Transfers in a polarized country: bridging the gap between efficiency and stability
We consider a political economy model of country whose citizens have heterogeneous preferences for a national policy and some regions may contemplate a threat of secession. The country is efficient if its break-up into smaller countries leads to aggregate utility loss. We show that in an efficient country whose citizens' preferences exhibit a high degree of polarization, a threat of secession cannot be eliminated without interregional transfers. We also demonstrate that, if majority voting is used to determine the redistribution schemes within the country, then a high degree of polarization yields the full compensation scheme as the unique political equilibrium.
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