The term "decentralization" embraces a variety of concepts which must be carefully analyzed in any particular context before determining if projects or programs should support reorganization of financial, administrative, or service delivery systems. Decentralization is the transfer of authority and responsibility for public functions from the central government to quasi-independent organizations and/or the private sector. Different types of decentralization should be distinguished because they have different characteristics, policy implications, and conditions for success.

Types of decentralization include political, administrative, fiscal, and market decentralization. Drawing distinctions between these various concepts is useful for highlighting the many dimensions to successful decentralization and the need for coordination among them. Nevertheless, there is clearly overlap in defining any of these terms and the precise definitions are not as important as the need for a comprehensive approach. Political, administrative, fiscal and market decentralization can also appear in different forms and combinations across countries, within countries and even within sectors.

Under appropriate conditions, all of these forms of decentralization can play important roles in broadening participation in political, economic and social activities globally. Where it works effectively, decentralization helps alleviate the bottlenecks in decision making that are often caused by central government planning and control of important economic and social activities.

Decentralization can help cut complex bureaucratic procedures and it can increase government officials' sensitivity to local conditions and needs. Moreover, decentralization can help reach larger numbers of local areas with services; allow greater representation in decision-making. Decentralization may lead to more creative, innovative and responsive programs by allowing "experimentation." It can also increase stability and unity by allowing people to better control programs at any level.

But decentralization is not a panacea, and it does have potential disadvantages. Decentralization may not always be efficient, especially for standardized, routine, network-based services. It can result in the loss of economies of scale and control over scarce financial resources by the central government. Weak administrative or technical capacity at local levels may result in services being delivered less efficiently and effectively in some areas of the country. Administrative responsibilities may be transferred to local levels without adequate financial resources and make equitable distribution or provision of services more difficult. Decentralization can sometimes make coordination of national policies more complex and may allow functions to be captured by local elites. Also, distrust between public and private sectors may undermine cooperation at the local level.

Centralization and decentralization are not "either-or" conditions. In most countries an appropriate balance of centralization and decentralization is essential to the effective and efficient functioning. Even when national governments decentralize responsibilities, they often retain important policy and supervisory roles. They must create or maintain the "enabling conditions" that allow local units of administration or non-government organizations to take on more responsibilities.

Although the main reason for decentralization around the world is that it is simply happening, there are a multitude of design issues that affect the impact of different types of decentralization on efficiency, equity and macrostability. In this regard, there is a growing body of literature examining the economic rationale for decentralization.

The specific services to be decentralized and the type of decentralization will depend on economies of scale affecting technical efficiency and the degree of spillover effects beyond jurisdictional boundaries. These are issues that need to be taken into account in the design of a decentralized system. In practice, all services do not need to be decentralized in the same way or to the same degree. In an important economic sense, the market is the ultimate form of decentralization in that the consumer can acquire a tailored product from a choice of suppliers.

The nature of most local public services limits this option and establishes a government role in ensuring the provision of these services, but it does not automatically require the public sector be responsible for the delivery of all services. Where it is possible to structure competition either in the delivery of a service, or for the right to deliver the service, the evidence indicates that the service will be delivered more efficiently.

Although politics are the driving force behind decentralization in most countries, fortunately, decentralization may be one of those instances where good politics and good economics may serve the same end. The political objectives to increase political responsiveness and participation at the local level can coincide with the economic objectives of better decisions about the use of public resources and increased willingness to pay for local services. At least five conditions are important for successful decentralization:

However, applying these principles in practice has not proven to be simple. Circumstances differ, often in subtle and complex ways, consequently the policy and institutional instruments that establish decentralization have to be shaped to the specific conditions of individual countries.

In order for government to solve public goods problems it would require selfless politicians. If we are consistent in our analysis, we must treat politicians as rationally self-interested people. They have every incentive to act to their own benefit at the expense of the taxpayer. How can the self-interest of the political class be kept in check?

Does democracy ensure that the political class will pursue the interest of the public, rather than their own? The answer is a resounding ‘no’. The reason is because voters are also self-interested.

In order for democracy to keep the self-interest of politicians in check, voters need to have an understanding of what they’re voting on and what policies are good for the whole of society. This would take a tremendous amount of time and effort. A single bill may be several hundred pages of technical legalese, and most elected officials vote on hundreds of bills in each term. For a citizen to be informed enough to know what policies are good for society vs. good only for the politicians is incredibly costly. Yet the individual vote of a citizen has almost no chance of changing the outcome or conferring any benefit. The rational response is to be ignorant of policies, because the cost of being informed is so much greater than the chance of benefiting from being informed. A dedicated, informed voter has one vote that is cancelled out by just one ignorant voter.

The incentives in a democratic system lead to special interests lobbying for and receiving privileges at the expense of society. Far from keeping the self-interest of politicians in check, instead democracy promotes and rewards it, so long as those politicians also provide benefits to every imaginable minority and hand the majority the bill.