Specialization and Trade: The Perspective of Club and Local Public Good Theories

This paper suggests a unified framework for explaining the potential Pareto superiority of a heterogeneous club (jurisdiction) structure over a homogeneous one when there are multiple private goods. The superiority of the heterogeneous structure has been observed by Wilson (1987) in the context of an economy with local public goods and by Gilles and Scotchmer (1996, 1997) in the context of an economy with clubs. In the unified framework suggested in this paper, the two models are combined and reduced to a simple optimization problem. The reduced model shows that the advantage of a heterogeneous structure consists of the gains from trade between differentiated jurisdictions; the disadvantage being the loss from inefficient jurisdiction size. Thus, the club and local public good theories provide a new rationale for specialization and trade among identical individuals. The unified framework is also used in showing that earlier results regarding the possibility of decentralizing the optimal allocation in the case of one private good are equally applicable to the case of multiple private goods.