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Lecture 5 – Economics of Federalism (Law4006)
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Lecture 5 –Economics of FederalismIntroduction
In previous lectures we didn’t care about the legislator that made the rules. In this lecture, the
following question is central: “If you are in a multi-level government setting (e.g. EU, central
government, province, and municipality), how does the allocation of power take place?”
Literature in the economics of federalism stems from the US. In order to create the United
Stated they where interested in the answer where to allocate what powers. These days the
literature is relevant in the EU: what powers do we want to allocate to the EU? What to leave
for the MS?
The topic is politically debated. Relevant is not ending up with an extreme (decentralization
versus centralization), but which type of tasks should be allocated to the central level and
based on what type of reasons? To some extend we can decentralize, and some we need to
centralize.
Criteria on when to choose decentralization and centralization, and how to apply them.
Starting point
Tiebout, 1950: optimal provision of local public goods. 1 He stated the following problem:
community can create several different public goods. How do we make these decisions? In
principle through democracy: the goods correspond to the majority of the people?
o The majority is happy, but what if you’re a minority?
Hirschman stated that there are three options if you’re a minority:
1) Exit: move to a neighboring community that has the facilities you want;
In the literature this is debated to also be a way of voicing: “voting with the feet”
2) Voice: start a lobby group, and make your voice heard at the local community;
3) Loyalty: do nothing, shit happens and not change anything.
Tiebout: if the system works well, people will move to other communities for different type of
services. He deems this to be good. People have different preferences and we all demand
different public goods. Therefore we will seek different communities that all offer different
services. They all offer those services that maximize the demands of the citizens living in their
community. The communities will start competing with each other. And if this system
dynamically works well, the process of voice and exit will make sure there is an optimal
allocation of people living in communities offering services that they want.
Downside:
o Relocation is costly;
o Decision on where to live is made on multiple factors, not just the fact that there is a
sports facility.
What has the above the do with law?
1
Public goods are provided by the government, we don’t have to pay directly for them (positive externalities): park, opera house, sporting
facilities.
, Law is a public good, offered by a legislator. Public choice teaches that legislation is a product
of the political market. Legislators will in principle also offer those types of laws
corresponding to the majority of the citizens. Preferences between people will differ, and
therefor there will be different laws. Economists say: the fact that laws between MS differ, is
not something to worry about (as a starting point).
Competition between legal orders: communities compete for citizens, legal systems do the
same. Countries compete with each other.
o Example: Dutch tax rulings
o Is this efficient? Later in lecture.
Comparitive law is a system of competition.
In Belgium for example there is a system of payment of lawyers on the basis of hours.
Economists say: this should be based on the success-rate. This will align the interest of the
lawyer and the client. Most systems in Europe prohibit this – but some countries do not
(result-based renumeration is allowed). Therefor people will do competitive research between
the countries. The differences are used in a way as a competitor to the Belgian system.
Why is this good?
o Experimentation;
o Mutual learning;
o Better rules will follow (learning from the best practices).
Economists reasoning: if all the laws are the same, that would be a monopoly. No
competition: high prices and bad quality. The advantages of differentiation are gone.
People have difficulty talking rational about this topic. EU created after war with idea: never
war again. But some people went further and stated: Europeans would understand each other
better in completely harmonizing the EU (‘European civil code’).
o “If the institutions are one, the people also become one”
Napoleon did this and succeeded, but people spoke the same language
Remember: what is our fallback position if everything would be the same?
o Would we, use the market: liability, private and contract law? Or,
o Use regulation
If we can reach all the results at the same cost use market, simpler.
Important because criteria for regulation (Shavell).
And what about this topic? Basic standpoint is decentralization. Rules as close as
possible to the people whom the rules apply to: local legislator has the best
information on the preferences of the people. Rules have to correspond best to
preferences of people. Preferences divert, but we don’t worry about this because
decentralization is starting point. Look for criteria for centralization – not other way
around.
Why is this important? Memo EU commission about subsidiarity: things that
shouldn’t be necessary regulated at EU level, can be at national level (model
federalism top-down). Economics of federalism works other way around: bottom-up.
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