Accountability and decentralisation in government: An incomplete contracts model

This paper approaches the question of the appropriate level of decentralisation of power in government as a problem in the allocation of control rights under incomplete contracts. The model of the paper compares allocations of power to local, central and regional government as alternative means of motivating governments to act in the interests of citizens. Centralisation allows benefits from policy coordination but has costs in terms of diminished accountability, which can be precisely defined as the reduced probability that the welfare of a given region can determine the re-election of the government. The model is extended to allow for conflicts of interest within regions, and externalities between central and local governments in a federation. It is also applied to determining levels of fiscal transfer between localities, and to circumstances where governments may act as Leviathans appropriating resources for their own use.