The Decentralization Tradeoff for Complementary Spillovers

Abstract

We examine a symmetric two-district setting with spillovers of local public spending where a spill-in from the foreign spending is not a substitute, but a complement to domestic spending. Specifically, we assume production of two district-specific public goods out of two complementary district-specific inputs. We compare equilibria in non-cooperative decentralization and cooperative centralization for different spillovers, complementarities and cost-division rules, and control for the effects of strategic delegation and the feasibility of voluntary contributions to the input in the foreign district. We find that centralization welfare - dominates decentralization in most institutional settings and for a wide range of parameters, yet we can also identify necessary and sufficient conditions for decentralization to welfare - dominate centralization. The setup features three novelties: In the absence of transfers, welfare in decentralization increases in spillovers, strategic delegation in decentralization improves welfare, and centralized provision may be non-monotonic in spillovers.

Keywords: spillover, spill-in, strategic complementarity, decentralization theorem, externality

JEL Classification: H41, H73, H77