Intragovernment Procurement of Local Public Good: A Theory of Decentralization in Nondemocratic Government

Abstract

Local governments (LGs) are seen as producers of the local public good ("the good"). An authoritarian country is one in which the government decides if the good should be produced and how much to tax to finance it, as versus a democracy in which voters decide. This paper identifies conditions under which it is more efficient for a nondemocratic government to delegate to the LGs the authority to 1) decide whether or not to produce the good and 2) collect tax to finance it if the good is produced. Two conditions are identified. First, when the net benefit of producing the good is sufficiently small so that, compared with the benefit, inducing LGs' effort under the centralized system is too costly (a moral hazard problem). Second, when the net benefit of the good is higher in a locale with a higher production cost parameter, making it difficult for the center to induce the LGs to truthfully reveal the cost parameter (an adverse selection problem). These results are consistent with the experience of China in the past several decades, where "too small to be worth bothering" and "too diversified and complicated local conditions for the center to know" have been the two most prominent official arguments made by the communist government itself for decentralization.

JEL Classification: H00