Political Decentralization and Economic Reform: A Game-Theoretic Analysis

Abstract

How does the degree of political decentralization in a state affect the outcomes of economic reform programs? Economic and political theories-from Tiebout to Weingastemphasize advantages of decentralization. Yet, recent experience-from Yugoslavia and Russia to Argentina and Brazil-suggests that decentralization may at times interact with economic liberalization to exacerbate fiscal, macroeconomic, or even territorial instability. This paper suggests a logic that can account for such cases. A simple, game-theoretic model is used to analyze interactions between central and local officials in a two-level state with significant cultural divisions. It finds that decentralization or local democratization increases the level of central redistribution required to prevent spirals of regional revolt. Consequences of economic reforms that have characteristics of public goods depend critically on the initial levels of cultural division and decentralization. In relatively centralized or homogeneous states, such reforms lead to virtuous cycles of growth and increased revenues and state capacity. In decentralized and deeply divided ones, the same reforms can lead to vicious cycles of higher redistribution, economic inefficiency, and political instability.