This paper considers a repeated prisoner's dilemma game in a network in which each agent interacts with his neighbors and cannot observe the actions of other agents who are not directly connected to him. If there is global information processing through public randomization and global communication, it is not difficult to construct a sequential equilibrium which supports cooperation and satisfies a property, called stability, which requires that cooperation resumes after any history. In this paper, we allow agents to locally communicate with their neighbors and show that it is possible to construct such an equilibrium without global information processing. Here, the role of local communication is to resolve the discrepancy of agents’ expectations about their neighbor's future actions.
A traditional argument in public economics says that externality favors centralization (decisionmaking by the central government) and information asymmetry favors decentralization (decision-making by local governments). In this paper, we find a linkage between externality and information asymmetry with regard to the relative efficiency of centralization and decentralization. In addition, we study the incentives of local governments to reveal their private information. When the uncertainty of private information is sufficiently high, it is possible to improve efficiency by providing a cost incentive for local governments to truthfully reveal their information. Without providing a cost incentive, it is also possible to improve efficiency with the local governments revealing their information partially, but not completely.
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