Theories of multi-level constitutional organization

The organization of the state falls into two main categories: the unitary state, characterized by a mono-jurisdictional organization, where the devolution to lower-level administrative bodies does not entail the transfer of taxation powers; and the federal state, characterized by a multi-jurisdictional organ­ization, where lower-level legislative bodies are entitled to levy taxes.

In the literature on federalism, following the Federalist Papers (see under Madison, 1787-88), the state is conceived as a multi-layer institution aggre­gating different levels of government empowered with certain functions and prerogatives, whether on an exclusive or on a shared basis. The breakdown of the governmental functions and prerogatives across jurisdictions occurs in both the horizontal dimension, whereby each equal-level government - such as states, regions, provinces or municipalities - exercises power within the boundaries of a certain territory, and the vertical dimensions, whereby the federal government circumscribes the prerogatives of the lower-level govern­ments. One of the main questions is whether individual utility is maximized when the packages of taxes and public goods are supplied by the central government or by lower-level governments. Economic theory has put forward the following criteria. Under two conditions centralization is relatively more efficient and two conditions leading to the superiority of decentralization: (i) public policies of a jurisdiction have a high number of spillover effects - such as externalities and interdependencies - on the individuals who are residents of the remaining jurisdictions and (ii) public policies enjoy economies of scale. Two other conditions instead favor a preference for decentralization: (iii) high heterogeneity of individuals’ preferences and (iv) more and better information is available for the lower-level jurisdiction governments than at the central level, because of their proximity to residents.

There are three main approaches to the analysis of governments:

1. Standard welfare economics assumes a benevolent government, with politicians appointed by majority voting to public office pursuing the maximization of citizens’ economic welfare. To avoid the shortcomings of centralization stemming from heterogeneous preferences, a central­ized system governed by a benevolent social planner could allocate different levels of public goods, each of them responding to the different preferences of local communities. However, the conflict of interests about how to distribute costs and benefits across jurisdictions may cause exces­sive public expenditures due to strategic delegation in the elections (Besley and Coate, 2000).

2. The public choice view maintains that central governments are inefficient Leviathans. The centralized state facilitates politicians maximizing their own utility function (that is, the objective of re-election), instead of pursuing the common good defined by a social welfare function. The expansion of public deficits for electoral reasons, as formalized by the well-known ‘theory of the political cycle’ (Nordhaus, 1975), creates the negative externality of a soft budget constraint. The public choice ap­proach argues that fiscal competition is a useful tool to keep the size of government small. Because of the proximity to the preferences of local communities, the competition principle is supposed to make economic efficiency a possible objective for lower-level jurisdictions.

3. The rent-seeking approach differentiates from the previous view because government failures are traced back to the competing interests of groups engaged in lobbying and bribing practices with the government, thus causing the diffusion of corruption. A decentralized provision of public goods is advocated to ensure that opportunities for rent seeking and the size of the central government do not mutually reinforce each other (Persson and Tabellini, 1994). Local governments are thought to be more efficient because the close monitoring of elected representatives by the local communities may discipline fiscal policy.

The following sections will examine, four categories of federalism: coop­erative, fiscal, competitive and functional.