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The Architecture of Federations: Constitutions, Bargaining, and Moral Hazard

  • Kessler, Anke
  • Luelfesmann, Christoph
  • Myers, Gordon M

The paper studies a federal system where a region provides non-contractible essential inputs for the successful implementation of a local public policy project with spill-overs, and where bargaining between different levels of government may ensure efficient decision making ex post. We ask whether the authority over the public policy measure should rest with the local government or with the central government, allowing financial relationships within the federation to be designed optimally. Centralization is shown to dominate when governments are benevolent. With regionally biased governments, both centralization and decentralization are suboptimal as long as political bargaining does not take place. With bargaining, however, the first best can often be achieved under decentralization, but not under centralization. At the root of this result is the alignment of decision making over essential inputs and project size under decentralized governance.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7244.

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Date of creation: Mar 2009
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Handle: RePEc:cpr:ceprdp:7244
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  1. Oliver Hart & Sanford Grossman, 1985. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Working papers 372, Massachusetts Institute of Technology (MIT), Department of Economics.
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