Working Paper: CEPR ID: DP7244
Authors: Anke Kessler; Christoph Lelfesmann; Gordon M. Myers
Abstract: The paper studies a federal system where a region provides non-contractible essential inputs for the successful implementation of a local public policy project with spill-overs, and where bargaining between different levels of government may ensure efficient decision making ex post. We ask whether the authority over the public policy measure should rest with the local government or with the central government, allowing financial relationships within the federation to be designed optimally. Centralization is shown to dominate when governments are benevolent. With regionally biased governments, both centralization and decentralization are suboptimal as long as political bargaining does not take place. With bargaining, however, the first best can often be achieved under decentralization, but not under centralization. At the root of this result is the alignment of decision making over essential inputs and project size under decentralized governance.
Keywords: constitutions; decentralization; federalism; grants; political bargaining
JEL Codes: D23; D78; H21; H77
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| centralization (H77) | efficient outcomes (D61) |
| regional governments are biased (R50) | both centralization and decentralization become suboptimal without bargaining (C79) |
| bargaining can lead to first-best outcomes under decentralization (C79) | efficiency of public policy implementation (D78) |
| alignment of decision-making regarding essential inputs and project size under decentralized governance (D79) | achieving efficiency (D61) |
| moral hazard considerations complicate the governance structure (G38) | intangibles cannot be effectively managed through cost-sharing arrangements (H82) |
| decentralization yields better investment incentives and project outcomes (O22) | compared to centralization (H77) |
| efficient grant systems in place (D61) | decentralization yields better investment incentives and project outcomes (O22) |