Law, Economics & Public Policy

Decentralized Knowledge, Charter Cities and Economic Development

2011-08-15T10:55:00.004+02:00

Poverty, misery, economic disparity and inequality are the salient characteristic of the modern world. These problems are one of the main concerns of the almost everybody and I was no exception to the rule. Though poverty sometimes seems to have a geographic pattern, in my view the problem of poverty is not directly related to geography, but it is closely related to the human capital of the people living within a "politically defined" territories which have been evolved through the ages of ebbs and flows of war and peace.

A quick look at the geopolitics and economics of poverty and development shows that the poverty and misery usually is confined in these political entities. In some instances, it can be seen that two states roughly within the same geography have two absolutely different standards of living. The bottom-line is that the poverty is not a natural or geographic phenomenon, but it is a human problem caused by humanity itself and could be dealt with human intervention. It seems that it is the cooperation and coordination failure which creates such problems or at least cannot prevent them from happening. Why is it so? And what can be done about it? What role legal and economic theory can play in dealing with these grave human problems?

In this short note, I see the status quo in international law and generally acknowledged theory of the state as the first culprit for having such a situation in place. The current system of international law is the debris of tumultuous history of wars. The suboptimal Nash equilibriua generated by the failure of cooperation and coordination along with innumerable prisoners' dilemma the humanity has been trapped into, in Westphalia in 1648, caused states to adopt the principle of sovereignty which normatively fortified states, isolated them and used the international law as a tool to reinforce their territorial sovereignty.

In this new geopolitical order states are defined firstly by their territories and secondly by the people. This is the territory which determined what laws should be applicable to the individuals. The policies and institutions of non-intervention and absolute sovereignty and territorial integrity are clear evidences for this claim. The peace treaty of Westphalia gave birth to the territorial integrity which afterwards made its way into the Charter of the United Nations. Within these territories each country has an absolute sovereignty, of which the governments tend to present a quite generous interpretation.

This abusive construction of the principle of territorial integrity has its roots in the double-degree agency problems the statesmen have in their international missions. The diplomatic mission participating in an international convention or meeting thinks of his own interest how to perpetuate his position and job in the career and forgets about the interest of the government he or she is representing and on the other hand, the government who chooses the agent/diplomat to send to the international conferences, thinks of its own interest how to perpetuate the government and his party in power; the forgotten man is the nation.

Though the states wanted to territorially define themselves and isolate themselves, the point is that many of the human problems cannot confine and accord themselves to the political borders, and they increasingly become global. On the other hand, Decentralized knowledge and the impossibility of central planning are among the biggest concerns of the economists from almost the outset of the modern economic thinking. In this paper, I want to analyze the implications of dispersed and decentralized knowledge for the size and structure of the state to see how the policy makers can take advantage of this local and decentralized knowledge to make a difference in the development studies.

The line of reasoning will be as follows: Economic misery has its roots in human mismanagement and misadministration. The optimal way of dealing with this problem is establishing knowledge-based economies. Since the human knowledge is dispersed, mechanisms that can involve everybody (free entry and exit) to voluntarily contribute to the public policy are the optimal ways of dealing with those problems. This model is a model which should be based on the free market for ideas. I will argue that one of the mechanisms to give the opportunity to citizens to engage and share his knowledge in the public policy is localism and creating strong networks among people. Given the flaws (coercion/involuntariness) and the problems of localism, one might take the idea of charter cities as an alternative way toward development; it might be considered as an alternative or a complementary way of the existing model toward development, as a constant and steady growth over a considerable period of time. The problem with this alternative idea is that it challenges the exiting conservative structure of international law.

Localism as a Mechanism of Exploitation of the Dispersed Knowledge
Let me start with the history to see how the dispersed knowledge in administering the territory caused even the greatest empires and states to abide by the special governance rules and structures. By a quick overview of history, we can see that even the most potent of empires of the world were restricted by the geographic and economic realities which played a very delicate role in their size and structure. Indeed, local governments have their roots in the long history of civilization and the rules of governance in large scale empires. As historians demonstrate; Cyrus, the Emperor of Persia, appointed the local officials for governing every region within the Empire. According to Herodotus, after conquering Lydia, Cyrus decided to appoint the ex-king of Lydia, Croesus, who was defeated by Cyrus as the governor of Lydia within the Persian Empire. Thereafter, Darius, the Persian king, did the same and appointed the local officials for the administration of the then Persian territories which at that time were constituted of about 20 provinces called “satrapies”. Though there might be a host of reasons behind these appointments, ex-post, it seems that one of the reasons was the difficulty of getting involved in the management of those vast and diverse territories without having a proper local knowledge.

As the above example shows, many of the empires who conquered a vast territory appointed the local governors for the administration of those occupied territories. This became a tradition in governance at least in the Middle East and the Minor Asia in ancient times. For instance, when Alexander conquered Persia, he made use of such a policy as well. The conquerors like Teymour Khan and Chingis Khan followed suit (again ex-post) partly because of the expertise problem and partly the common sense and intuitively known idea of the diseconomies of scale arising from such a big territory under administration, decentralized nature of the knowledge which made central planning impossible for them and would have frustrating effects on their territories and their strength of traditional sovereignty.

This continued tradition had its special advantages and economic justifications for those emperors. Although many of the ancient empires officially claimed that they had a universal sovereignty, save King Canute, they were well aware of the limits of their power. Van Creveled puts it this way, [because of] “the problems of time and distance as well as the limits of the information at their disposal, many emperors preferred to deal with entire communities – tribes, chiefdoms, villages, cities, even client-kings – rather than with individuals”. This insightful phrase is the gist of what I am going to say and almost perfectly shows how the case for local governments was established. This comment also shows that almost from the advent of urban life and civilization, how great empires with vast territories severely suffered from the transaction costs, agency problems and diseconomies of scale. Add to the scope of the country the problems arising from the lack of means of communication that the industrial revolution partly solved for their modern counterparts. These limits imposed multilevel or multilayer system of governance even to those ancient empires. The insightful lesson that we can take from history is that decentralized knowledge breeds decentralized government, unless you live in a body politic in which "La République n'a pas besoin de savants" (the Republic does not need the erudite).

Theoretically speaking, localism can promote the use of local and dispersed knowledge and contribute to the socio-economic development. Many of the adherents of localism argue that smaller governments provide a better context in which the citizens can have a better sense of community. Some of these proponents go farther and argue that the constitutional and legal rights should be context sensitive. These advocates of localism believe in a broader decentralized constitutionalism. They argue that the courts should respect the “geographical variations of constitutional requirements in the aid of community”. In addition, the existence of large number of local governments who are much more familiar with the needs of the special communities and certain localities, with the amount of services and consumption which is usually limited to their own jurisdiction increases the economic efficiency in the provision of public goods and certain utilities.

Localism can promote economic efficiency by taking account of the differences in preferences and cost differentials in the locally needed public goods. Therefore, it appears that the efficient level of output in local public goods seems to be variable in the local jurisdictions and likewise governments provide the better allocation of local services in a decentralized structure. Other economic adherents of localism argue that the very existence of the localities brings about plurality of localities and extend the opportunities of the citizens to move into better localities which provide the better allocation of services and taxes and eventually serves the economic efficiency. Tiebout was the first theorist who elaborated the idea of the “voting with the feet”. However, it seems that he overlooked some costs affiliated with his idea such as tremendous migration costs, externalities and asymmetric information, which adversely affect the outcome of the theory. All in all, these local governments play an extremely important role as a channel through which local knowledge channels into the federal level and makes planning in a central level a bit less onerous.

Unfortunately there were inefficiencies in the localism as well which could not bring about the desired result we might have expected to reach. But why do we see inefficiencies even with having local governments in place for centuries? The answer is in the inefficiencies embedded in the localism. Inefficiencies resulting from the diseconomies of scale, high costs of communications among many local governments, duplication of efforts and the forgone opportunities of network economic effect in a sub-optimally organized networks of local governments, existence of the commons in the regions, free riding problem, and problems arising from the taxation, transactions costs and hold-out problems hindered the local governments from flourishing and the long fought battle between home rule and Dillon's rule was resolved in favor of the latter.

Let's have a quick look at the history to see why this form of government could not be efficient enough. With the gradual evolution of urban life, consciously or unconsciously, some other problems and thereafter concepts came into existence; the concepts similar to annexation and incorporation in the history of urban life. The rising of these phenomena signaled that the network economic effects (having bigger entities with lots of individual components) prevailed over the benefits of the having small local governments.

First let's see why would people like to migrate and live in prosperous places rather than the isolated underdeveloped places? The answer lies in a concept known as network externality. Network externalities appear when greater numbers of users join to a network. This theory assumes that “the utility that a given user derives from a good depends upon the number of other users who are in the same “network” as is he or she.” This network can appear for example when the municipalities join together in a unified network to share their resources. Although this fact may generate some unintended consequences like diseconomies of scale, but it seems that taking the size and number into a serious consideration and not letting them grow more than necessary, this will increase the positive externalities of networking.
One of the best historical examples of network effects which caused some cities to grow immensely, is the city of Baghdad at the time of Abbasid Caliphate (Rome might be a good approximate to a western mind). At that time, the city of Baghdad had a position in the world comparable to world cities of today. Ibn-e-Khaldun describes the City of Baghdad as follows:

“[T]he town will extend farther and farther. Eventually, the layout of the town will cover a wide area, and the town will extend so far and wide as to be almost beyond measurement. This happened in Baghdad and similar cities. Baghdad included over forty of the adjacent neighboring towns and cities. It was not just one town surrounded by one wall. Its population was much too large for that, the same was the case with al-Qayrawan, Cordoba, and al-Mahdiyah in Islamic times. It is the case with . . . Cairo at this time, so we are told.” (Badi, 1988, p. 86)

This discussion of the growth of large cities such as Baghdad is similar in essence to what is referred today as the process of suburbanization, a phenomenon that in turn causes sprawl. With the growing number of districts within a country or a city, other problems come into being as well, i.e., coordination problem embedded in the decentralized and (more recently) separated power structure of the state. So from the above examples and economic history indications, one can see that neither large nor small sizes are optimal for the states/cities.

The further complication is that the size of the population of societies does not remain constant and increasingly changes with the fluctuations in the labor, capital and technologies, while the supply of the land almost remains constant. Furthermore, there exists an optimal size for the states. But who knows what that optimal size is? Therefore, the restructuring of the state will not mitigate the problems and if it does, further problems will arise (coordination problem & the like). As above examples show, many of the problems could not be dealt with either by centralization or decentralization. There must be a way out.

International Law and the Exchange of Authority: Towards Creation of Charter Cities
The idea of comparative advantage based on the division of labor and ensuing expertise simply states that each country can be good in producing or providing some special goods or services, and they can enter into a contract to exchange goods and services that can create new economic value for both sides of a transaction. Based on this theory and upon the demise of the zero-sum fallacy, rise of the marginalism, and new theory of economic value, we almost see the end to the beggar thy neighbor policies that the states pursued in the pre-modern era by waging extremely costly wars against their neighbors or rivals. These theoretical transformations gave birth to the new theory of international law, i.e., the economic theory of international law, the goal of which is to let the states to achieve their preferences with better and greater efficiency through exchanges of authority and transactions in Jurisdiction. This is a very good point to set the stages to establish our argument for charter cities. This approach to international law can explain how a metamorphosis in international law; i.e., from sovereignty based international law to market based international law can contribute to the economic prosperity and development of the nations.

Although, the economic approach to international law states that the states can do more efficiently by exchanges of authority and transactions in jurisdictions, we can push the argument one step further in the sense that nation-states exchange their sovereignty over the defined pieces of territory. This model proposes that to enhance efficiency, nations should bargain on their territories and hence this model supports the creation of a market for the national territories (specially barren and undeveloped national territories) so that the territories will go to their most valued use. This is roughly what the idea of "charter city" proposed by Paul Romer is.

First let's see what a charter city essentially is. The concept of charter city, as formulated by Paul Romer, is a city which is composed of three elements: host state, source state and the guarantor. The host country provides undeveloped lands, the source country or countries provide the residents and guarantor ensures that the charter of the city (which is essentially the constitution of the city) is enforced. The host country is supposed to ensure that it will not apply his internal rules and regulations on that specified undeveloped land and the charter will ensure that the basic requirements of rule of law will be in place. Notice that each of these countries has comparative advantage in goods, capital and services they provide for the Charter city.

Successful historical examples of charter cities are Lübeck in twelfth century, Pennsylvania/Philadelphia in the 17th century, and Hong Kong in the 20th Century, each with different stories which in this paper, for the sake of brevity is forgone. The argument is that if these models of the charter city achieve success, other countries will follow suit as other states and countries did in case of Pennsylvania and Hong Kong.

The difference between localism and the charter city mechanism is that localism is an attempt to involve everybody by creating incentives and increasing differential value of voting to increase the marginal value of voting to make it attractive for voter to become involved in the elections. Charter city is an attempt to provide an alternative pattern to the existing patterns of democracy and development to make the environment and context more dynamic. Charter city is an attempt to involve those who see it in their interest to involve and those who will.

Unfortunately, the principle of territorial integrity in international law was abusively construed by national authorities not to let nations to enter into a bargain on their territories while history documented several transactions transferring national lands such as Louisiana and Alaska purchase. The biggest problem in the way of such an idea is the double-degree agency problem in international law. As stated above, the government or the diplomats who are negotiating such a deal might have conflict of interest with the nation they are representing. Though the mechanism of checks and balances can mitigate this problem to a considerable extent, it can never eliminate it. And maybe this is the reason why many countries in their constitutions do not allow any negotiations on their territories.

The requirements of the modern complicated world with its extreme problems imposed on the isolated fortified states, requires more cooperation, coordination of the efforts and contribution of the capacities in which every individual state might have comparative advantage, to solve the problems of global magnitude.
The status quo is that there are many underdeveloped countries with vast territories under their rule and simultaneously there exists geographically small countries with almost fully-developed lands and in need of more lands. A salient example of an inefficiency caused by the "sacred", fortified boundaries is the example of Japan and Russia. Large population of Japan living on a bunch of small vulnerable islands while vast pieces of lands remains underdeveloped in Russia. It might be said that those lands are not inhabitable, but evidence shows that people even can make use of the swamps to live in if they do not have any better choice.

There is certainly tremendous amount of deadweight loss negatively affecting the lives of millions just because we drew some lines around us and made a lot of taboos around it, murdered and were murdered because of those usually fictive lines.
I know that the history of international law was a very sad one. And this history of wars which gave rise to the present extremely conservative international legal system, but the increasing realities may not wait for that conservatism of international law to vanish gradually. The population growth and the interconnectedness of this population will impose greater challenges on the international law than the immigration and other present environmental challenges. This time the target will be the very principles of international law.

As the last point, It should be noted that though the idea of charter city seems unrealistic and utopian, given the growing rate of obsolescence of ideas due to the accumulation of dispersed knowledge of the people through the virtual networks which connect the individuals from all over the globe, it will not be too far that everybody will see the flourishing of ideas which were considered too unlikely and unfamiliar. What seems à la mode today, will be obsolete tomorrow, special thanks and tribute to fiber optics, microchips/processors, satellite and internet.

International Trade and Race to the Bottom

2011-06-10T21:37:00.002+02:00

"Should other states be concerned about your environmental protection choice?" This is a fundamental question in trade policy and regulation which is asked almost everywhere to set the stage for starting the debate about international trade regulation and our class in Economics of International Law was no exception. Most of the answers offered to justify the governments' intervention in the international trade policy are based on the externalities (jobs displacement, protection of the infant industries), strategic trade theory and race to the bottom argument. What I will be talking about is the last argument offered for having restrictions on international trade.

What constitutes the core idea in the race to the bottom argument for restricting the international trade and perceived to be the strongest argument for a hidden protectionism is the race to the bottom. It is argued that the free international trade will be in favor of the countries with less restrictive labor, environmental and human rights measures and will be detrimental to the countries with higher standards with regard to the above mentioned standards, so trading with those countries not only puts the countries with higher standards in comparative disadvantage, but also makes the acute problems of the environment and human rights worse, so there should be either no trade with countries with low standards or there should be some restriction on trading with them.

I my view there are problems with this argument.
1. In terms of economics, since the advent of the marginalist revolution based on the modern theory of economic value, no sound economist could be found to be thinking that there should be no trade at all. One of the fundamental methods of thinking like an economist is thinking marginally. It means that most of the times, we are not dealing with the problems involving either/or, but problems of different degrees or levels taking account of other available alternatives at disposal. Marginalism should be understood as part of the fundamentals of the theory of the microeconomics dealing with the optimal allocation of the limited resources to the unlimited wants and desires. It implies that most of the choices we are making in our life is not about whether we want something or not, but how much of something we want in combination of how much of some other things. So, when the question is not about all or none, but about how much, the answer should be about how much trade with those countries and how much restrictions should be put on those trades.

2. Second and more logically based argument against the race to the bottom is about the fallacy/problem of equivocation lying in the context of the debates on the international trade. The repeated use of the race to the bottom argument makes economists to take it as granted. I think the question we should ask should concern with the meaning and implications of the word "bottom". We should come up with an idea of what this bottom means and after setting the reference/anchor points in the definition of the bottom, proceed to make use of this argument against international trade. Someone sitting in the developed country may see a situation as bottom while the other one in an underdeveloped / undeveloped / emerging market sees it as top. This fallacious argument arising from the improper use of the language and ambiguity in the meaning of the words is called equivocation. If we want to resolve this problem, the parties to an argument should first agree about the meaning of the concept or the conception of the particular concept they have in their minds in that particular context.

The other days, I was watching an interview with an ex-Chinese teacher who was working in a factory at that moment, he was telling to the interviewer that when he was a teacher he earned one hundred Yuan per month (I am not sure about the currency and the period, but sure about the numbers), while working in the factory he could earn 3.000 and despite being in a very modest situation he was very happy. What developed world sees a bottom, to him it was top.

There is a nice and almost untranslatable verse in Persian which best describes this problem with a very palpable analogy. It goes as follows:
حوران بهشتی را دوزخ بود اعراف
از دوزخیان پرس که اعراف بهشت است
A'raf is a place located in between the heaven and hell. The verse says that for the angels of heaven, A'raf is a hell, while for the residents of hell, it is a heaven. So two categories of people with two different socio-economic! standings, see one thing differently and consequently if these two with the above specifications argue about the a'raf, they have two distinct conceptions in their mind and cannot come to a proper conclusion on that.

It appears that in the race to the bottom argument convergence on the word "bottom" has yet to be achieved. Though this "bottom" concept could be roughly taken as granted when we are talking about one domestic legal system, we should not hastily and unthinkingly borrow the concepts from the domestic legal or economic system and apply it to a different legal structure.

Another important argument against restricting the trade with countries with looser standards is that it will prevent the evolutionary process of divergence of the conception of the concept of the "bottom" which trade with those countries can bring about. As the basic principles of economics imply, no trade/ voluntary exchange can occur unless it is beneficial to both parties, when we see that one enters into a voluntary exchange of goods or services, it is appropriate to assume it is in the interest of both parties to engage in that particular trade. Having this in mind, it will become clear that imposing restrictions on the trade with these countries will wipe out both producer and consumer surpluses and will be detrimental to both parties, especially it will make barriers for developing countries to reap the profits of the trade and will leave them in their regrettable status quo, i.e., poverty and starvation, while having trade can fill the gap between those countries and more developed ones to a considerable degree and pushes the "bottom" up.

3. I personally believe that the main reason behind this kind of argument is nothing more than a hidden filthy protectionism formulated and propagated by the more organized producers to the detriment of the non-organized consumers and society trapped in the collective action problem unable to further their interests.

The last point I want to make is that we cannot judge and evaluate the arguments in vacuum, when we want to assess the implications of particular policies we are supposed to look at the alternatives we have at hand. There seems to be two alternatives for having trade with countries with looser standards, first having no trade with them and sanctioning their products, second having limited trade imposing higher tariffs and quotas on their product. I think both of these arguments are doomed to fail. Why? The first one is quite obvious, it will end up in huge losses in the forgone gains of trade and both parties to the trade will lose. The second one will result in a huge deadweight loss arising from the restrictions on the trade. Though less detrimental than the first one, it will bring more restrictive measures to the trade in favor of the organized interest groups which will endure even after the change in circumstances. After an institution is established, it will be very hard to unravel it. On the other hand, this institution will generate public officials and bureaucrats seeking their interest to the detriment of the society as a whole.
So it seems appropriate to ask whether a free trade with emerging markets even with looser human rights, environmental or labor standards will result in the race to the bottom or race to efficiency.

Hawkin's Round Trip Fallacy

2011-05-17T08:47:00.002+02:00

Mr. Hawkin knows very well how to play (maybe he does not really play). Once he wrote there is a God and Millions of copies of his book were sold, now he claims on the contrary but confusing no evidence of Heavens/God with evidence of no heavens again. A big round trip fallacy which seems to be very delightful for many, and once again will turn him into another bestseller. Once I have read this quotation somewhere: "Without education we are in a horrible and deadly danger of taking educated people seriously" and as time passes, I realize it is the most plausible justification for getting educated.

Regulatory Paternalism and its Unanticipated Consequences

2011-05-07T11:14:00.001+02:00

One of the ironies of the modern word is the unwanted and unanticipated (who knows?) consequences of the regulatory intervention in economic activities. One of these consequences is in the securities regulation in which regulators had hard times regulating recently. Regulators are supposed to protect investors and one of the mechanisms of investor protection is the disclosure requirements in public offerings. They think that the disclosure of information will protect the investors while many unsophisticated individual investors cannot make heads or tails of the disclosed information. I do not like to focus on this issue, what I would like to discuss is the problems arising from the paternalistic approach of the regulators. As I said, this disclosure requirement is limited to public offering while laws and Regulations made some exceptions to this general requirement and one of those exceptions is the private placement.

As defined in the famous case of 1953 SEC v. Ralston Purina Co. "a transaction not involving a public offering" is "an offering to those who are shown to be able to fend for themselves." Who is able to fend for himself, SEC Rule 501 (a) defines such a person as an "accredited investor". Accredited investor is any "natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of his purchase exceeds $1,000,000”; any “natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year”; plus executive officers and directors of the issuers.

There are some other details into which there is no need to enter. The hedge funds and private equity funds are among those issuers of securities taking advantage of the above mentioned provisions who can sell securities to accredited investors. Having a quick look at the hedge funds returns and a quick comparison of their overall returns to S&P 500 and other indices returns reveal that hedge funds either in times of economic prosperity or in times of turmoil earns much more and lose much less than other indices. It means that both in upturns and downturns they outperform the market. Thanks to the SEC/securities regulation which does not restrict the hedge funds and some other private equity funds' strategies while doing so for other financial institutions. Taking advantage of this laxity in regulation for hedge funds and more stringent regulation for other financial institutions, hedge funds are able to have better risk management strategies because a wide variety of the financial strategies, especially short selling mechanism, at their disposal, .

Anyhow, the hedge funds outperform the market with having a helping hand from regulators who create an economic rent for them. The irony is that only the so called "accredited investors" can invest in these funds and general public are banned from investing in them. It means that if you are poor, you cannot invest in them and have higher return on your equity, but if you are rich enough, you can do so and get increasingly richer than the poor in market upturns and in the market downturns lose lot less than the poor does.

Promoting Individual Responsibility by Social Mechanisms

2011-04-27T21:04:00.001+02:00

Let's start with an example. In the Netherlands, to use the public transportation, you should get a card/ticket, called OV chipcard, that is basically a rechargeable/reloadable card that one can reload it whenever s/he wants to use the public transportation, but how it works. The mechanism is basically as follows: when you want to check in the public transportation, you should introduce your card to the automatic machines (screen gates), the machine automatically reduces 4.00 Euros from your card, when you want to check out, you should introduce your card again and based on the number of kilometers traveled, that machine reduces the proportionate number of Euros. If you forget to check out, your total 4.00 will be gone.
Compare this to Italy. In Italy, and especially in Bologna where there is no subway system, you have a host of deals in getting the tickets to get on the buses. Hourly, daily, three days, monthly and annual passes. When you check in, these passes should be validated once and will be valid till the end of the period printed on the ticket. If you have an hourly pass, you should swipe it into the machine; otherwise you just do nothing if you have already validated it. There is a random check by the public transportation (ATC) officers to see whether the passengers have the tickets or not. If you do not have the tickets, you will be fined, how much is the fine, at the time I were in Bologna, it was around 40 Euros. And the hourly ticket was 1 euro (it is now 1.50). The fine was calculated as the one time travel fare times 40. Anyway, given the enforcement of this law by the ATC officers, if you multiply the probability of being caught by the inspectors by the amount of fine, it economically makes sense not to buy the ticket, get a free ride and be fined for violating the law, overall you would have paid less, if you wanted to get a free ride.
This is a law which is inherently self-defeating and encourages its own violation. One can see how one law encourages people to be alert and punishes the forgetfulness and absentmindedness and the other encourages irresponsibility and violation of the laws, though there might be some justifications for having these kinds of laws in place, the downside is drastically dangerous, spreading the irresponsibility in the society. These are small (micro) distinctions which make big (macro) differences in the long run.

The Interesting World of Finance

2011-04-25T21:29:00.003+02:00

The world of finance amazes me all the time. I cannot help thinking about a saying of a friend of mine who once said that he could not understand why someone buys and someone else sells the same stocks at the same moment, think of it, the transaction happens at the same point in time. Needless to say, this transaction does not arise from a need to exchange goods or services, the parties just exchange financial assets. This is one of the most interesting phenomena I have ever seen in my life. This I cannot understand either. Information asymmetry, different technical and fundamental analyses, different expectations … Now, the thing that amazes me more is the mechanism by which speculators speculate on credit default swaps …

Petitio Principii in Economic Analysis

2011-03-08T22:19:00.000+01:00

The current trend in the economic analysis is to analyze almost everything through the lens of economists. Today while attending the class (and when the class got so much boring that no one cannot resist dreaming), I was thinking much about the economic analysis and its foundations. Maybe it is mostly because I have started to read a book titled The Foundations of Economic Method: A Popperian Perspective. It is a very thought-provoking book. It starts with the point that why methodology does not matter in the mainstream in economics viewpoints. It provides some insight about the issues which is worth reading. As a PhD student, I was expected to have methodology based courses in the EDLE, but unfortunately except one, we did not receive any. Thanks to Prof. Parisi who turned the class of Economic Analysis of Law into a class similar to how to think like an economist about law and how to build models in Law & Economics.
Anyway, I was talking about the importance of economic method. In the modern mainstream economics, which is mostly based on the neoclassical economics (enshrined with lots of insights from game theory and behavioral economics), what matters is the economic value and utility. Roughly speaking everything enters into the utility function in the economic analysis. Needless to say, in order for something to be included in the utility function, it should be quantifiable and for economists monetized. But in addition to many critics of the economic method about non-quantifiability and et cetera, et cetera, there seems to be a fundamental flaw in this kind of reasoning. And that is the extreme reliance of economists on the revealed preferences while studying the utility functions and the value that the individuals attach to the phenomena.
Since the whole idea of at least normative (and at most positive) economics revolves around the pivotal word "incentive", and what makes people to be incentivized to do something or to avoid doing that, is the utility they derive from their economic activities. So the word utility and its definition should be scrutinized very carefully in economics.
It says that everything (i.e., incentives which is almost everything in economics) depends on the utility individuals derive from their choices/activities. The problem is that no one knows about individuals' utility. Just after the fact, on the basis of revealed preferences, the economists say that something which is done had more utility that something forgone, or the choice made is preferable to the choice forgone because it had more utility for the individual. The difference is mostly about the difference between ex-post and ex-ante. What we cannot do is reading the mind of economic men, so we are forced to assume that what people do, had more utility for them than something forgone.
In order to understand the fallacy, let's see what the fallacy of petitio principii is. The key issue in this fallacy, which is also known as the fallacy of "begging the question" is the assumptions made in the process of the argument (and economics is replete with the assumptions). In this fallacy, the asserted part in the conclusion is assumed in the very premises. In such a setting, the argument becomes circular because the same statement is used to prove itself.
In economics we say that the economic choices of people depend upon their utilities they derive from their choices. The same thing could be said about the economic value. When you value something over the other, it means that you are deriving more utility from that "something" over the other "something". So how can we know who values what more? The criterion as I said above is the revealed preference, when someone chooses something over the other, ex-post, it is said that she preferred/valued that thing over the other and hence she derives more utility from that than the thing forgone. So the fallacy lies behind the revealed preference. One can easily see the circularity in the definition of the utility/economic value. What is utility? Utility is something which measures level of satisfaction from an economic activity (including the usefulness of such an activity), what is satisfaction from the economic activity? The act that gives more utility to the actor and it is never known ex-ante.
Fortunately, economics cannot say ex-ante what should be preferred to what, because it is something quite subjective. Different individuals have different tastes and behave on the basis of their individual preferences and economics avoids making value judgment about those preferences. So the good news is that the economics is quite neutral about the preference, and after the preference made, it suggest how we can rationally get to the objective we have chosen. In fact, economics does not deal with the objectives; it just comes into play when we need instruments we are taking to get to those objectives. And the most important tool it uses is the rational behavior which itself is a quite controversial topic to ponder on. But I think this distinction in the concept of rationality cannot be limited just to the ways and methods we are using to get to our objective, but it necessarily spills-over the preferences of individuals too (an issue that will be addressed later) and that is what makes the utility and its definition more important.

Crime and Punishment: the Problem of Proportionality

2011-03-01T22:07:00.001+01:00

One of the main principles in criminal law is the proportionality of crime and punishment. Opening every criminal law textbook, one of the main topics which pops up immediately is this proportionality. But to the best of my knowledge there was no study of what really proportionality means. (Of course I am not a criminal law expert and my knowledge about that is quite limited). This proportionality could be studied from many different points of view. From psychology, philosophy, sociology, economics to mathematics!!! Which in my view of one the interesting views should be the psychological one.
Anyhow, to me it seems there is no universal criterion for this proportionality. If there was, the intensity of the punishment to the like crimes in different countries should be the same or at least alike. But it is not. This is an evidence of subjectivity of this proportionality. And it absolutely depends on the anchor points or reference points each society sets in his social norms and code of laws by historical accident or consciously. So it is not enough just to repeat and repeat and emphasize that the crime should be proportional to the punishment, it is also important to embark on the experimental, behavioral and empirical studies to show what these anchor points are.
The importance of this point becomes critical when we take proportionality into fairness and justice consideration. If so, for designing a fair or just or economically optimal criminal system, the perceptions of proportionality in that specific legal system should be studied to find a basis for criminalization. For instance, in some countries, like China, this anchor points are set very high for the economic crimes such as corruption, while in other countries these crimes are responded more gently. As an extreme example, same sex sexual relationships in some countries are not even a crime, while in others responded by capital punishment.
What is clear is the fact that the social norms, religions, ideologies and cultures play a substantial role in creating these reference points. Different historical incidents every society has gone though have significant impact on those points. What encouraged me (a non-expert in criminal studies) to write these few lines was the importance of building models for measuring this proportionality (which is totally context dependent) in different societies by designing experiments and having empirical research on the subject.

CENTRAL BANK INDEPENDENCE & MONETARY-FISCAL POLICY COORDINATION

2011-01-15T12:59:00.001+01:00

The debate over the independence of the central banks is a very deep rooted one and discussed from many legal, economic and political standpoints. In this short paper, I will discuss the issue in a game theoretic setting and using a simple model of game theory will argue for the independence of central banks (uncoordinated monetary and fiscal policy making) rather than having one authority or two authorities with coordinate policy making powers. The problem of the coordination of the monetary and fiscal policy is a question of constitutional law as well as a question of the economic policy making. The power over issuing money is the most critical instrument for having ones policies implemented and it is mostly assigned to the Independent Central Bankers. Since there are many structural and institutional links between Central Banks and Parliament and sometimes other government bodies, the independence does not mean isolation, what we speak about here, is a relative independence, as it is a common knowledge, in most countries the head of the Central Banks are appointed collaboratively by Parliaments and the Administration (Presidents), so no one can expect an absolute independence in an extremely interdependent political systems.
On the other hand, the power over taxation and expenditure is almost equally important and basically regulated by constitutions. Historical origins of constitutions show that the taxation played a prominent role in the emergence of the modern state and democracies. And hence, almost every modern constitution has a provision or provisions about the power to taxation.
Here, the question is whether there is any plausible justification for having independent central banks and having almost no coordination between parliaments (as fiscal policy makers) and central banks (as monetary policy makers) and what is the logic behind the prescription of the constitutions and laws on having two separate and almost independent policy makers for fiscal and monetary policy which seem to be pursuing one common goal. At first blush and intuitively, it seems that having one institution taking care of both monetary and fiscal policies is better than having two coordinate institutions and also it intuitively seems plausible that the coordinate institutions are preferred to uncoordinated ones. In order to deal with this problem we should first delve deeply into the incentive systems that they might have and study the incentives of both monetary policy-making and fiscal policy making institutions.

Incentives of Fiscal and Monetary Policy Making Authorities
Each of these two institutions might have different incentives and the incentives are basically dependent upon many factors among which the institutional design is of critical importance. On the other hand, their incentives are also dependent upon the effects of the policy instruments of these two institutions which I will categorize those policies into two general categories of expansionary and contractionary policies.
Institutionally and somewhat traditionally, Central Banks are in charge of the stability of the economy by controlling inflation rate and accordingly, many central bankers think that they should control inflation rate before dealing with many other policy objectives. Controlling price stability is not as easy as it appears. There are lots of complexities involved and it requires playing many different games in many different manipulated contexts. For example, when they try to beat the inflation with increasing interest rate by manipulating the policy instruments they have at their disposal, there will be concerns about unemployment and in turn if they want to have the expansionary policies to beat the unemployment there will be other problems, since fiscal expansion will increase the real interest rates, rising interest rates will make capital accumulation for the businesses extremely hard and hence slowing the growth of the aggregate supply, when the central bankers want to beat the inflation by increasing interest rate, they will found themselves under pressure of diminishing growth. On the other hand, monetary expansion has the effect of decreasing the interest rates and hence easing capital formation and increasing aggregate supply but the cost is higher inflation, something that central bankers do not like at all. Though there are lots of complexities in pursuing one or more policies, for the sake of simplicity, we assume that Central Banks can achieve their targets by instruments they are legally and institutionally conferred.
In addition to these formal incentives and objectives these institutions have, there are other incentives which might be helpful in analyzing the behavior of the two institutions. For example, parliament and administration who are mutually in charge of the fiscal policy making are both elected bodies of the government and they tend to be mostly in favor of short sighted popular policies and hence pursue expansionary policies, but expansionary policies also lead to huge budget deficits, and one of the key concerns about the government budget deficit comes into play when we want to consider the impact of savings on economic growth. Since savings will result in capital formation and capital formation in growth, government's huge borrowing may have a crowd out effect on the private firms' borrowings, because large government borrowing will deplete the borrowing resources for the private firms and in the long run will inhibit economic growth. Now, we might be able to see why dealing with the budget deficit is not as easy as it seems.
On the contrary, the Central Bankers with their longer tenure, are assumed to be in charge of long term economic policies (mostly because of the fact that the tenure of the chairmen of the central banks outlive the tenure of the office of the elected bodies of the government) and their first concerns by law or in fact is dealing with inflation and having a price stability. This might explain why the Central Bankers prefer the contractionary policies and because the administration and the parliaments are elected bodies, they prefer the expansionary policies to deal with at least problems that they face today and to pass the burden of the problems to the next generation of law makers and hence increasingly increasing the budget deficit through time.
Furthermore, nevertheless they have different objective and opinions about the state of the economy and also they have different views about the instruments that should be used to deal with the problems encountered in an economy, we assume both of these institutions making rational decision with respect to the status of the economy. What gives rise to a game theoretic setting in this context is not that one of these or both of these institutions might have perverse incentives, we assume that both of them are benign policy makers and do what they think to be beneficial for the economy. Otherwise, we could have a very complicated settings which should have broken down to many other games to be solved, so for the sake of simplicity we assume they are benign and their difference on policy issues is rooted in the fact that they have different opinions on dealing with the economic issues except the fact that the fiscal policies tend to be expansionary and monetary policies tend to be contractionary. In addition to the above mentioned complexities, there are externalities associated with every decision or policy that each of the players on the other player, this is exactly what gives rise to the game theoretic setting in this context.
The question firstly arises is why these two bodies should not be consolidated into one body so that we have a single body deciding on the fiscal and monetary policy? If the answer to the above question is no, we should think of the coordination between these two major policy makers of the nations. Why should not we have a single authority to decide about the coordination issues between Central bank which is in charge of the monetary policy and the parliament which is in charge of the fiscal policies?
In this simple model, among the possible mix of coordination, i.e., a single unified policy maker, uncoordinated policy makers, and coordinate policy making (leader follower arrangement), I choose two uncoordinated policy makers playing a simultaneous game and then an uncoordinated leader follower arrangement in which the two institutions will engage in a sequential game and will analyze the two situations to see if it fits well with the optimal total payoff which the society as a whole pursues from both monetary and fiscal policy. So, I will confine myself to the study of two uncoordinated policymakers which best fits with reality of the many legal and political systems with regard to the fiscal and monetary policy making.

The model: Designing the Game
In designing the game we should take into account at least three elements of the game i.e., players, strategies and the payoffs. For analytical ease we will simplify our game as much as possible so that by isolation and then adding other elements and considerations into our simple model we can develop a better and much complicated model.
Players are central Bankers (Assumed as the sole monetary policy makers) and Parliaments (as a single body considered as the fiscal policy maker, though the executive has a great deal of say in designing the budget and there are game played in drafting the budget between the administration and the parliament, for the ease of analysis, we just consider the parliament as the ultimate decision maker in this study.)
Strategies come from incentives. As partly discussed above, incentives of the central banks can be categorized as macroeconomic stabilization and controlling the inflation. Central banks are perceived to pursue long run economic objectives. On the other hand, the growth, having higher output and the unemployment are the two most important concerns of the fiscal policy makers who are perceived to pursue the short run economic objectives. So it seems plausible for central bankers to embark on the contractionary policies and for the parliaments to pursue expansionary policies. Therefore, I will group the strategies into two inclusive strategies: expansionary or contractionary fiscal or monetary policies. Although these strategies could be divided into its composing elements and make some other games within the larger game played by the central bankers and parliaments, for the sake of simplicity, we assume that the result of those sub-games will constitute expansionary or contractionary policies at large.
Timing: This game could be formulated both simultaneously and sequentially in which once parliament leads and Central Bank follows and once central bank leads and government follows. But in this short study first we will limit it to a simultaneous move, as it evident, simultaneity does not mean that the decisions are taken at the same time, but it also implies simultaneity when the other player is not aware of the other player's strategy. After analyzing the simultaneous game, we will turn to the sequential game and will study the case in which these two institutions of governments acting asynchronously and repeatedly.
Payoffs: In this game, which is a kind of prisoner's dilemma, we assume 4 is the best payoff and 1 is the worst for every player. And in the combination of the two outcomes, we assume that the expansion by the monetary policy and contraction by the fiscal policy is preferable for the both (3, 3) to the contraction of monetary policy and expansion of the fiscal policy (2, 2).

The above matrix illustrates the payoffs for both players trying both strategies. The best response from the monetary policy making authority to the expansionary policies from the fiscal policy maker, is to take contractionary measures and hence get 2 instead of one, and the best response of Central Bank to the contractionary policy of the parliament is to have a contractionary policy (4 is preferred to 1). On the other hand, the best response to the expansionary policy of central bank is to take the contractionary policy for the parliament and the best response to contractionary policy of the central bank is to take the expansionary policy. So the Nash equilibrium which is the intersection of Nash strategies is the pair (2, 2) which is not a Pareto optimal or is a bad equilibrium. Although in this step of analysis, it seems that the coordination of these two major economic policy makers might yield higher payoffs by moving from bad equilibrium to a good one (or Pareto Optimal equilibrium), we shall see that, if the game is played repeatedly, the good equilibrium could be achieved.

More on Timing & Repetition:
Let's have a more realistic approach to this setting, by realistic, I mean that, in reality almost always we have a sequential game played by the parliaments and the Central Bankers. It means that there is a leader follower arrangement in which first one player decides what to do and then the other having seen the other player's move, moves. In this context it gets more complicated to find out who gets to move first. In reality, we observe that the central bankers make their policies more frequently than the fiscal policy makers. Fiscal policy makers usually make their policies annually and the monetary policy makers do it almost every other week or monthly depending on the different legal frameworks, but generally they make their policies more frequently.
In this case, too, suppose that first the fiscal authority moves and decides how much to tax and spend. Making this decision, it is fully aware that the fed is watching them and will respond with a strategy which will maximize its payoffs, so as the above matrix shows parliament will anticipate that the response of the central bank will be contraction, so it will respond with expansion. The fiscal policy maker will predict that the Central bank will play contraction, whatever the parliament's decision is. So the parliament will decide to play expansion, so we will be in (a sub-optimal) Nash equilibrium again. The same line reasoning can be applied to the case that the central bank moves first and the parliament follows. In this case too, the central bank knows that the dominant strategy for the parliament is expansion and then responds with contraction and once again, we have the (sub-optimal) Nash equilibrium.
What will repetition contribute to this setting? In other words, what will happen if we have a repeated game in this setting, the assumption which best fits the reality, it means not only parliaments and central banks play a sequential game, but also they play a repeated game too. In this sense, as anticipated, the follower knows that his decision in the first period will affect the leader's decision in the second period and acting rationally, it will take it into account. So this repeated interaction should play an important role in giving a spontaneous order to the interaction between parliament and central bank so that in the long run they can achieve a Pareto optimum (3, 3) and reduce the losses arising from the difference between 2 (which was attained in a one shot game) and 3 attained in a repeated game. In fact having this kind of arrangement (uncoordinated fiscal and monetary policy making) is equal to creating a system of checks and balances in which the Central Banks can discipline the fiscal policy and also the Parliaments can exercise certain degrees of discipline on the Central Bankers. So this interaction in time and repetition will make the leader to make decisions and take actions more in tune with and taking into account the targets and the objectives of the follower. And in turn, it will cause the follower to do so as well. This spontaneous cooperation (and not coordination) will emerge because they are entering an almost never ending game, if the game were a game of finite repetition, one might argue that because game will be finished at some point, by backward induction, none of the players might not enter a cooperation because they know that the other player will be cheating in the last game and so every player might think that it might be screwed up, therefore, neither player has the incentive to enter that cooperation, but since both the players know that the game will be played infinitely and more importantly, if by any change there would be a disruption in the continuity, no players know the period in which the game might be disrupted, they will end up playing cooperatively, and will move from the sub-optimal equilibrium to the optimal one.
The other objection might be that, because generally the tenure of the members of the parliaments ends after around 4 years, because of the lame duck effect that these limitations over the tenure might cause for the members of the parliament, we should expect a disruption in the repetition of the game, but this objection misses another important point and that is it ignores the fact that the members of the parliament have the incentive to be reelected, and this reelection which in almost most countries, is infinite. So, the incentive to be reelected as a member of parliament infinitely, can guarantee an infinity to the game played by both monetary and fiscal authorities and hence the cooperation and achieving a Pareto-optimum equilibrium. On the contrary, the limitation on the participation in consecutive elections to be elected to be a president might cause the lame duck effect, so one might guess why constitutions did not granted the fiscal policy making to presidents (executive power) instead of parliaments. Although this problem might be mitigated in countries with small number of established parties competing with each other over taking over the government.
All in all, quite contrary to the intuition, it seems that the uncoordinated fiscal and monetary policy making may yield higher payoffs and result in an optimal equilibrium than the coordinated one which might impose the one political or economic ideology over a system which if turns out to be false, might have catastrophic effects on the economy. These higher payoffs will emerge from the repetition of the games played by the fiscal and monetary policy making authorities under specific circumstances and having particular infrastructures such as the free and repeated and fair elections and established political parties.

Market for Stolen Bikes

2010-11-08T19:23:00.003+01:00

Theoretical Speculations
In Bologna many people do not buy the new bikes, instead they tend to buy the old and stolen ones and almost no one cares whether it is stolen or not, i.e., it is not considered morally bad to buy a stolen bike at least among the students. It seems that the reason is the prominence of the bike theft in Bologna. In such a context with a high probability of one's bike being stolen, in making a decision for buying a bike, as the presumption of rationality suggests, nobody should buy a new one. Two other strategies left are either to buy an old non-stolen bike which is supposedly more expensive or to buy a stolen old bike. Since no one can track a stolen bike (there is no numbering or identity card (registry) or any other electronic tracking device for them) and also the buyer runs the risk of getting his bike stolen, s/he will prefer the stolen bike which is supposedly cheaper (at a discount, let's call it the theft discount).
This seems to be working very well and everyone is happy, though those who attach some sensational values to their bike certainly are not. Why is it so? First: It does not cost a small fortune for the buyer to buy the bike and since the buyer did not pay much for the bike, s/he is not regretting the bike getting stolen. The thieves are taking the role of the brokers, and they are bearing the risk of being caught by the police and hence are getting compensated for bearing the risk with getting the whole price of the stolen bike. So the thief is happy too, because he is getting a brokerage fee and living a life on that. In this way, it seems that in the absence of state enforcement of property rights or let's say its weak enforcement, people are getting around and reaching (for now) an efficient outcome. Thought deciding whether the situation is efficient or not requires more investigation.
The problem with this analysis is that the original buyers are the real losers and no one will buy a new bike. So, if we can generalize this non-enforcement of property laws, the bike making factories will go bankrupt. But it seems there is a counter argument to this too. Since the bikes will be worn out with the passage of time, and they will not be usable anymore, there will be new demand for the new bikes, even at the higher prices. But still there is hold-out problem, not anyone will be the first mover to buy the new one because of a huge first-mover disadvantage, i.e., because if he buys it at a higher price, he will run the risk of losing a fortune. This seems to be a dead-end to the this speculation, but still there are people who value the new bikes more and they might prefer having a new bike despite knowing that it might be stolen. In addition, the hold-out problem will contribute to decreasing the price of the new bikes down (it will decrease the demand for the new bikes). There is another concern with that and it is a very well-known problem called "Race to the bottom". Since the bike factories will come across the shortage in demand, they will produce low quality bikes so they can survive. Therefore, one of the biggest problems is the decreasing quality of the bikes produced by the bike factories.
Besides, it might also be said that the buyers of the stolen bikes are free-riders, because they do not have to pay the full cost of bike which is paid by the original buyer, but given that the buyer of a stolen bike runs the risk of his bike being stolen, s/he should not be taken as the free rider, s/he just gets the bike at a discount for the risk of being stolen., or to put it in another words, s/he probabilistically pays for that.
I am also told that if your bike is stolen, the victim can go to the police and by showing his or her bike to the police, request the removal of the lock and the return of the bike to the original owner, the police will break the lock and give the bike to the owner. This, which I am not sure of its credibility, sounds very stupid; the problem with this solution is that when one goes to the police, how can the police verify his statement about the ownership of the bikes? Without traceability and registry system, it is quite stupid to go for such a solution.
One might say that there will be asymmetric information and adverse selection problem between the thieves and the buyers of stolen bikes. Certainly there will be such a problem and this will cause inefficiencies in the market for stolen bikes. This asymmetric information will create a situation in which the thieves should either issue an insurance policy for the stolen bikes or issue a warranty for them while selling them or sell them with a discount. Since there will be no enforcement for such an insurance, no one will buy that insurance. Hence there remains the possibility of discount and in fact, the thieves are actually selling the bikes with a huge discount. This huge discount causes another acute problem.
Say the police wants to increase the bike theft enforcement to a full enforcement so that there will be no theft or next to zero theft. In this case, this level of enforcement will affect the discount rate in selling the stolen bikes, that is, this high level of enforcement will increase the discount rate. The increase in the discount rate in turn will affect the enforcement of the property rights with regard to the bikes, how? With increasing discount rate, the prices of the bikes will reach to a very low level that the very enforcement will be inefficient. It means that this level of discount will wipe out the efficiency of the enforcement. Though this enforcement level might reach to a point in which the very theft might be inefficient too. By a strict enforcement, the police can eliminate the market for stolen bikes, and the thieves seeing this will not steal the bikes at all, but it might be inefficient to do so.
The question is that if we can model this phenomenon as a game or design an experiment in a game theory setting for this phenomenon, which set of payoffs, will be the Nash equilibrium? Is this move from an enforcement based property rights to a so to speak market based property rights free of enforcement an optimal Pareto-efficient outcome? Is there any concern with regard to the justice and fairness in this example? What other consequences this model might have?

The Experiment Design
There are two hypotheses in response to the question of “What causes the bike to be stolen more in a city like Bologna and less in other cities?”:
1. First hypothesis is the law enforcement is less with regard to the property rights in bikes in Bologna than other places.
2. Second hypothesis is that there exists a positive relationship between drug addiction and the number of stolen bikes.
So, beside those theoretical concerns about the bike theft, what I am going to do in this short draft of a proposal are two things. First we will see if there is any relationship between non-enforcement of property rights about the bikes as the independent variable and the rate of the stolen bikes as dependent variable and second since there are some speculations about the drug addiction and its rate on the rate of bike theft, we shall by experiment see if there is a relationship between drug addiction as an independent variable and the stolen bikes rate as dependent one. This could be done either within the experiment while selecting the subjects heterogeneously, i.e., the drug addicts and the drug-clear subjects or by choosing a completely homogeneous group of drug addicts and designing a new experiment for that purpose.
To design the experiment and in order to be able to measure the differences that might arise from the different experiments done, it seems we should divide our sample groups into two groups, i.e., the experimental group and the control group. Control group is the group which is not exposed to the independent variables, instead, the experimental group is the group who is under the experimental variables and we expose them to the independent variables. So first we should develop an experiment with zero level of enforcement and then by changing the level of property rights enforcement (civil and criminal sanctions) measure the response of the behavior of the thieves to the level of change in the stolen bikes.
To do that we shall first see what are the constituent parts of the behavior in this setting and what affects the behavior of the subjects. Intuitively, it seems that the followings are contributing to the behavior of the subjects.
1. The level of enforcement which can be manipulated by, for example, a. installing the surveillance cameras in the areas in which the bike racks are located. b. making bikes traceable through numbering or special registration or c. making people sensitive about it which will have the force of a social enforcement and peer pressure or to put it differently, making the social enforcement more stringent through which making the secondary market for the stolen bikes illiquid. This illiquidity problem may have an extraordinary effect in the incentives of the individual thieves. This can be done, by issuing a certificate for every bike, in the experiment and then banning the people from getting the bikes without the certificate. After each step, the re/actions of the subject should be subtly recorded.
2. The price gap between new bikes and stolen bikes. This price gap, which is huge in reality, can incentivize the thieves to get more involved in the theft of bikes. In our experiment, by filling this gap or widening the gap, one can manipulate the incentives of the thieves to steal a bike or not.
3. There might be a host of other variables contributing to the theft behavior which can be measured while selecting the individuals as the experimental or control group. Though not exhaustive, the characteristics which might contribute to the theft behavior are as follows: economic status (occupation and earning power), drug addiction, parents’ occupation, the size of family, religious affiliations, schooling and education, and a host of other characterizes.
To do the experiment, the following procedures should be followed:
There should be a number of subjects representing the social mosaic of the society in question, to do so; we shall take two steps, first steps is to decide to select the subjects either randomly, or from a pool of people knowing their social standing. In this stage, it seems randomization can work better, it should be stated that in the process of recruiting the subjects the public announcement should not be used, because it might generate biases, like self-selection bias. That is mostly because if we use public announcement for recruiting which is supposedly paid for the experiment, it will urge relatively poor people enter into the experiment. In order to check to see if there exists any relationship between certain characteristics of the subjects with the level of the bike theft, we may use a questionnaire to check their backgrounds and have access to their background information. Though this may blur finding the causality relationship in our experiment, the best way is to select subjects randomly from a melting pot and preferably from different backgrounds and meticulously track their behavior the using a questionnaire check for their social standing and overall background.
Since one of the important elements in criminology is the probability of being caught and punished by the police/law enforcer, i.e., higher or lower level of being subject to the law enforcement, it will not be enough to make laws or rules in this context and publicly declare to all the subjects that the punishment for this crime is high, if the level of the punishment is high, but the level of the enforcement is low, the thieves who are rational decision makers, will calculate the expected utility of the crime, that is they will calculate the disutility of being caught by the police., in monetary or non-monetary terms and will compare it to the utility they will derive from stealing a bike by multiplying it to the disutility from the probability of being caught.
Repetition matters: repetition will matter, if the design of the experiment is game theoretic. As two examples, reputational effects and the credibility of threats can be included in this setting. If the police establishes a reputation of being tough, this will affect the behavior of the subjects in the next repetition. This can be said about the credibility of the threats imposed by the police to take tough action in dealing with the thieves. In this setting, the peer pressure will become increasingly important with the repetition of the game too. That is to say, by creating a belief that the theft is morally bad, or internalizing the belief in all subjects that the breaking the law is bad, there will be a peer pressure on the subjects who want to steal the bikes. While stealing there would be a sense of being demoralized and also fear of voluntarily report of the theft by the third parties/peers. By repetition, anonymity and non-anonymity of the subjects will matter, taking into account the fact that the theft might be considered immoral; we should design a setting to eliminate the effects of the peer pressure or anonymity to successfully measure the relationship of the law enforcement with the rate of theft.
The condition of the bikes might matter. The newer the bike, the market for that will be more liquid because the buyers can take more risk to get the bike even with higher level of law enforcement. In addition, the price of the accessories to take care of the bikes, such as locks might matter as well. Sometimes the price of locks surpasses the price of the bikes themselves, so bringing the utility of the older bikes lower to be bought in the market for stolen bikes.
To find the relationship between the drug addiction and the level of bike theft, changing the price of the drug as an independent variable could be very helpful. Since there are speculations that the price the thieves charge for a stolen bike is a function of the amount of the drug good for one time consumption, changing the price of the stolen bikes in the market might have a substantial effect on the incentives of the thieves who are drug addict. The questions that should be answered in the experiment with regard to the relationship of drug addiction and the bike theft are as follows: Will the change in the price of the drug affect the price of the stolen bikes? If the price of the drugs is much higher than the price of the bike, will it worth for the thief to steal the bike for buying some drug? This might be tested by changing the level of the price of the bikes too.

Is there any limit to innovation and Invention?

2009-05-25T05:09:00.000+02:00

“Suppose that to make a finished good, 20 different parts have to be attached to a frame, one at a time. A worker could proceed in numerical order, attaching part one first, then part two…. Or the worker could proceed in some other order, starting with part 10, then adding part seven…. With 20 parts, …there are [more] different sequences … than the total number of seconds that have elapsed since the big bang created the universe, so we can be confident than in all activities, only a very small fraction of the possible sequences have ever been tried.”

Paul Romer, “Ideas and Things”, in The Future Surveyed, supplement to The Economist, September 11, 1993, pp. 71-72,

Economics of Regionalism in Megalopolis

2009-05-18T15:43:00.000+02:00

ECONOMICS OF REGIONALISM IN MEGALOPOLIS
HOSSEIN NABILOU
May 2009

Abstract
By applying the economic theories to the legal scholarship, contemporary legal studies have undergone a radical change since the advent of such an approach especially in the United States legal academies. One of the most critical arenas that the economic analysis of law is concerned with is the issues subject to study in the local government law and urban studies. One of the biggest concerns in this field is the problem of the “size”. Concepts like zoning, incorporation, annexation, consolidation and regionalism are dominating issues in this branch of legal studies. The common element in all of these issues is undoubtedly the “size” which is effecting the local governments one way or another. On the other hand, the economists have dealt with the problem of size for a long time and they always tried to find a logical relationship between the efficiency of a firm and its size. The problem of size in Urban Studies and Local Government Law literature is merged into the dichotomy of localism and regionalism.
In this paper, my primary purpose is to explain the size of local governments by applying economic methods of thinking. In this regard, at first, after briefly introducing localism, I will try to show its economic inefficiencies. By emphasizing the inefficiencies of local approaches in solving regional problems in megalopolises, it will be argued that save having a regional approach, many unavoidable flaws will emerge. In this regard, I will try to show that the sources of economic inefficiencies in local approach to regional problems are multifold. First and foremost, these inefficiencies arise from the diseconomies of scale including costs of communication among municipalities, duplication of efforts and cannibalization in locally fragmented megalopolis. The other sources of inefficiencies are the tragedy of the commons and anticommons in the region, positive and negative externalities producing free riding, gentrification, environmental problems and sprawl. Last but not least, the problem of high transaction costs and hold-out problem for the municipalities to come together to contrive a solution for the regional problems will be discussed. Eventually, taking the socio-political concerns like problem of representation and paradox of voting, the sense of community and the like into account, I will argue in favor of the coexistent model of localism and regionalism, as an idea to minimize the economic inefficiencies arising from the purely local approach to regional problems in megalopolises.

Key Words: Regionalism, Localism, Megalopolis, Economic Efficiency

Introduction
One of the most critical flaws of many legal systems –especially in some parts of the world with a long history of civilization whose history of legal systems dates back to the advent of civilization and hence natural and divine law— is that it is not consistent with the facts and real world. Economics, among other academic fields is the best tool that can conciliate the relationship “between facts and norms”. Inherent nature of legal norms makes it stagnant and it needs the other disciplines to give it a hand to be dynamic and up to date. As Berolzheimer says “Economics and law considered as static phenomena are related as content and form; but both are subject to change—the one continuously, the other from time to time”. (Berolzheimer, 1968, pp. 22-23) This continuously changing nature of economics gives it a live spirit. By transplanting this spirit to law, the law can stay dynamic and live. This emerging interdisciplinary approach to law is the harbinger of change in the legal world, even if it should bravely face big questions of justice and efficiency. In this paper, I am to have an economic approach to local government law a field less touched by the economists.
Multilevel structure of the government has been one of the issues focused by many scholars from many different disciplines such as economics, law and politics. The political entity accepting such a multilayer government will engage in intricately increasing problems arising from the vertical and horizontal interdependencies of these governmental units. “Multilevelism” in the government tradition has its genesis in the historical facts and theories that believe that the separated power is less vulnerable to corruption, this belief which is adopted by many constitutional democracies all around the world, requires its logistics. Vertically, these logistics in the United States are provided by the federal, state and local governments.
Although American historical facts have enough evidential strength to justify these divisions, emerging regions, metropolises and megalopolises in the United States may require the “change” in American local government structure. Studying megalopolitan America, it seems that the factual requirements for the change are met and economists and local government scholars are trying to complete the theoretical side. Megalopolises in the United States urban areas with large population have trespassed the municipal boundaries and have grown in a pace that the traditionally known conservative and static nature of law and politics could not keep pace with them. Despite the quantitatively large number of the proponent of the regionalism especially in the metropolitan areas, thus far, their efforts to create a fully fledged regional government were in vain even in the presence of acute and continuing regional problems.
It should be noted that there are many issues in the law and economics of local governments that will remain untouched here because of the limits of the space. Methodologically, after having a brief introduction to the two fundamental concepts of localism and regionalism, I will start with the economic criticism of localism. In doing so, I will mention flaws in localism such as diseconomies of scale, the problem of the commons and anticommons in the region, local taxation and its consequences, transaction costs and hold-out problem in dealing with the regional issues. I will study them as the factors paving the way for regionalism. This means that the economic criticism of localism provides justifications for regionalism. I will end with the legal and democratic concerns about regionalism and argue for a coexistent model of localism and regionalism in the metropolitan areas.

Localism vs. Regionalism: A matter of Definition
Localism
History
Local governments have their genesis in the long history of civilization and the rules of governance in large scale empires. As historians demonstrate; Cyrus the Great the Emperor of Persian Empire had appointed the local officials for governing every region within the Empire. As Herodotus points out after conquering Lydia, Cyrus decided to appoint the ex-king of Lydia, Croesus, as the governor of Lydia within the Persian Empire. Thereafter, Darius, the Persian king, did the same and appointed the local officials for the administration of the then Persian territories which at that time were constituted from about 20 provinces called “satrapies”. (Farr, 1850, p. 152)
As the history of the Middle East shows, every empire who conquered a vast territory appointed the local governors for the administration of those occupied territories. And this became a tradition in governance at least in the Middle East and the Minor Asia. For instance, when Alexander the Great conquered Persia, he took advantage of such a policy. The great conquerors like Teymour Khan and Chingis Khan continued that policy partly because of the expertise problem and partly the common sense and intuitively known idea of the diseconomies of scale which would have frustrating effects on their territories and their strength of traditional sovereignty. This continued tradition had its special advantages and economic justifications for those emperors. Although many of the ancient empires officially claimed that they had a universal sovereignty (Van Creveld, 2002, p. 48), save the king Canute, it seems they were well aware of the limits of their sovereignty.
As scholars of the history of the state hinted, “the problems of time and distance as well as the limits of the information at their disposal, many emperors preferred to deal with entire communities – tribes, chiefdoms, villages, cities, even client-kings – rather than with individuals”. (Van Creveld, 2002, p. 48) This fact shows that almost from the advent of urban life and civilization, some limits have been imposed by factual economic facts like transaction costs for even the greatest empires in the world. Add to the scope of the country the problems arising from the lack of means of communication that the industrial revolution afterwards brought for the states. These limits imposed multilevel or multilayer system of governance even to those ancient empires.
The above historical examples show the very existence, though seminal, of local governments. With the gradual evolution of urban life, consciously or unconsciously, some other concepts came into existence; the concepts similar to annexation and incorporation in the history of urban life reflects the fact that the problem of size was one of the big concerns of the social scientists, economists and legal scholars. One of the best examples, which caused many problems very similar to ours today, was the city of Baghdad at the time of Abbasid Caliphate. At that time, the city of Baghdad had a position in the world comparable to world cities of today. Ibn-e-Khaldun describes the City of Baghdad as follows:
“[T]he town will extend farther and farther. Eventually, the layout of the town will cover a wide area, and the town will extend so far and wide as to be almost beyond measurement. This happened in Baghdad and similar cities. Baghdad included over forty of the adjacent neighboring towns and cities. It was not just one town surrounded by one wall. Its population was much too large for that, the same was the case with al-Qayrawan, Cordoba, and al-Mahdiyah in Islamic times. It is the case with . . . Cairo at this time, so we are told.” (Badi, 1988, p. 86)
This discussion of the growth of large cities such as Baghdad is similar in essence to what is referred today as the process of suburbanization, a phenomenon that in turn causes sprawl and the need for regional governments.

Definition
Although defining the phenomena in social sciences that are mixes of descriptive and normative issues sounds very difficult and in some instances impossible, in order to be clear enough and as a point of departure, it is better to start with the definition, although it might be something that is not inclusive and exclusive enough. Undoubtedly one of the best definitions of localism is given by Prof. Briffault, though we accept it here. He goes on defining localism as follows:
“a belief that land-use regulation, schools and tax policy ought to be controlled locally, with the interests of local residents as the exclusive desideratum of local decision makers. Localism reifies local borders, using invisible municipal boundary lines to delimit the range of local concern and the proper subjects of local compassion and treating the creation and maintenance of local borders as a basic right. Localism translates questions about the proper structure of government and the proper relationship between different levels of government (and between different governments at the same level) into a language of rights…Local borders, once created, reinforce local identification, become a focus of sentiment and symbolism and create a powerful legal bulwark for the preservation of local interests. Localism provides a normative basis for excluding regionally necessary but locally undesirable facilities and for treating problems that originate outside local borders as unworthy of local concern or the expenditure of local resources.” (Briffault, 1990b, pp. 445-46)
In his article about localism, he goes farther on Local government and associates it with the individual autonomy. In his view, the role of the local policy making in schooling, home and family leads to the tight connection between localism and western individualism and individual autonomy. Talking about localism, Prof. Briffault uses the language of rights, he emphasizes that much of the local rights are tightly related to right to privacy and immunity rights from the government intervention. (Briffault, 1990b, pp. 445-46)
Despite such an ardent defense of localism and its theoretical importance in protecting individual rights and especially negative liberties of the citizens, there is a long established constitutional tradition that gives less weight to localism than it may deserve. American constitutional law considers local governments just as state-subdivisions and do not recognize it as independent components of the body politic as a whole. (Ford, 1996-97, p. 1382) Although the political forces through history have greatly affected the creation of local governments, it seems that the strong economic incentives were the most important factors in the creation of local governments at least in the United States. Resource allocation within each state which is tightly related to land use is one of the areas that can prove our idea. On the other hand, one of the biggest problems in the local government law is the problem of size and boundaries. Taken one locality into account, localism and its aftermaths create both “citizens” and “non-citizens” at the same time. (Schragger, 2001, p. 373) This struggle over natural, financial and “local” resources created the local government as well as the political, cultural and social concerns related to it.

Justifications
At first blush, it seems that there are two major advocacies of localism arising from two different sources:
1. The Political and Legal Theory of Localism advocates localism because of the beliefs that:
a. Localism can lead to local autonomy and brings about bigger chances for the people in the maximization of the citizen participation and regulation of their public life, more generally self-determination which can be achieved with more ease through the smaller governments rather than the bigger ones. Because these small size governments bring the government much closer to the voters and consequently more accountable to them.
b. It is said that the localism makes democracy palpable for the general public and since their votes are counted locally, every citizen may have a voice in the election. This can be an incentive to have a higher participation or turnout in local elections.
c. The third argument for the local government arises from the plurality of the local government and the horizontal distribution of power among them. Supporters of localism argue that the very existence of the localities potentially protects the minority subgroups from the tyranny of the majority. In addition, local governments are “significant arbiter of the subgroup relations” because at the local level “subgroups have greater control over the composition of “their” jurisdiction”. (Ford, 1996-97, pp. 1367-68)
1. Many of the adherents of localism argue that smaller governments provide a better context in which the citizens can have a better sense of community. Some of these proponents go farther and argue that the constitutional and legal rights should be context sensitive. These advocates of localism believe in a broader decentralized constitutionalism. They argue that the courts should respect the “geographical variations of constitutional requirements in the aid of community”. (Rosen, 1999, pp. 1130-39 & Kymlicka, 1989, pp. 206-16)
2. The Economic Theory of Localism claims that:
a. The existence of large number of local governments who are much more familiar with the needs of the special communities and certain localities, with the amount of services and consumption which is usually limited to their own jurisdiction increases the economic efficiency in the provision of public goods and certain utilities. (Briffault, 1990a, p. 5) The question here is how it increases the economic efficiency. We should find the answer in the differences in preferences and cost differentials in the locally needed public goods. Taking this into account, it appears that the efficient level of output in local public goods seems to be variable in the local jurisdictions and governments are likely provide the better allocation of local services in a decentralized structure. (Oates, 1999, pp. 1121-22, see also Oates, 1972)
b. Other economic adherents of localism argue that the very existence of the localities brings about plurality of localities and extend the opportunities of the citizens to move into better localities which provide the better allocation of services and taxes and eventually serves the economic efficiency. (Cashin, 2001, pp. 753-54) Tiebout was the first theorist who elaborated the idea of the “voting with the feet”. (Tiebout, 1956) However, it seems that he took some related issues which adversely affect the outcome of the theory such as tremendous migration costs, externalities and asymmetric information as granted.

Regionalism
Definition
The first and foremost defense of the localism can be found in the works of Charles Tiebout who was an ardent advocate of localism and the notion of “Consumer-Voter”. In his view, the diversity and the high quantity of local government will cause the diversity and a vast scope of the citizens’ choices. If citizen’s are not content with the services provided by a given local government, she can move and choose another local government jurisdiction that can provide better services to live in. Tiebout’s theorem has some flaws and undoubtedly is not a Pareto optimum. In this case, the consumer voter will engage in the exorbitant transaction costs that will affect the optimality of the theorem. This theorem also generates inefficiencies that are unavoidable and can be removed by large scale regional action. Counter-arguments of Tiebout’s theorem are often raised focusing on the excessive fragmentation of a specific region. Some proponents of regionalism argue in favor of regionalism because of the appropriate redistribution of infrastructure and the costs of services that the regional government can do and the local one cannot.
Regionalists do not have a consensus on the policies how to realize the regionalism in the real world. Taking a “pattern of failure” in this realm into account (Weir, 2000, p. 127), they are now very cautious how to prepare and also define the regionalism to meet the criteria set forth by the constitutions and existing legal structure. They may not be the supporters of the revolutionary ideas set forth by Brooks about the session of the megalopolises and creating a new government for these regions anymore. Instead they are making the claims narrower, but these are the limits which the legal and political realities imposed on them and maybe this retreat does not have something to do with the merits of the arguments for the regionalism. Now as appears from the ideas of regionalists, there are at least three trends in regionalism which inspire three different notions of regionalism at least in practice:
1. Those who consider regionalism as an idea and are content with the proposals and cooperation of the municipalities and state governments for solving regional problems. These regionalists who surrendered to the legal and political constraints are minimalist in the claim in creating new institutions for regional governance.
2. Those who are in favor of creating some single purpose governments for regional governance of regional problems and sometimes are called “selective regionalists”.
3. Those who consider the regionalism as “creating a supra-municipal regional special district or “public authority” to address a region-wide need for an infrastructure-intensive service, such as transit, drainage, sewers and waste disposal”. (Reynolds, 2007, p. 486) The proponents of this trend in regionalism believe that so long as the selective regionalism exists, “the fundamental inequality and mal apportionment of metropolitan areas’ resources, services, and opportunities are likely to remain. (Reynolds, 2007, p. 487)
Elements
In order to deeply understand regionalism, we should have a close look at its elements. The idea of regionalism is supposed to have at least three elements:
1. The whole metropolitan area is a real socio-economic unit.
Studying this element we should take the whole metropolitan area as a unit and as a cultural, ecological, economical and sometimes political entity in which the residents of multiple municipalities constantly move back and forth into account. In this sense as David Rusk mentioned, “the real city is the total metropolitan Area”. (See: Rusk, 1995, cited form Frug, 2006, p. 395) In fact, the environmental and economical problems arising from living in a metropolitan area know no limits and often surpass the given municipalities’ political and urban boundaries. The conglomeration of population is the widespread and dominant form of settlement in the twentieth century United States. In some instances, the metropolitan areas and megalopolises represent the de facto identities between cities and states and in some particular instances form an entity far larger than the legal jurisdictions of the states and even it may result in an inter-state megalopolis, something emerging in the Northeast of the United States. However, these entities lack the legal personality and no metropolitan government or any other governmental institution in the United States formed for the administration of these megalopolises. Although there exist many single-purpose entities with a limited jurisdiction and often appointed administrators who are administrating special issues within these regions, but they often lack the jurisdiction and legal powers to think of comprehensive regional policies for these areas. The U.S federal and states’ constitutions lack the capacity to create some entities in between, i.e., between local governments and state governments and probably inter-states entities. Hence, this fact often results in the failure of the attempts to create metropolitan governments. The fact is that, at least in this respect, the legal norms could not keep pace with the changes in real world.
2. The necessity of regional policies instead of purely local ones
Taking the interrelation of the local municipalities with each other into account, it is really hard to think of some problems that are “purely” local. The problem of the externalities, be it positive or negative, exacerbates the situation. The very interrelation of the local communities, imposed by the fact that there exist no purely local issues in the megalopolises, is the result of contriving some mechanisms of dealing with the problem of externalities. These externalities result in phenomena for which the large amount of the efforts of the local government scholars have been exhausted, i.e., gentrification, sprawl, free riding and so and so. Since the possibility of finding “purely” local issues is next to nothing, then it does not sound wise to contrive purely local solutions for the problems in metropolitan areas or megalopolises. In fact, almost all of the problems in the megalopolis are intertwined in a way that dealing with one of them produces side-effects. Hence, the policies made for dealing with the problems with inter-municipal essence should have also inter-municipal essence too. The logical conclusion is the desire for the regional instead of (purely) local policies. This desire is reflected in the proposal by the regionalists concerning the economic development, tax, affordable housing, planning, education, finance, sewerage and so and so in given municipalities.
One of the strongest advocacies of regionalism is based on the fact of economic interdependence of the local governments and municipalities in a metropolitan area. Proponents of regionalism argue that the economic prosperity of the metropolitan area can only be achieved by having a strong central city with a comprehensive legal jurisdiction on the whole region which its policies for the regional problems can best serve the whole region or metropolitan area and reduce economic inequalities and redistribute the wealth in the region. This idea is predicated on the notion that the healthier and wealthier municipalities in the region should support the other areas. Some regionalists emphasize that those who are affected by the decisions of local governments which have impacts on the whole region should have a voice at least in the elections of that municipality. Because, it is almost impossible that the people adversely affected by the policies of the one municipality have a voice in political issues of other municipalities in the present local government context, they argue in favor of the regional solution to this problem. In the regions that can be considered as an entity –slightly unified socio-economic entity—this arguments seem sound. By transferring the local powers to the regional entities, these kinds of negative features of the local governments may disappear (Reynolds, 2007, p. 490-94). All in all, the democratic theory which once was in favor of the local governments, this time is going to be reversed and taking the whole region into account, will provide strong incentives and arguments for regionalism.
3. The desire for new mechanisms for regionalism for formulation and implementation of regional policies
As mentioned above many proposals concerning a fully-fledged regional government has been failed and thus far, no fully-fledged regional government exists in the Unites States. In fact, this failure caused regionalists to think of the limited purpose governments as the preeminent solution, but in fact these governments failed too. These facts propelled the regionalists and policy makers to think of other mechanisms to create regional policies and solutions. Actually, in their opinion the policy making for the region does not require the regional institutions which their creation will make the heavy bureaucracy and the high costs of communication of the U.S heavier and higher. In this respect, they found the solution in accepting the legal status quo. In this context, in addition to NGOs, the proposals for solving the regional problems may originate the existing local government, state governments or the federal governments. (Briffault, 2000, p. 6)

Economic Criticism of Localism: A Move toward Regionalism
In this section, I will try to briefly elaborate an economic analysis of localism and provide a basis and economic justification for regional governments in the metropolitan areas. This economic analysis will cover the diseconomies of scale, problems arising from the commons in the region, taxation, and its consequences like free riding, vote buying, gentrification, sprawl and transaction costs. Although there exist many other issues worthy of mentioning, the limits of place do not let me to do so here.
The first and foremost economic justification for regionalism can be found in the potential interlocal conflicts between the different localities with different interests. These interlocal conflicts arise from the fact that:
1. Municipalities like rational individuals are associated with the profit maximization and cost minimization characteristics,
2. Absence any regional government, municipalities like rational individuals are economically risk adverse and want to pass the bucks to other municipalities in regional issues.
3. Legal norms and rules cannot keep pace with the natural and real ones
Local boundaries within a megalopolis or any metropolitan area automatically narrows the attention of the residents just to the local events and simultaneously makes them blind to the broader issues going on in the region and within the jurisdiction of other municipalities which directly and indirectly affects their lives. Once Local governments historically formed in the U.S., they are considered as the sole limited authority without any other de facto or de jure city or any considerable population in the environs. This idea was depicted by the vast amount of accessible and usable land for the Americans. The mind-set was that “the law had to fit the needs of big, open country, with faith in abundance, and with huge tracts of vacant land”. (Friedman, 1985, p. 412) Unfortunately, after considerable change in population size in the U.S. throughout two centuries, even now, localism is established on that faulty and outdated idea. The fact that every municipality is affected by the actions of other municipalities makes it clear that there should be something including policies, regulations or any other mechanism to deal with them. The fact that localism fragments the whole ecologically, economically and socially de facto region or metropolitan area, increases the economical hindrances and especially transaction costs between municipalities to a considerable degree.
The fact that the local governments in metropolitan areas cannot fully meet the economic efficiency, be it Pareto or Kaldor-Hicks, is virtually obvious; mostly because of the external or spillover effects of the decisions made by every individual local government. But one should be reminded that the efficiency model, as we shall see in the next sections, does not argue that the local governments should be abolished in favor of the regional government. Instead, it suggests the mix of localist and regionalist structures and policies. These mechanisms “can develop norms or guidelines for local decisions; review and veto local decisions that impose unacceptable costs on neighboring localities or on the region as whole, or at least provide a mechanism for obtaining the consent of and providing compensation to those who are adversely affected by local decisions; and provide poorer localities with a share of regional resources so that a broader range of localities will have the fiscal capacity to provide the services their residents want.” (Briffault, 2000, pp. 23-24)

Economies and Diseconomies of Scale and Regionalism
As Stigler puts; “The theory of the economies of scale is the theory of the relationship between the scale of use of a properly chosen combination of all productive services and the rate of output of the enterprise.” He also emphasizes; “in its broadest formulation this theory is a crucial element of the economic theory of social organization, for it underlies every question of market organization and the role (and locus) of governmental control over economic life.” (Stigler, 1958, p. 54) Strictly speaking, this theory briefly implies that “the greater the level of output, the lower the average cost of production”. (Cooter & Ulen, 2000, p. 31)
The two economic terms “economies and diseconomies of scale” with the original application in the industrial organizations and theories of the firm, have spilled over to other fields, especially urban studies. Many of the economists even at the outset of the economic theory have applied and taken the advantage of the economies and diseconomies of scale in the analysis of the economic phenomena, unconsciously or intuitively. For instance, Adam Smith in his famous book An Inquiry into the Nature and Causes of the Wealth of Nations gives an example of a big pin factory and its size aftermaths like specialization of labor in that factory and compares it with another pin factory that consists of just one laborer. (Smith, 1976, pp.18-20) This example given by Adam Smith gives us this intuition that the economies of scale arise from the bare fact that workers within a firm can be specialized in one field and needless to say that the specialization lets them to be more skillful on their assignments. There are other problems with this theory that might result in a quite converse phenomenon called “diseconomies of scale”. It is often said that the diseconomies of scale arise from the coordination problems which are the inherent characteristics of any large scale economies. At the lower levels of production, the increasing size of the firm results in the economies of scale because diseconomies of scale is not so cute yet, but in the higher levels of production, because the benefits of the economies of scale have already been achieved, the effects of diseconomies of scale become more acute and this effect will cause large firm not to grow too large. (Mankiw, 2006, pp. 274-75)
What makes economies of scale interesting for economists is that taking advantage of economies of scale will reduce the unit costs. There are at least two major reasons why growing large generally reduces per unit costs:
1. As stated above, economies taking advantage of use of mass production methods will result in the specialized use of labor and machines. This specialization of labor in turn will bring about the innovation and creativity in the labor capital and the creativity and innovation in specialized labor will generate cost-reducing techniques. This process means higher productivity of specialized labor originating from the economies of scale.
2. One of the characteristics of the large scale economies is the higher start-up and fixed costs, in these kinds of industries having small scale firms will cause diseconomies of scale because the higher fixed costs will adversely affect the price of the marginal unit and will result in the lower surplus both for producer and consumer. In these kinds of industries, once the means of production established, and the fixed costs consumed, the marginal costs will be very low. In this case, extending the firms scope will result in higher marginal benefit. (Gwartney et al., 2006, pp. 187-88)
3. Taking advantage of the Law of Large Numbers increases the predictability for a better planning for the region.
But taking the advantage of economies of scale continues to a point, beyond that point, the firms will run into diseconomies of scale. Some reasons for diseconomies of scale are as follows:
1. Bureaucratic inefficiencies which has its genesis in the rules and general orders in the management of large firms and will result in the inflexible rules and general orders,
2. Reduction in the innovation rate,
3. Cannibalization or competition among one’s own parts or products,
4. Principle-agent problem (agency costs),
5. The need for more levels of monitoring.

Although diseconomies of scale may appear with a high variance in different firms, but the general theory is that there is a point for the firms beyond which diseconomies of scale will outweigh the economies of scale. In economic terms, beyond that output level the long-run average total costs will rise and stifle the economies of scale. (Gwartney et al., 2006, pp. 187-88)
According this theory, there exist a maximum and minimum efficient size for the firm, the firms below the minimum efficient size usually have higher per unit costs and the firms larger than that sufficient size cannot earn as much as desirable. Taking advantage of economies of scale is one of the characteristics of the oligopolistic markets in which in the supply side, there are a few suppliers and they can meet the needs of the whole market. (Gwartney et al., 2006, pp. 241-42) Thinking of the economies of scale, it should also be noted that there are differences between the markets subject to study. Based on the industrial, agricultural and service economies, the ideal firm size may vary. The industrial economies tend to be larger, while the two others tend to be smaller.
The question is that how to apply the economic concepts of economies and diseconomies of scale to local government context and how to take advantage of them as one of the justifications of regionalism in metropolitan areas or megalopolises. The lost ring of this application is that, if there are economies of scale in the industry, “one” firm can produce any level of output in a lower cost than “many” firms and also the fact that public utilities tend to fall under the theory of economies of scale. (Cooter & Ulen, 2000, p. 31) In urban studies, economies of scale are often called agglomeration economies. History of urban studies shows that in the United States throughout the nineteenth century the annexation and enthusiasm for the large cities was dominant. This idea was inspired by the “booster spirit” and also by the idea that the large scale economies will bring about the advantages of the economies of scale. Hence, in this century a large number of annexations and consolidations of municipal governments happened that the underlying idea was the business and economic idea of economies of scale. As Jackson puts it, even sometime the supporters of efficiency in large scale cities used it as mask for their own desires for exploitation and controlling the whole region what he calls “the local or downtown brand of urban imperialism”. (Jackson, 1985, pp. 144-45) It seems obvious that the large scale businesses and mercantilist spirit prefer large scale markets and they are likely to support these large scale cities; in fact, in the annexation and consolidation context in the nineteen century they did what they should have done.
Needless to say, local governments do engage in many activities that have something to do with economics in one way or another. Strictly speaking, they are engaging in economic activities. Should local governments are to provide the residents with the public goods and services, they will engage in a lot of economic activities such as transactions and contracting. Thus, local governments too, can take the advantage of many aspects of the theory. For example, in a very small municipality, it will be inefficient to a municipality to provide the citizens with a sewerage system, power, waste disposal, if it wants to do it alone.
As seminal empirical studies showed local government covering small geographical area and population spent larger sums in comparison with their larger counterparts. (Shapiro, 1963, p. 176-77) The nature of the services provided by the local government is very similar to the large firms in the high start-up and fixed costs. Once established they can provide more services to larger population with lower marginal costs. In 1940s Hansen and Perloff suggested “incorporated municipalities required a minimum of 10,000 persons for the efficient performance of modern municipal services” (Shapiro, 1963, pp. 176-77). In Sweden from 1950s till now, two municipal reforms have taken place. The first municipal reform in 1950 reduced the number of municipalities from 2498 to 1037 and the second reform in 1974 also reduced the number of municipalities to 278. The underlying idea behind these reforms was achieving economies of scale. The first reform wanted to generate municipalities no less that 2000-3500 inhabitants and the second reform has taken place in order to form municipalities no less than 8000 inhabitants. (Hanes, 2003, p. 3)

As stated above there is a correlation between the size and population of the local government and also the services that it should provide the residents with. The larger the municipality, the vaster the services that the local government should provide people with. This logical correlation may suggest the economies of scale in local governments. As Shapiro points out in 1963, the consolidation of the local governments in the metropolitan area in a regional government will not be the proper solution because of the diseconomies of scale. He says that at that time the “economic efficiency may be highest in medium-sized communities of 50,000 to 100,000 residents”. (Shapiro, 1963, p. 178) In this regard, one of the enthusiastic proponents of regionalism suggests that “it is important to permit central cities to annex surrounding communities with relative ease. He argues that cities that can easily annex surrounding territory are elastic and therefore can “capture” suburban growth, while cities that cannot are “inelastic” and therefore “contribute to” suburban growth”. (Rusk, 1995, Cited from: Frug, 2006, p. 396)
From a different standpoint, Buchanan and Tullok in response to the question of the optimum and appropriate size of the government or collective unit say that: “The group should be extended so long as the expected costs of the spillover effects from excluded jurisdictions exceed the expected incremental costs of decision-making resulting from adding the excluded jurisdictions… Conceptually, the answer is given by a comparison between the additional decisionmaking costs involved in moving from a lower to a higher level and the spillover costs that remain from retaining the activity at the lower level.” (Buchanan, & Tullock, 1999, pp. 113-14) Following this subject, below, we are going to discuss some major sources of inefficiency in fragmented megalopolises.

Costs of Communication
In every firm, each worker should have a one on one communication with each other in order to have a symmetric cooperation and to prevent the duplication of efforts. Once the number of the workers increases, the number of the communication channels for connecting them will increase too. It is evident that the communication will not be costless. Every communication imposes some kind of costs and those costs will increase the transaction costs within a firm. But there is another fact that exacerbates the situation. The fact is that the number of the communication channels is growing much faster than the number of the workers. The relationship of the number of the workers and communication channels is shown below:

Therefore, in case we have 10 workers, it will require 45 channels for communication. As noted above channeling and communication will impose some costs for communication which is a type of transaction costs.
Let’s come back to local government context. The state of Pennsylvania has 2566 local governments. Imagine that there exists an environmental problem that engages fifty local governments in the state of Pennsylvania, absence of any regional and state government, it will impose a very high transaction costs for them to come together, negotiate, reach a conclusion and enforce it. Just think of one thousand and two hundred twenty five come together and negotiate about the regional problem. Although in reality, it will not be so hard to do it, but in the absence of the regional or state government, there will be no way round. Although, the state governments will take action about the state problems but what if a metropolitan area or a megalopolis which consists of many fragmented municipalities and also trespass the boundaries of many states run into such a problem?

Duplication of Efforts
Duplication of efforts may be considered as one of the results of the large amount of communication channels and high transaction costs. Suppose that there are many municipalities in a metropolitan area, one regional problem occurs, the channels that they should create for communication will costs a small fortune for each municipality. Because of this high transaction costs, it is more probable that they will be blind of the efforts that each municipality takes in order to deal with the problem, and the obvious consequence will be the duplication of efforts that will causes many wasted parallel efforts and consequently, decrease the overall efficiency.

Network Effects
Will the consolidation of the municipalities to form a regional government lead into network economic effects? Network externalities appear when greater number of users join to a network. This theory assumes that “the utility that a given user derives from a good depends upon the number of other users who are in the same “network” as is he or she.” (Katz & Shapiro, 1985, P. 424) This network in the local government law can appear when the municipalities join together in a unified network to share their resources. Although this fact may generate some unintended consequences like diseconomies of scale, but it seems that taking the size and number into a serious consideration and not letting them grow more than necessary, this will increase the positive externalities of networking. One of the examples worth mentioning here is the networking of the schools and universities in the region and sharing their resources with each other rather than insulating one another. The good example is the example of the University of Pennsylvania, Drexel University, Villanova University, Southeastern University and Saint Joseph University in the greater Philadelphia which by networking and taking the advantage of the economies of scale and network externalities can compete with the higher rank universities in the United States and around the globe. Although this scheme might not be probable, because of the rank and resource differentials among these universities and some other biases, but all things equal, it seems a solution that might work. Being aware of their limited resources and technologies, European universities now are taking advantage of the economies of scale and network externalities by generating new networked programs and degrees.
The best way of networking occurs in the cyberspace rather than the actual world. Of course there is a problem with this approach, i.e., in the long run, the shared resources characteristics will change from the private property or source and turn into the public good or the commons which will be studied at the next chapter. It means that it is probable in many cases; the problem of the commons may frustrate the sources of the better providers of the shared resource and disincentivize him or her from investing the amount needed. Indeed this kind of resource sharing needs precise regulations.
At the end of this section, it is also worth mentioning that like any other rational human being, local governments and municipalities are assumed to be rational agents and being a rational agent, makes them to have almost all characteristics that a rational individual has, like cost minimizing and benefit maximizing and being risk averse and the like. This fact leads these local governments to engage in a frustrating competition with each other within the regional structure called cannibalization which may reduce the overall efficiency of regionalism.

The Tragedy of the Commons and Anticommons
Form the advent of the concept of property, although most “things” are considered to be eligible for ownership, there exist some “things” that were not intended to be owned and controlled by individuals. In Roman law these things that were not subject of the private ownership were called res extra commercium. These things were categorized in three subtitles as follows:
1. res communes: things that could only be used and not owned and hence they were adapted to general use.
2. res publicae: Things that “were adapted to public use, that is, use for public purposes by public functionaries or by the political community”
3. res sanctae, res sacrae, and res religiosae: things “devoted to religious purposes or consecrated by religious acts inconsistent with private ownership” (Pound, 1992, pp. 110-111)
As Pound puts it, in modern law “we have made the second category into property of public corporations.” And accordingly legal scholars have distinguished between three categories of res publicae:
1. “Those things which cannot be owned at all, such as human beings…
2. Things which may be owned by public corporations but may not be transferred…
3. Things which are owned by public corporations in full dominion.” (Pound, 1992, pp. 110-111)
The modern general definition of “the commons” is not so different from the three categories recognized by Roman law. But the main problem in the modern law which emerged by the population growth and its consequences is how to regulate the commons in a way to preserve it from depletion. Population growth in the modern era causes the commons to be vulnerable to depletion and this raised the voices for mechanism for preserving them, that is, how to regulate the “things not subject to the private ownership”?
The term “tragedy of the commons” coined by Garret Hardin in his famous article in 1968 indicates a source shared by a group of people, (Hess, & Ostrom, 2007, P. 4) in which individuals are granted the right to use that given resource without any cost-efficient way of monitoring or limiting each other’s use. This will lead to the destruction of that resource. Considering this situation, without any control of the entry or any other regulation, the common resource will be exploited “even at the levels of negative marginal productivity”. As Hardin emphasized: “Ruin is the destination toward which all men rush, each pursuing his own best interest in a society that believes in the freedom of the commons. Freedom in commons brings ruin to all.” (Hardin, 1968, p. 1244)
This happens because the external effects are not fully internalized within the choice of each individual decision maker. There might be two kinds of externalities in the commons:
1. Static or current externalities: in the static externalities simply taking advantage of a given source reduces other people’s chances to take advantage of that source.
2. Dynamic or future Externalities: In dynamic externalities the uses of a renewable resource today may have destructive effects on the future uses of that given resource.
In the commons because of the lack of conformity between the use and the exclusion rights —one of the inherent characteristics of the ownership in the western tradition— individuals do not use the commons with due care and attention and they do not bear the whole costs of their activities, i.e. the externalities cannot be internalized using the commons. (Parisi, & Depoorter, 2005, pp. 74-75) On the other hand, anticommons problem may occur when multiple owner, each have the effective right to exclude the other form the common source, this means that all of the owners at last will be prevented from “maximizing his privilege of the use”, and the common resource will remain unused and be wasted even if there is net social benefit in using them. In other words, the Commons and anticommons problem are the consequence of “symmetric structural departures from a unified conception of property”, and are the consequence of a lack of conformity between use and exclusion rights, i.e., the fragmentation of the property rights. (Parisi et al., 2004, pp. 175-76)
Taking the fact that a commons may exist in different levels into account, from a very small group like family and its refrigerator to the community (Sidewalks), national, international and global levels (atmosphere and the place beyond it) (Hess & Ostrom, 2007, p. 4), it seems that it is unavoidable in the local government law to escape the tragedy of the commons. The problem of the commons in the present local government structure arises from the bare fact that the natural boundaries do not coincide the political, administrative or manmade boundaries. Considering many municipalities in a region which contains the commons like a lake, river or air which knows no municipal boundaries, and all the municipalities can take advantage of that source and no one will be in charge of neither of them which may internalize those externalities, will cause serious problems to it. Also, if in a common source in the region, every municipality holds the right to exclude others, the tragedy of anticommons will occur. These two phenomena is two strong defenses in favor of creating (at least single-purpose) regional governments to preserve the commons in the region.

Taxation
Undoubtedly, the tax and taxation which has its roots in the theory of the state (Bentley, 2007, p. 17 & Feser, 2000) and is one of the most important issues that the local, state and federal governments willy-nilly engage in it. In fact, absence of taxation, especially in societies that the sources of expenditure of the government comes from another source rather than tax, local government and hence local government law does not make sense and its importance will be reduced to the administrative divisions of the centralized state. In some countries like Iran, the taxation system is paralyzed to the extent that at first blush the beholder may not find any trace of taxation and its effects on the local and national politics. Therefore, thus far, in these countries local governments has not been taken into a serious account. The taxation is the confluence of the three disciplines of economics, law and politics, Then if one cannot say that tax system and taxation is not the raison d’être of the local government law, it is one of the most strong reasons of existence. Many of the concepts in local government revolve around the tax like zoning, incorporation, annexation and so forth.
The taxation is the incentive for many of the issues in the local government especially in zoning, incorporation and also regional governments and so and so. As Gary Miller puts it “the most basic and pervasive common denominator for incorporation was the avoidance of high property taxation”. (Miller, 1981, cited from Frug, 2006, p. 339) Competition over the mix of lower taxes and higher services in terms of quality and quantity also is the source of disputes in many areas like schooling, zoning, incorporation, economic development and many other component parts of the local government law. In this paper, the main issue is that the current local tax system may produce many problems in the local governments that cannot be avoided save having a regional approach to taxation. These problems are as follows:
1. Gentrification: One of the major problems caused by the manipulation of the property tax in the different municipalities is the phenomena called gentrification which is in turn the source of many economic, social and especially racial conflicts.
2. Free riding: The people might live in low tax municipalities and work in the high tax central cities. This causes the negative externalities whose actual victims are the congested, high crime central city residents.
3. Effects on schooling
4. Sprawl and excessive suburbanization
5. Tax may cause local government to take the exclusionary zoning as a strategy to exclude the people with lower income and higher demand for social services and amenities. This may put the municipalities who do not take exclusionary strategies in trouble, because they may be overwhelmed by the families with lower income and consequently its tax base will shrink. (Cashin, 2001, pp. 752-53)
Although localism may encourage tax payers to pay the taxes as willingly as possible, because they can see the effects of the taxes which are distributed and spent in the same locality they reside, and in this regard, many criticism of the taxes which is raised by the economists may resolve, the above-mentioned externalities may cause many problems that would serve as a potential justification for the regional governments especially in the metropolitan areas. Three of the externalities which the local taxation may generate and without having a regional approach they will not be internalized will be studied below.

Free riding
As mentioned above, one of the major sources of free riding in the region is the different rates of taxation in different and usually adjacent municipalities. Free riders are those who consume more than the fair share of their use and also shoulder less than the costs they should do. In other words, free riders are those who receive the benefits of the goods without paying for them. (Gwartney et al., 2006, p. 118) Public goods, having two distinct characteristic in comparison to the private property, that is, nonexcludibility and nonrivalry and mostly provided by local, state or federal government, are most likely vulnerable to free riding.
Although there are many ways of free riding in the adjacent municipalities, the most obvious one is the problem of commuters. It seems that the commuters under the provision of the “freedom of movement” (See for instance: Universal Declaration of Human Rights, Art. 13 & U.S Constitution, Article IV, section I) use the local services without paying for them. And residents perceive commuters as free riders. Since commuters take advantage of the services provided by local governments and municipalities, and often do not pay for them. In fact, those who shoulder the tax burden are residents. It means that the taxes paid by the residents are consuming to serve the non residents. The question here is that how can local government avoid the free riders problem. How can local governments capture revenues from those nonresidents who are taking advantage of the local services without paying for them? The question is whether taxing commuters is just or not. (Shields & Shideler, 2003, pp. 27-28) As Shields and Shideler in their empirical evidence suggest “traditional jurisdictional taxing mechanisms (i.e., poll taxes) will generally fail to generate Pareto-efficient outcomes”. They suggest that although the commuters should be taxed, “the impacts of commuters on local government expenditures at the workplace are slight”. Commuters have also positive impact on some local public expenditure and they also have “differential expenditure impacts at the margin between workplace and bedroom communities”. Taking the revenue side into account, we can find out that the commuters pay the taxes for the services they are provided with, in one way or another, whether by their employers who are in charge of the business taxes which some amount of it can be considered as the compensation of the using the municipal services by their employees. At the end of the day, their empirical inquiry suggests that the policy makers should be hesitant to levy the tax for commuters for fairness reasons. (Shields & Shideler, 2003, pp. 40-41)
The other free rider problem may arise between city and suburb, as cities taxes are much higher than the suburb, the people living in cities, tend to be suburbanites with a lower tax rates and with the advantage of escaping congestion and obnoxious aspects of urban life while taking advantage of the economic and cultural advantages of central cities. (Hall, 1988, Cited from Frug, p. 309) This may cause the city to become poorer and poorer and the suburbs much better off. Escaping the congested gray city and taking refuge in the quiet and green suburbia caused some scholars call the suburbia as the “utopia for middle class” or bourgeoisie. (Fishman, 1987, cited from Frug, p. 328)
The second type of free riding occurs in a different arena, i.e., in the local elections in countries that have no voter registration and voters can vote in another jurisdiction to which they do not belong. This phenomenon generates vote buying. This kind of vote buying will also appear because of the disproportionality in the size of the adjacent constituencies. Vote buying will generate less accountable representatives towards the constituency and also a gap between the votes and the public interests. (Karlan, 1994, pp. 1474-75) For example, in Iran, where there exists no legal provision for voter registration which in turn enables voter mobility the day of the election, this phenomenon frequently occurs.
The extreme disproportionality can be seen in Tehran Metropolitan Area (Greater Tehran) in which the biggest constituency with 30 representatives is surrounded by many small constituencies with very small population and one or two representative. Since the costs of vote buying in Tehran constituency is very high because of the larger constituency, there will be no costumer for votes, but the candidates of the smaller constituencies near Tehran, taking advantage of voter mobility, transfer the people from Tehran to the constituencies in which there is no voter registration and also there is no legal sanction against the transferring the voters in the day of election. In this case, it seems that the candidates who buy the votes are free riders. Because as mentioned above, vote buying has some consequences that makes the citizens living in the residencies that are vulnerable to vote buying, not to have their voice in the local election while paying the taxes for local services. This is called the disruption of the votes from public interests. While the outsiders by selling their votes which are supposed to have no economic value for them, especially when they know that their votes will not have a significant impact in very large constituencies, will sell their votes even if in a very low price to the vote buyers who gain a significant political advantage in a small constituency. In this case, the residents who are committed citizens are bearing the burden of unaccountability of their representatives.

Gentrification & Racial Segregation
During the 1970s and 1980s with the growing importance of some cities in the U.S and around the world, like New York and London, we have seen a capital flight from the other areas to the central cities. This phenomenon resulted in the higher rates and prices in real estates in the central cities and consequently higher property value and taxes in that area. As a result, the lower and middle income residents living previously in those areas now could not afford higher taxes and are forced to leave those areas, and wealthier people will replace them. The wealthier the area becomes, the lower income people should leave. This will generate a new gentry and this process is called “gentrification”. Needless to say that the newly arrived wealthy residents, need new and better services which is not comparable to the services existed before for the low or middle income residents, then as far as the services grow, the tax grows concomitantly and the poor people should be priced out. (Maurrasse, 2006, p. 44) Gentrification (also called “suburbanization in reverse” or “reverse exclusionary zoning”) is a term generally used for the arrival of wealthier to the existing relatively poor neighborhood and pricing them out. It indicated the incursions of middle and high class households into decaying inner city neighborhoods. (Scott, 2008, p. 71) This phenomenon will result in the change in the character and culture of the area and may also cause the racial and economic stratification and therefore racial conflict because residents of the affluent communities have an incentive to avoid sharing the tax burdens of the poor. (Briffault, 1990a, p. 5) Although at first blush, it seems that this phenomenon is economically desirable, its effects are in fact very complicated.

In the United States the debate over gentrification is intertwined with the debate over racial segregation and stratification. As wealthier neighborhoods in the U.S are the nest of the white high income people and quite to the contrary, the decaying neighborhoods are considered the home for the black lower income families. As Richard ford suggests even race-blind policies in the United States will result in the segregation and socio-economic stratification within a society with a history of racism. (Ford, 1994, pp. 1850-51)
One of the biggest incentives that can exacerbates the gentrification and racial segregation is the competition among local governments. As David Rusk puts it “Fragmented local government fosters segregation” and “unified local government promotes integration”. In the context of the United States always the fragmentation of the metropolitan areas is intertwined with at least a minimum degree of the social and residential segregation. Although for most Americans, smaller government always was a symbol of the local communities with a better interaction with the voters, but it seems that in reality the smaller governments are serving the neighborhood least and also as an externality these fragmented small governments are generating racial and economic segregation. Quite to the contrary, the bigger the government geographically, the more the racial and socio-economic integration and the greater social mobility are. (Rusk, 1995, Cited from Frug, 2006, p. 398) Needless to say, the more fragmented the metropolitan area with local governments, the less likely to mandate the integrating strategies. As David Rusk puts:
“What is clear is that, absent federal or state mandates, a metro area in which local government is highly fragmented is usually incapable of adopting broad, integrating strategies. Conversely, a metro area in which key planning and zoning powers are concentrated under a dominant local government has the potential to implement policies to promote greater racial and economic integration if that government has the courage and vision to do so.” (Rusk, 1995, Cited from Frug, 2006, pp. 398-99)
The amount of the segregation in the United States is so high that the white people no longer want to live in neighborhood in which the blacks are in majority and also they “are willing to pay13% premium in order to live in an all-white neighborhood”. Needless to say, this premium is an indicator of the de facto segregation, in a world that it is supposed to be no de jure segregation. (Cashin, 2001, pp. 737-38) It seems that we can achieve the converse relationship between economic growth including well-paid jobs, better schools and property and the number of blacks in most part of the Unites States like Atlanta, Washington and Chicago. This in turn causes the “increasing average commute times and limiting access to “New Economy” jobs.” (Cashin, 2001, p. 757)

The important problem here is the zoning and its impact on neighborhood segregation and gentrification. In most instances, zoning has an important impact on the prices of the real estates and the zoning that increases the costs of the retaining housing can lead in the gentrification. As stated above these kind of zoning will displace the low income families to poorer areas. As we know every transaction in the real world has transaction costs and the displaced often black families, because of the high taxes and high costs of new amenities, who are leaving the community will engage in a very high transaction costs of the searching suitable and affordable housing.
The important point here is that usually the gentrification process is justified under the title of economic development by government which sometimes leads to the eminent domain cases. The opponents of gentrification –under the guise of economic development –argue that the government has the responsibility of improving the neighborhood without letting the gentrification occur and displacement of citizens. May be their rationale is the market failure, but the fact that the government interference for improving the neighborhood entails and imposes higher taxes beyond the capability of the lower and middle income classes often adds to the complexities of the problem. (Dubin, 1992-1993, pp. 768-70) Needless to say that this kind of gentrification under the guise of economic development, in addition to its social and economic impacts has a great psychological aftermaths, that is, the citizens may see it as a plot for organized gentrification and it will decrease the confidence of the citizens to the government which is often considered as one of the most important social capitals. This fact will favor the emergence of the “right to protective zoning” which is a very controversial issue in local government law.

Sprawl
One of the results of the conflicts among different municipalities is sprawl. The uncoordinated and unchecked growth of the cities and municipalities in a metro area in the United States with a vast amount of available land caused sprawl. (Frug et al., 2006, p. 419) At first blush, sprawl provides certain benefits for people living in congested old cities. It can provide the lower income families with the new housing opportunities outside the city. It gives citizens almost unlimited space for their automobiles. It takes the citizens away from the fiscal and social problems of the cities and can provide better and also more homogenous place to live in. Lower property taxes and also proper education are the other benefits. Some of the laws and policies, especially zoning policies, in the local level are accentuating the sprawl in the U.S. (Burchell et al., 2005, pp. 15-16) In this context, sprawl can be considered as one of the negative externalities of localism. Economists have argued that the sprawl does not result in an efficient outcome. It can be said that sprawl has four categories of costs that in an economic calculus, it produces inefficiency. The four categories of costs that sprawl may impose are as follows:
1. Environmental Costs
2. Economic Costs
3. Social Costs and
4. Public Health Costs (Jackson, 2005, pp. 301-305)

This is because; sprawl has four main characteristics in its definition that make it extremely costly:
1. “Unlimited outward extension into undeveloped areas.
2. Low density
3. Leapfrog development
4. strict segregation of housing and commercial development, often through the construction of standardized development types, automobile dependence, and fragmented planning and governance” (Burchell et al., 2005, p. 12)

One of the causes that the localism can lead to sprawl is that the local governments are largely dependent on the property taxes as a source of revenue. As an economic assumption the local governments are fully aware of their own cost and benefit analysis and they do not want to have new residents whose costs exceed their benefits. In the context of sprawl, it means that local government will take advantage of the land use and zoning policies to exclude the residents and also businesses that providing them with the services will cost more than their contribution to the tax base. In this case, local governments will do their land use and housing power in a way to increase the property value in their residency and will make the entry cost higher to their residency. This will result in the fact that the poor families will be displaced to the poorer localities with a lower tax. This in turn may have a “ripple effect” in the region and other localities may do the same to protect themselves from less affluent citizens with a lower contribution to the tax base and also probably more need for public goods and services. This ripple effect will bring about the exclusionary zoning across metropolitan area and as a result the property value will increase. In this situation less affluent families will be forced out from the metropolitan area to the outside of the metropolitan area and they will go and constitute residencies that they can afford. Adding the factors like developments in new transportation, advent of the electronic government and new communication technologies has contributed to the sprawl. Theses technological advances decreased the dependency of the families to the central cities and even to the suburbs and in some cases encouraged them to live in exurban and rural areas.
In addition, sprawl has another obnoxious effect on the industry, As a result of sprawl, the local governments attempt to collect more taxes to provide the sprawling area with the infrastructures like roads, sewerage system and so and so. This in turn, will raise taxes to a considerable degree and the elected local governments prefer to impose the tax burden not to the voters but to the businesses. This will cause the flight of businesses from that area.
The second argument for the regionalism in the context of sprawl is the poverty in metropolitan areas. As mentioned above, poorer areas are more service recipients and have less contributing in the tax base and this will cause the flight of the more affluent families and also businesses from certain municipalities in the metropolitan areas. To be clear, more affluent families who are mostly bearing the tax burden of the particular municipality do not receive enough services will move to better-off municipalities with stronger tax base, i.e. with more affluent residency and in this way they will contribute both to the concentration of poverty and also sprawl. As Prof. Briffault puts it “concentrated poverty operates as a “push” factor…[and]the availability of commercial and residential sites elsewhere in the metropolitan area… operates as “pull” factor inducing people to move.” (Briffault, 2000, pp. 12-14) In the end, following Prof. Briffault, we should say that because the “sprawl is a regional phenomenon”, (Briffault, 2000, p. 10) the existing local government system will not let it to be controlled by regional policies. (Briffault, 2000, pp. 10-12)

Transaction Costs & Hold-out Problem
The costs parties incur in the process of a bargain i.e., searching, negotiating, reaching, and enforcing agreements are called transaction costs (Polinsky, 2003, p. 14). At first blush, it seems that the localism can reduce the transaction costs in democracies to a considerable degree. Localism by decreasing and limiting the geographical scope of certain communities and consequently by decreasing the number of the citizens can help the public decisions be reached out with a lower transaction costs. In this part of the paper, we should consider the transaction costs in two different viewpoints: firstly, decisions that should be made with the participation of the citizens directly and secondly, decision which should be made with the participation of the localities or municipalities about the whole region or metropolitan area. Therefore, in this regard, the transaction costs should be taken into account twice. Having regional government without having municipalities or in other words, merging municipalities in the regional government can reduce the costs of transaction to a considerable degree. It means that the most costly and expensive part of the transaction costs for decision making about the issues in question, will be reduced. One of the major arguments for indirect democracies has its roots in the high transaction costs of the every individual participating in the democratic process. As John Stuart Mill says:

“It is evident that the only government which can fully satisfy all the exigencies of the social state is one in which the whole people participate; that any participation, even in the smallest public function, is useful; that the participation should everywhere be as great as the general degree of improvement of the community will allow; and that nothing less can be ultimately desirable than the admission of all to a share of the sovereign power of the state. But since all cannot, in a community exceeding a single small town, participate personally in any but some very minor portions of the public business, it follows that the ideal type of a perfect government must be representative.” (Mill, 1865, p.69)

In this statement from Mill, it seems that there exist two economic hindrances that do not let direct democracies work, that is, the participation of the whole people and the transaction costs and hold-out problem plus the opportunity costs that people may incur to be fully participative in democracies. This argument is the foundation of the representative government. The transaction costs in direct democracies are high to the extent that in the modern world there is no sign of such a government unless in some places and in its weak forms. Although the representative governments have a considerable agency costs, and there are some settings in representative governments that almost plagues the process of bargaining in political sphere, (Parisi, 2003, Pp. 25-26) transaction costs of the direct democracies outweigh the agency costs of the representative government. (Wittman, 1989)

It should be taken into account that every decision made in the regional level impacts the lives of the residents in the localities and quite vice versa. If so, the decisions made by democratically elected representatives by people and supervised by the system of checks and balances in the whole region will reflect the ideas of the region. On the other hand, the costs of communication among localities or municipalities in case of a regional problems are very high, especially in a disorganized society, because within well organized societies, costs will be reduced through effective lobbying and fighting a court case, but in an unorganized society, the cost of organizing people will be added to the costs of negotiation and solving the problem. (Lawson, 2007, p. 27) The negotiation tactics (hold-out) and strategic behavior of the parties will exacerbate the situation and will increase the transaction costs tremendously.

Democratic Concerns
Democratic theory has traditionally served the localism; even within the American metropolitan areas, no one claims that the efficiency arguments should outweigh the democratic argument or concerns and hardly anyone argued in favor of the abolition of the local governments. Because local governments has long been adopted as the realization and the most concrete example of the democratic theory as laboratory of democracy. But at least, the situation in which modern metropolitan areas and megalopolises are in, had propelled the theorists of democracy not to look at the regionalism as pessimistically as they did before.
With The advent of the Public Choice Theory or Positive Political Economy, Hobbsian and Lockean political man has been replaced with the economic rational individual or “utility maximizing political consumers” (Duch, & Stevenson, 2008, Pp. 8-9) In fact in this calculus rational individuals and “parties formulate policies in order to win elections, rather than win elections in order to formulate policies” (Downs, 1957, p. 28 ) With the introduction of this man in political economy literature, the main concern shifted from the nature of state or government to the procedural characteristics of modern democracy and consequently, electoral systems came to the focus of attention of the political economists. This approach is dominated by the issues concerning the economic vote. In fact these theorists tried to explain how economic factors impact the voters’ utility function.
One of the big problems that can be argued against the regionalism and at the same time is the most important argument in favor of localism is the paradox of voting. Paradox of voting briefly suggests that the individuals’ votes which came out of their preferences will probably not affect the outcome of the election. An individual in deciding whether to vote or not, will take account of different factors in order to make sure that his or her vote will be of any effect. These factors are as follows: 1. what is the marginal benefit of voting, 2. what is the marginal costs of the voting, and 3. How much is the probability of the decisiveness of my vote? The rational individual also thinks of the marginal benefit of voting. It seems that the opportunity costs of voting is just the opportunity costs of casting the vote on the election day, that is relatively low cost, but compared to the marginal benefit of voting which will be affected wholly by the probability of decisiveness which is extremely low, is not so trivial. When the political consumer finds out that the marginal costs of the participation in the election are nontrivial and the marginal benefits trivial, the rational individual will prefer not to vote.
In the context of localism and regionalism and the election, it can be said that the lower the number of the people in the municipalities, the more the probability of being decisiveness in election and vice versa. Then construction a regional government with a greater constituencies, will result in less probability of being effective in the election result and the voters as “utility maximizing political consumer” will have less incentive to participate in the election. This will cause a lower turn out in the democracies with big constituencies. (Duch & Stevenson, 2008, pp. 8-9) We can formulate these factors as follows:
Marginal benefit of voting= probability of decisiveness × differential value
If
1. Marginal benefit of voting> marginal costs of voting= higher turnout
2. Marginal costs of voting> marginal benefits of voting=lower turnout
If population goes up, probability of decisiveness comes down and vice versa.
In regional elections the voter turnout will be much less than local elections.

The most crucial and central idea of the democratic theory is the right to self determination. And the central idea of that right requires that the people who are anyhow affected by certain decisions of the governors be able to have their voice in making those decisions. To put it differently, one of the most important premises of the democracy is the equal voice of those affected by the decisions should be considered in the decision making process. As stated above, the pure localism lacks at least this criterion; because of the externalities that the local decisions may impose on other citizens outside the locality. As a matter of course, this fact infringes the basic presumption of modern democracies i.e., political equality. This problem appears in areas such as land use and zoning which may directly affect the citizens rights living outside of the local boundaries. Maybe one can cite thousands of examples that the local governments decision bringing about negative externalities. On the other hand, local governments’ decisions may lead into some positive externalities too, but in this case the free riding problem may arise against localism. As prof. Briffault mentions: “The extralocal consequences of local decisions, thus, not only cause inefficiency; they undermine the assumption that local actions are democratic.” (Briffault, 2000, pp. 24-27) Therefore, the sole democratic argument against localism remains is that the sense of effectiveness that citizens may feel when they are participating in small units of governments, and it seems that this argument will lose its importance in the presence of the efficiency argument. Although the citizens may have a palpable participation in local elections and they may feel the democracy at home, in metropolitan areas, the fact that the local government cannot deal with the regional issues that might be of greater importance for the residents of metropolitan areas, limits the power of the local solutions. In this case, citizens may be voiceless in regional matters and they may be left to the political bargains. The fact that there are many purely local issues that have not any extraterritorial effects, supports the idea that the “combination of localist and regionalist policies and institutions rather either a totally fragmented localist system or the consolidation of all local government decision-making at the regional level.” (Briffault, 2000, pp. 24-27)
In addition, there are many other socio-political concerns about regionalism, such as concerns about accountability, social concerns, especially concerns about the sense of community (See: Kanter, 1972, pp. 148-175 & Jackson, 1985, pp. 272-82), concerns about diseconomies of large scale economies or governments such as cannibalization, existence of purely local issues in the region and so and so that do not let us to choose either regionalism or localism at the expense of the other.

Concluding Remarks
The main idea of this paper is the current local structure in the United States’ local government structure does not result in an efficient outcome both for local and state governments especially in the metropolitan areas and megalopolises. In supporting this idea, by taking advantage of the economic concepts and applying them in the local governments’ context, I have gone through some factors in my analysis of current structure of local governments in the United States. In this regard, I started with a brief introduction to localism and regionalism and their political and economic underpinnings. At the second step, I continued with the economic criticism of localism which its reverse side was the economic justifications for regionalism. In doing so, I have considered the economies and diseconomies of scale and their potential effects on the local governments and also studied the optimal size of local government from the economic stand point. The lower costs of communication, eliminating the duplication of efforts and achieving network economic effects were among the advantages that this theory provided for the regionalism as opposed to localism. Although this theory implies that the regional governments should not grow too large because of the diseconomies of scale and cannibalization they may generate.
The second factor in my calculus was the tragedy of the commons and anticommons which may occur in case of a region-wide common source shared among municipalities. Local taxation and its aftermaths, i.e., free riding, vote buying in countries without voter registration which facilitates voter mobility, gentrification and sprawl were among the consequences of the local policy making about taxation that serves as a justification for regional planning. Needless to say, the existence of so many local governments in the present structure of the local government system in the U.S will result in a high transaction costs and also strategic behavior such as hold out problem in the cooperation of the local governments coping with a regional problem. All in all, these economic arguments are all in favor of having regional approach to the regional problems in American metropolitan area and megalopolises. Although these economic justifications are all in favor of the regionalism, it should be noted that all these arguments have the characteristics of the “slippery slope” argument. It means that there are some other legitimate socio-political concerns about regionalism which do not let us to believe in the total abolition of the local governments; concerns about representation, accountability, sense of community and diseconomies of large scale governments, propel us to be in favor of the coexistent model of localism and regionalism in megalopolises.

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