Geoscience Reference
In-Depth Information
The risk of external economic shocks creates political demand for a common
pool of resources, that is, in favor of relatively more integrated fiscal structures
(Alesina and Perotti
1998
;Cremer and Palfrey
2000
). This is because the
prospect of an external shock works to reduce the distance among regions
in terms of their risk profiles. Neither the poor nor the wealthy region know
ex ante whether they will be affected by the shock. What they both know,
however, is that if a negative shock hits them, they would be worse off with-
out a common insurance scheme.
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By contrast, insofar as there is a cross-
regional fiscal structure at work, the region negatively affected by the shock
can transfer some of the cost to the common pool. Otherwise, it must fend
for itself. The possibility of an external shock creates a risk that cuts across
regional boundaries, thereby compensating the effect of specific risks associ-
ated with the uneven geography of labor markets. As a result, they create
incentives for the formation of coalitions in support of a more integrated fiscal
system.
So, which specific form should this fiscal system take? Will people support a
fully centralized system (C)? Or would they prefer a combination of decentral-
ized interpersonal redistribution and large scale interregional transfers (H)? The
answer to these questions depends on the nature of cross-regional economic
externalities.
Economic shocks are bound to have differential effects on regional
economies. A sudden drop in the demand for agricultural or manufacturing
products is unlikely to affect all regional economies equally. Likewise, the
deindustrialization associated with transitioning to a service economy is likely
to have a stronger impact on those regions with a larger concentration of
manufacturing industries. For example, the 1929 international financial crisis
affected North American states and provinces in different ways. The Great
Depression hit some areas, particularly rural areas, harder than others.
In this context, the key issue is whether the negative socioeconomic effects
associated with the common shock of the financial crisis spanned across regions
or remained geographically concentrated. If the latter, the redistributive and
institutional contentions among citizens in different regions will exacerbate.
The polarizing effects of the geography of risks will be enhanced by the shock.
However, if the social consequences of the crisis cut across regional bound-
aries, the dynamics of preference formation might change dramatically. This
brings us to the geographical mobility of redundant workers and their depen-
dents as a key engine behind cross-regional externalities. In the event of a
negative shock affecting their local economy, laid-off workers will seek alter-
natives in areas of the country less affected by the crisis. At the same time, in the
absence of a centralized welfare system, the unemployed and their dependents
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To see this in terms of the model in Appendix A, consider the economic effects of a negative
shock on regions A or B. Any region affected by a negative shock faces simultaneously a loss
of tax base (w) and an increase in the demand for redistribution (via the ratio between the
employed and the unemployed populations,
α/(
1
−
α)
.
