Efficiency in International Unions

Justin Valasek () and Jenny Simon

No 757, 2012 Meeting Papers from Society for Economic Dynamics

Abstract: Can a union of sovereign nations efficiently implement fiscal projects, even when members are purely self-interested? We construct a model where forming a union can be beneficial for all members, even though some nations are net contributors to the union budget. In our model, joining the union gives member nations access to a set of joint projects that cannot be implemented in autarky. Each nation prefers one specific project over the others, but enjoys spillover effects from all other projects as well. This setup allows us to examine a union with aspects of public good provision and redistribution, while at the same time taking individual rationality constraints into account. We use this framework to study the effects of different decision rules in the union. Our results do not rely on any elements of uncertainty, nor of long-term relationships and repeated games. Instead, we highlight the effects that arise only because of the institutional design of decision rules within the union, even in a static and completely certain framework. We find that unstructured bargaining over contributions to, and allocation of, the union budget generally leads to both budgetary and allocative inefficiency. Inefficiencies are small as long as members of the union are homogeneous or the union projects are unimportant relative to domestic consumption. As the asymmetries between member nations, or the importance of the union grows, unanimity rule leads to increasingly inefficient outcomes. Further, these inefficiencies are larger the more nations join the union and bargain over its fate. We show that a majority rule can improve efficiency, and argue that its implementation can be beneficial for all member nations at the same time. Majority rules might serve as a commitment device to implementing high-yield projects over inefficient ones that is beneficial to all members of the union.

Date: 2012
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