Endogenous Institution in Decentralization

Abstract

Decentralization policy by itself is not a panacea for problems of accountability. A model is developed to exemplify a condition whereby given widespread 'capture’ in local elections, voices or people’s participation stands out as the most important factor that determines whether the decentralization system produces positive or negative local capture. The size of local budget and the initial welfare condition matter as well. The latter can also explicate the persistent gap between poor and rich regions observed in many countries. The welfare effect of the policy depends on the behavior and quality of local leader that govern the interplay of the above factors. The model can thus produce multiple equilibria. To the extent that the quality and behavior of local leader play a critical role, a three-player coordination game is constructed to reflect the hypothesis postulated by the theory of endogenous institution.