On Intergovernmental Communication: a Tale of Two Decentralization Reforms

Shiyu Bo (Jinan University )
Liuchun Deng (Halle Institute for Economic Research (IWH))
Yufeng Sun (Shanghai University of Finance and Economics)
Boqun Wang (University of International Business and Economics)

Abstract: Motivated by the contrasting experience following the two waves of decentralization in China, we develop a formal model of inter-governmental communication to study the impact of decentralization on economic performance under an authoritarian regime. Decentralization shifts the decision power of policy-making from the central government to the local. The local government has the information advantage, but it also has the loyalty concern, the political incentive to follow the policy prescriptions from the central. We show that the loyalty concern impacts the economic outcome of decentralization by distorting inter-governmental transmission of information as well as final policy-making. A strict adherence to the central could render decentralization welfare- reducing, causing low output and high volatility. We offer several theoretical extensions to highlight the underlying mechanisms and demonstrate the robustness of our results.

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