that city governments are dissimilar in their economic and institutional structures. A city’s
fiscal structure depends on its environment, which reflects
the constrained choices confronting city policymakers, based
on the city’s institutional framework or on its underlying economic base. It also “mirrors the locally constrained priorities
of designing an ‘appropriate’ revenue structure that reflect
the values and desires of the city’s residents.”12 This diversity
among city government environments — which includes the
differences in jurisdictional tax bases and structures, their
institutional arrangements, community size, and form of government — makes analyzing the relationship between fiscal
health and innovation particularly complex.
The Index of Fiscal Health was developed to reflect this
diversity of fiscal structures and to establish a measure of
fiscal health that allows for comparisons. It focuses exclusively on elements of city fiscal structure such as revenue
wealth and spending needs.13 The availability of fiscal slack,
presence of home rule, level of fiscal autonomy, type of
leadership, and size of city governments were considered
as independent but contributing factors to localities’ fiscal
environment model.
Defined within this framework, performance management
— using a system of performance indicators designed to
systematically estimate the quality and quantity of services
delivered by government — has been the innovation most
broadly implemented by local governments. Within the last
15 years, numerous U.S. cities have embraced performance
management for a range of services as a means of improving performance. These cities represent diverse jurisdictions
with varying economic capacity, size, institutional structures,
and leadership characteristics. The GFOA national survey
found that the intensity of performance management implementation varied from government to government, which is
not surprising. Yet, no one has conducted a comprehensive
evaluation of the quality of performance management implementation from a policy innovation perspective.
Performance management systems were usually evaluated
by traditional performance management research based on
factors including the timing of adoption; the availability
of clear, measurable goals; the impact of the measures on
decisions; the testing and benchmarking of performance
measurement information; and the use of customer surveys.15
At the same time, it was argued that the timing of when the
innovation is adopted represents only one dimension.16 “The
quality of the policies that are developed — their scope,
sophistication, and whether adopters continue to keep pace
with state-of-the-art developments in the field — are also
important dimensions of innovation.”17 Since the intensity of
innovation varies over time, the scope of its implementation
(as a measure) offers a more accurate picture.
Taking these arguments into consideration, the study used
factor analysis for evaluating the scope of performance management innovation in city government, based on the answers
to the GFOA’s national survey. The Scope of Innovation Index
was developed as a result of this analysis; it condenses the
variance in the answers to 60 survey questions to 15 distinct
factors that reflect functions that are performed by city government (relevant to performance management implementa-
June 2012 | Government Finance Review 15
Exhibit 2: Main Factors of Performance
Management Innovation Scope in City
Governments
Factor, in Order of Importance
(from highest to lowest)
Budget Document
Benchmarking Time
Benchmarking Targets
Standard Measures
Share Data with Others
Formal Review
Budget Process
Link to Strategic Plan
Accountable Executive
Scorecard Use
tion). Ten of the most important factors contributing to city
performance management innovation were identified (see
Exhibit 2). These factors were then combined into a single
scale, the Scope of Innovation Index.18
THE RESULTS
The main finding of this research is that fiscally healthy
cities innovate more. In other words, wealthier city governments — those that have the most financial resources at their
disposal — score higher on performance management innovation. At the same time, the innovation behavior of fiscally
healthy city governments differs from that of fiscally stressed
ones; performance management innovations in the former
have higher implementation scope and vary according to the
degree of fiscal autonomy and form of government. These
findings support the argument that financial resources (or
wealth) are necessary to initiate, direct, and implement innovation. The results of this research additionally support the
assertion that performance management implementation is a
complex innovative policy, and accomplishing it entails more
than a considerable investment of budgetary resources (e.g.,
administrative structures, professional expertise and coordination, crucial for innovation implementation). Performance
management implementation is also determined by the jurisdiction’s institutional environment.
Even though good fiscal health is a key factor, performance
management innovation appears to be more of a political
than economic issue for the cities, an issue that is largely
defined by the institutional structures of city governments.
16 Government Finance Review | June 2012
The most important predictor of city innovation appears to
be form of government. Cities with a statutory mayor-council
form of government are more likely to innovate than cities
with a statutory council-manager form. Local government
innovation is thus still highly determined by the priorities
and decisions of local public policy officials. Therefore,
when designing public-sector performance management
systems, particular attention should be paid to assuring that
the jurisdiction’s political leadership completely understands
the benefits.
Degree of city government fiscal autonomy — defined in
terms of fiscal home rule or tax and expenditure levels — is
the second most significant determinant of local government
innovation. Cities that have more fiscal autonomy — that is,
cities with no limits on property or general tax and expenditure levels — innovate more than those with lower fiscal
autonomy levels. In other words, cities that have more discretion in their fiscal decision making tend to implement more
innovations than cities that don’t have such discretion.
Fiscal slack has a nearly insignificant correlation with the
scope of implemented performance management innovation. In addition, functional home rule, fiscal authority,
adapted administrative form, and size of government appear
to have little or no significant effect on performance management innovation in mid-sized U.S. cities.
CONCLUSIONS
The study confirms that significant resources are necessary
to initiate, direct, and implement innovation. Moreover, since
innovation implementation takes time, resource commitment has to be constant until the implementation process
is complete. The results of this study have three important
implications for public policy and government decision
makers, related to the fiscal component of the research,
innovation financing mechanism in general, and the institutional characteristics of the individual city and the features of
innovation itself.
The study demonstrates that good fiscal health leads to
higher scope of performance management innovation — in
the context of local government, the availability of financial
resources is crucial for innovation. Yet, fiscal health is not
the only factor determining innovation. The analysis shows
that good fiscal health translates into a higher degree of
innovation implementation only when
it is combined with a relatively high
degree of fiscal autonomy and a statutory mayor-council form of government. Thus, the study backs the long
maintained argument that home rule
provisions (fiscal home rule, in the
case of this analysis) define the powers
of local government: More flexibility in
financial decision making translates
into a higher degree of innovation in
middle-sized U.S. cities.
Despite recent public administration research arguing that cities with
an administrative form of government
(in which administrative professionals
play a crucial role in initiating new policies and improving transparency and
accountability) have every reason to
be more supportive of such resourceand administrative skill-driven innovation as performance measurement,
the mayor-council form of government appears to be more supportive
of city innovation. It is noteworthy
that an institutional factor such as form of city government
appears to be an even more significant element in implementing city government innovation than the fiscal health
of the jurisdiction. y
The economic and institutional
diversity among city government
environments makes analyzing
the relationship between fiscal
health and innovation particularly
complex.
Many argue that local government innovation is heavily
dependent on internal funding, requiring internal resources
to support it. The long and unpredictable payback, the
uncertainty of future outcomes, and the intangible nature of
the assets produced make it difficult to finance local government innovation with external sources. Thus, it is reasonable
to consider the availability of internal resources as one of the
determinants of innovation in city government. Better fiscal
health was shown to be crucial, while components of fiscal
structure such as slack had no significant effect. City managers need to consider this when designing financing strategies
for innovations.
Notes
1. Kseniya Khovanova, How City Fiscal Health Affects its Innovation, dissertation, University of Illinois at Chicago, 2011.
2. Anne Spray Kinney and Michael J. Mucha, ed., The State and Local
Government Performance Management Sourcebook (Chicago:
Government Finance Officers Association, 2010).
3. Mark Muro, Sarah Rahman, and Amy Liu, Implementing ARRA:
Innovations in Design in Metro America, working paper, the Brookings
Institution, July 2009.
4. The Guide to Management Improvement Projects in Local Government,
The International City/County Management Association, 1990.
5. Gerald Zaltman, Robert Duncan, and Jonny Holbek, Innovations and
Organizations (New York: John Wiley and Sons, 1973).
6. Barry Bozeman and E. Allen Slusher, “Scarcity and Environmental Stress
in Public Organisations,” Administration and Society, II, 3, 1979.
7. Charles H. Levine, Irene S. Rubin, and George G. Wolohojlan, The
Politics of Retrenchment (Beverly Hills: Sage Publications, 1981).
8. Michael Pagano, “Municipal Capital Spending During the ‘Boom,’”
Public Budgeting & Finance (22)2; and Michael Pagano and Jocelyn M.
Johnston, “Life at the Bottom of the Fiscal Food Chain: Examining City
and County Revenue Decisions,” Publius: The Journal of Federalism 30:12 (Winter 2000).
9. James M. Poterba, “Capital Budgets, Borrowing Rules, and State Capital
Spending,” Journal of Public Economics. 56, no. 1: 1995.
10. The states of Colorado, Georgia, Illinois, North Carolina, Ohio, Oregon,
Texas and Washington were selected for analysis based on geographic
distribution, the number of cities with populations between 25,000 and
200,000 as of 2005, and the degree of local fiscal autonomy granted to
city authorities in terms of their access to property, sales and/or income
tax bases, and level of existing tax and expenditure limitations. (See
Khovanova 2011.)
June 2012 | Government Finance Review 17
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Cities that have more discretion in their fiscal
decision making tend to implement more
innovations than cities that don’t have such
discretion.
11. These tools were devised using financial and performance management data for mid-sized cities (with populations between 25,000 and
200,000) provided by two main sources: performance management data
from the GFOA’s 2004 National Survey on Performance Management
Implementation, and data on city government finances from the U.S.
Census Bureau (fiscal years 1995, 2000, 2005). Additional demographic,
economic, and financial data were taken from comprehensive annual
financial reports (CAFRs) of the localities that submitted their CAFRs
to the GFOA’s Certificate of Achievement for Excellence in Financial
Reporting Award program during the 10-year period (from 1995 to
2005); from the U.S. Census Bureau County and City Data Books (1994
and 2007) that include data for all U.S. states, counties, and cities
with populations of 25,000 or more; the U.S. Census Bureau Data for
Governments and American Community Survey (2005); Uniform Crime
Reports from the Bureau of Justice Statistics; recent city CAFRs that contained financial data for the last 5-10-year period, and other statutory,
financial, and regulatory documents obtained from the governments’
official sites or via direct contact with cities’ financial officers.
12. Pagano et al., 2007.
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13. The estimated Fiscal Health Index values for 140 cities under consideration vary from 9.94 to -6.1 (with 10 being the highest value). The
cities rating by Fiscal Health Index shows that six of the top ten “fiscally
healthy” middle-sized cities are located in northwest (Washington), and
seven of ten lowest-ranked cities are in Ohio. Of the cities analyzed, 76
of 140 analyzed have negative values in the Fiscal Health Index (0 to
-6.1).
14. Paraphrasing E.M. Rogers and J. I. Kim, “Diffusion of Innovations in
Public Organizations,” In Innovation in the Public Sector, eds. Richard L.
Merritt and Anna J. Merritt (Beverley Hills: Sage Publications, 1985).
15. Christopher D. Ittner, D. Larcker, “Innovations in Performance
Measurement: Trends and Research Implications,” Journal of
Management Accounting Research, Fall 1998.
16. Frances Stokes Berry and William D. Berry, “State Lottery Adoptions
as Policy Innovations: An Event History Analysis,” American Political
Science Review 84 (2), 1990.
17. Caroline J. Tolbert, Karen Mossberger, and Ramona McNeal,
“Institutions, Policy Innovation, and E-Government in the American
States,” Public Administration Review. May/June, 2008.
18. A city in Washington attained he highest value of the 140 cities in the
Scope of Innovation Index, 96.4; the lowest was 0.
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18 Government Finance Review | June 2012
KSENIYA M. KHOVANOVA-RUBICONDO is a policy evaluation offi-
cer at the Council of Europe, Strasbourg, France. She can be reached
at [email protected].