Intergovernmental communication under decentralization

Abstract We develop a 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 to follow the policy prescriptions from the central. We show that the loyalty concern impacts the economic outcome of decentralization by distorting both inter-governmental transmission of information and final policy-making. A strict adherence to the central renders decentralization welfare-reducing, causing low output and high volatility. Our model implications shed light on the history of decentralization reforms in the People’s Republic of China. A reinterpretation of our analytical framework also extends the core insights to representative democracies.