Political Institutions and Federalism: A “Strong” Decentralization Theorem

In this article, we investigate how differences in the political institutions necessary for implementing decentralization reform may affect the efficiency and welfare properties of decentralization itself. We incorporate insights from political science and economics into a rigorous and formal extension of the influential “decentralization theorem” first developed by Oates in 1972. In our analysis, we go beyond Oates by producing a strong decentralization theorem that identifies the political conditions under which democratic decentralization dominates centralization even in the presence of interjurisdictional spillovers. More specifically, we find that beneficial outcomes for public service delivery will obtain when democratic decentralization (i.e. the creation of popularly elected sub-national governments) is combined with party centralization (i.e. the power of national party leaders to nominate candidates for sub-national office). We also find that the participation rules of primaries, whether closed or open, have important implications for the expected gains from decentralization. Most notably, we find that, when primaries are closed, even Oates’ conventional decentralization theorem does not hold. In summary, our theory shows that political institutions matter considerably in determining the welfare gains of decentralization outcomes.