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International Tax and Public Finance

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01.04.2013

Size versus scope: on the trade-off facing economic unions

verfasst von: Oliver Lorz, Gerald Willmann

Erschienen in: International Tax and Public Finance | Ausgabe 2/2013

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Abstract

This paper analyzes the relationship between the size of an economic union and the degree of policy centralization. We consider a political economy setting in which elected representatives bargain over the degree of centralization within the union. In our model, strategic delegation affects the identity of the representatives, and hence the equilibrium policy outcome. We show that the relationship between the extensive and the intensive margin of centralization may be non-monotonic: Up to a certain threshold a larger size implies deeper integration, whereas beyond that threshold centralization declines with further increases in size. We also show that freezing the level of centralization and associate memberships can mitigate this trade-off.

Vorheriger Artikel Tax compliance under tax regime changes

Nächster Artikel Optimal taxation and welfare benefits with monitoring of job search

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Alesina and Spolaore (1997, 2003) analyze the role of heterogeneity in explaining the size of countries. Lockwood (2002) sets up a legislative bargaining model that explains as to why centralized policies may be insensitive to heterogeneous local policy preferences. Crémer and Palfrey (1996, 2000) study voter preferences for centralization in a setting with uniform policies and heterogeneous citizens.

See Schneider (2007) on a “discriminatory membership” and also Alesina et al. (2005). Berglöf et al. (2008) analyze how the threat to form an inner club in the union exerts pressure on some union members for more deepening.

For recent surveys on the political economy of economic unions, see Ruta (2005) and Lockwood (2006).

Janeba and Wilson (2005, 2011) determine the optimal degree of centralization in tax-competition models.

On strategic delegation with respect to local public good provision, see also Chari et al. (1997), Cheikbossian (2000), Ferretti and Perotti (2002), and Dur and Roelfsema (2005).

Related papers dealing with strategic delegation in a bargaining context are Segendorff (1998), Buchholz et al. (2005), Rota Graziosi (2009), and Harstad (2007, 2008, 2010). Another related strand of literature is that of strategic information transmission (see, e.g., Olofsgård 2005). None of these papers, however, deals with the issue of policy centralization.

In our specification of utility, public goods are imperfect substitutes, similar to Besley and Coate (2003).

It is straightforward to relax this assumption.

In a rent-seeking approach, for example, centralization costs per country tend to be decreasing in the number of countries whereas in a setting with policy uncertainty, the effect may have the opposite sign.

Note that we are abstracting from country differences and in particular from core-periphery considerations. Otherwise, the spill-over term β would also depend on the size of the union, for example, if the union grows from the core to the periphery.

Harstad (2007, 2008) compares the limit cases of free transfers versus prohibitive transfer costs.

Since \(d\tilde{\beta}^{*}/dn=-\tilde{\beta}^{*}/(n-1)\) from (5), we obtain \(d [1+(n-1)\tilde{\beta}^{*} ]/dn=0\). Therefore, the first term in (13) decreases in n for \(\tilde{\beta}^{e} = \tilde{\beta}^{*}\). In addition, the expression n(2lnn−1) increases in n, such that the expression \(d V_{i}(\bar{\alpha},\cdot) / d\alpha_{i}^{\mathrm{rep}} \) decreases in n.

As the decision problem of the median voter is highly nonlinear, we are not able to go further and determine analytically the influence of n on the endogenous variables in our model. Our benchmark simulation uses ad hoc chosen values of \(\bar{\alpha}=3\) , f=0.5 and γ=0.5.

This clearly illustrates the fact that the inefficiency in our model results from the possibility of paying transfers between union members. Given this outcome, one may argue in favor of prohibiting such transfers in the first place. However, in a more general framework with heterogeneous countries, transfers also play a positive role as they facilitate cooperation (see, e.g., Harstad 2010). Moreover, if direct monetary transfers between regions were not possible, governments may resort to alternative ways of making concessions, for example, when deciding about the location of certain common institutions or the nationality of the decision-makers in the union.

For the complications involved in analyzing an asymmetric setting even for the case of only two countries, see Lorz and Willmann (2005).

In a recent paper, Desmet et al. (2011) study the sequence of the break-up of Yugoslavia using such an approach.

Thus, the ratchet cannot completely eliminate strategic delegation, but it can prevent a possible decline in the degree of centralization.

Note that similar graphs can be drawn for admitting more than one associated member.

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Titel: Size versus scope: on the trade-off facing economic unions
verfasst von: Oliver Lorz
Gerald Willmann
Publikationsdatum: 01.04.2013
Verlag: Springer US
Erschienen in: International Tax and Public Finance / Ausgabe 2/2013
Print ISSN: 0927-5940
Elektronische ISSN: 1573-6970
DOI: https://doi.org/10.1007/s10797-012-9223-2

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