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Endogenous Leadership in a Federal Transfer Game

Sengupta, Bodhisattva (2016): Endogenous Leadership in a Federal Transfer Game.

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Abstract

The paper explores the issue of leadership in central transfer within a federation. In a federal country, provinces, in anticipation of the ultimate federal bailout, may spend more than what is optimal. Such behaviour creates negative fiscal externalities and harms the central government. To counter such tendencies, it is suggested by policymakers that central authority should always be a first mover in the transfer game: once the grant (presumably formulaic) is dispensed, it should refrain from any ex post transfer. In spite of such recommendations, central governments, in almost all countries, chooses to be the second mover from time to time. We explore the conditions, other than the familiar political economy arguments, under which the central government optimally chooses to be the second mover. The key determinants of the first or second mover advantages in such situations is the nature of spillover effects of public goods between the two tiers of government

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