Yardstick Competition, Efficiency of Local Public Goods, and Fiscal Transfers
Yardstick competition theory depicts intergovernmental competitions with advantageous effects to discipline the performance of local governments. However, in yardstick competition, the equilibrium level of public goods provision is below the optimal level. In this paper, to improve the efficiency of yardstick equilibrium, we study the effects of bilateral intergovernmental transfers among local governments and tax-cum-transfer policy by central government. In the “voting with their feet” model, a bilateral voluntary transfer by local governments assures the optimal provision of public goods. We indicated that under the yardstick competition equilibrium, a transfer program by the central government is needed to ease the under-provision of public goods. Our results, therefore, imply that the central government should intervene to improve the efficiency of resource allocation by local governments.
Keywords— Yardstick Competition, Asymmetric Information, Transfer Program.