by Genevieve Jeffrey ’15, current student in the Economics of Public Policy program.
Nobel Laureate Roger Myerson presented his latest paper, ‘Local Agency Costs of Political Centralization’ to the Barcelona GSE community on the 3rd of June.
The central focus of the paper is to examine how efficient the widely accepted notion of Political Centralisation is.
Some existing literature already argues that political decentralization and community empowerment may be the key to successful development. They show how autonomous local governments can reduce entry barriers in national politics. Creating the space for success on a smaller scale can lead to them becoming strong candidates for higher office. The decentralization of power also gives local leaders a stake in nation building.
Others argue that one centralized government could also have the same effects by applying differentiated policies accounting for regional differences.
The need for targeted policies for differing dynamics in different regions is clear but the way to achieve this is still being explored. Myerson comes in with this paper is to show that in order to achieve efficient local public investment there needs to be accountability which is best achieved with decentralization of power.
The mechanism he uses to analyze this issue is a model of moral hazard in local public services in which an efficient solution is only feasible when officials are held accountable to local voters.
Political Decentralization can lead to Accountability
If the quality of the local public services can only be observed by the local residents, then unless the residents have power over the officials’ career, they will not be accountable.
If the local residents do not have the power to dismiss the officials, their careers would depend more on political relationships than on effectively managing local public services. This would have a roundabout effect on development as without good public services, private investments would be scarce since the success of these investments would depend on the quality of these public services.
In his talk he expounded on the following example to illustrate his findings. In a remote town, if we imagine each resident invests to start an enterprise whose probability of success would depend on the amount spent on public services in the town. The only observable evidence that the official spent the money on public services would be the number of successes among the residents’ enterprises.
This budget is managed by the local official, who could divert any part to his personal consumption. What Myerson shows is that there is a premium that can be paid to the official in addition to his salary that would incentivize the official to stay. This would make up the moral hazard rents and allow the efficient amount of investment to be spent.
Myerson shows that for a given budget if the official is paid ‘p’ if a specified fraction of residents report success then the renewal thresholds and official salaries can be set as functions of the local population ‘n’ that would result in the efficient budget and induced public investment levels.
Distrust and Instability
However if there were distrust, the voters would rather replace the incumbent if they expect the funds to be stolen in the future. In this case, public investment and residents’ benefits would be a decreasing function of the political instability parameter ‘q’. However as long as the utility from the induced public investment for the given level of instability is positive, residents can still benefit.
Autocracy – Rulers Incentive
In an autocracy the national ruler can commit to allow the town to elect an autonomous local government in exchange for a tax the residents would pay until their utility is maximized.
Moral hazard rents would be paid by candidates in terms of cash or political support. The autocracy could offer these offices as rewards for support and help them ward off challengers in this way.
If the national ruler could credibly commit to allow an autonomous local government after picking the first incumbent local official, the ruler could gain fiscal and political benefits per resident. But for this to happen, the ruler must make a credible commitment to the division of power constitutionally which would be against his interests ex-post.
With local accountability then the ruler would not be able to use the offices as rewards as this would make him vulnerable to voters distrust.
If successful they could be serious contenders for national office competing against him. This may be politically too costly for the incumbent national leader.
Separation of Information from Influence in an Autocracy
Key supporters are important for the success of any leader. A leader can get more support when key supporters monitor how he treats others so not rewarding one would cause distrust in all. If successful, competitors cannot recruit supporters without constraints.
Since an autocratic ruler is only accountable to these courtiers, they must deter wrongful dismissals as he can resell the vacant offices with moral hazard rents.
Courtiers can impose political costs on the ruler but these costs cannot depend on information that the ruler would be able to manipulate.
Courtiers could impose a penalty on the ruler depending on the set of dismissed officials. They should choose this penalty such that the dismissal set is a small fraction of all offices. If the net service value the ruler would get from replacing the official would equal his penalty for dismissal, the ruler would pick the dismissal set based on information on public services. However on the other hand, he might choose to dismiss those with the best services as they may prove to be strong contenders and rivals.
Under democracies also, political leaders need the reputation of rewarding patronage to motivate supporters. Under democracy, local autonomy threatens to increase competitive entry into national politics against the interest of national officials. One example of this given was Pakistan. National democratic competition also raises the political risk for the retention of appointees.
However if Local Accountability leads to better Public Services could Democracy induce leaders to promise it?
An analysis shows that with sequential bids the challenger can win by offering marginally more in most districts and zero where the incumbent spends the most. Contrary to the optimal socially, this will lead to small offers everywhere.
Endogenous Decentralization in a Unitary Democracy
However if public budgets are fixed as in most cases, then candidates can compete based on promises of accountability of the local officials. An alternative for this would be for the candidate to sell the office for a political contribution and then spend this money obtained on the campaign. This would win over the uninformed voters while the informed would vote for the best promise. This result thus depends on the proportion of the population that is informed.
Inefficient Centralization in a Unitary Democracy
Citing the example of Ukraine, Myerson also warned of the possibility of politically neglected regions being dangerous for a nations territorial integrity if it facilitated the opportunity for disaffected regions to secede. In an equilibrium of a 2-candidate election for national leadership of a unitary state, each candidate would naturally maintain inefficient centralized management of local public services in a fraction of all districts.
The key points were that moral hazard in local public investments can be efficiently managed with local accountability. When the public services can only be observed by local residents, officials can only be held accountable if their careers depend on the resident’s approval. Political decentralization would guarantee such local power.
However if the leader can resell offices then he would not a neutral judge of the local public services. In the specific case of a centralized autocracy, dismissal must be approved by the national elite and residents cannot communicate their complaints to them, so without a guarantee of local political rights there can be no credible commitment to sustain efficient local investments by the autocratic national government.
Full Barcelona GSE Lecture by Roger Myerson: