Construction of facilities under asymmetric information: do constitutions matter ?
A country consists of two non-overlapping regions, each ruled by a local authority. The federal government plans to construct a facility in one of the regions. If the facility is constructed, it generates a social value in the host region and has spillover effects in the rest of the country. The federal government does not observe the local value (which can be high or low) because it is in fact the local authority's private information. To deal with this informational gap, the federal government designs an incentive-compatible mechanism, specifying if the facility should be constructed and a scheme of interregional transfers. But the federal government is constitutionally constrained to respect a given measure of both regions' welfare. The type of local misbehaviour is shown to depend crucially upon this minimum utility the central government must at least implement.
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