A theory of (de)centralization

Abstract

This paper compares the efficacy of a centralized and a decentralized rights structure in determining the size of an externality‐generating project. Consider a central authority and two localities. One locality can operate a variable‐size project which produces an externality that affects the other locality. Each locality may have some private information concerning its own net benefit from the project. Under centralization, localities are vertically integrated with a benevolent central authority who effectively possesses all property rights. Under decentralization, localities are separate legal entities (endowed with property rights) who bargain to determine the project size. We examine the performance of these two regimes and show how one or the other may dominate depending on the distributions of private and external benefits from the project.

Should a benevolent government provide public goods if it cannot commit?

“…There are also several papers that analyze the same question under incomplete information but do not allow for communication among the regions (e.g., Kessler, 2014 or Cho, 2013), which limits the benefits of decentralization. Klibanoff and Poitevin (2013) is an exception in that the authors do allow for some bargaining to occur between the regions. However, when modeling the decentralized system, it is assumed that the regions are able to write contracts among themselves.…”