A Theory of (De)centralization

This paper compares the efficacy of a centralized and a decentralized rights structure in determining the size of an externality-generating project. Consider a central authority and two localities. One locality can operate a variable-size project which produces an externality that affects the other locality. Each locality may have some private information concerning its own net benefit from the project. Under centralization, localities are vertically integrated with a benevolent central authority who effectively possesses all property rights. Under decentralization, localities are separate legal entities (endowed with property rights) who bargain to determine the project size. We examine the performance of these two regimes and show how one or the other may dominate depending on the distributions of private and external benefits from the project.