Centralization versus Decentralization as a Risk-Return Trade-Off
Journal of Law and Economics, Vol. 53, 2010
29 Pages Posted: 12 Sep 2007 Last revised: 30 Mar 2011
Date Written: February 11, 2009
This paper characterizes the choice between centralization and decentralization as a risk-return trade-off and examines it in a model that integrates ideas from committee-decisionmaking and portfolio theories. Centralization, by pooling expertise, rarely yields erroneous decisions; however, when it fails, the consequences are global. In contrast, in a decentralized system, erroneous decisions are more frequent but their consequences are locally confined. We assess the relative desirability of (de-)centralization in various scenarios with independent versus interdependent risks. We further discuss the robustness of the model and the relevance of our results for policymaking.
Keywords: centralization, decentralization, federalism, Condorcet Jury Theorem, risk diversification
JEL Classification: D72, K00, K33
Suggested Citation: Suggested Citation