Endogenous Leadership in a Federal Transfer Game

Conventional wisdom suggests that, to negate fiscal externalities imposed by provinces which spend too much and raise lower local resources, central authority should always be a first mover in the transfer game. In spite of such recommendations, central governments, in almost all countries, chooses to be the second mover from time to time. We explore the conditions, other than the familiar political economy arguments, under which the central government optimally chooses to be the second mover. Moreover, ex post transfer protocols may induce provinces to generate more local resources than otherwise. The results depend upon the benefit received by each level of government from the project outcomes of other tier.