Does Federalism Preserve Markets?

Abstract

This Article examines the positive and normative implications of market-preserving federalism ("MPF"). In Part I, we summarize Weingast's model and sort out some of its positive and normative claims. We argue that the model lacks important institutional features that, if included, would affect its predictions. We have no quarrel with the logic of the model as it stands. Rather, our critique highlights the lack of a strong theory explaining how these conditions might arise in real political systems. Weingast's work is insufficiently grounded in a theory of politics. In Part II, we ask whether MPF can in fact solve the "fundamental political dilemma of an economic system," and question whether state-level politicians really have no alternative but to maximize state income and wealth. We argue that, under a range of plausible conditions, federal systems will not bear out Weingast's predictions. When they do not, a move to greater decentralization may reduce rather than increase efficiency. Part III asks whether an MPF is sustainable as a political equilibrium under which a federal government credibly limits itself to providing public goods like a common market, contract enforcement, and a stable currency. We also examine political responses to some costs of decentralization and argue that the strong but limited central government required by MPF may be very difficult to maintain. Part IV addresses normative concerns. Calls for radical decentralization and deregulation in the name of efficiency are sometimes made by developmental economists, and the MPF model would seem to bolster their arguments. Weingast implies that de jure federations like Argentina, Brazil, and India would experience Chinese-style economic performance if they were to decentralize their federal systems along MPF lines. By contrast, we question the value of MPF as a guide to institutional reform in the developing world and suggest that it may exaggerate rather than ameliorate some important institutional impediments to development. We do not claim that a completely centralized system ought to be the norm. Obviously, in an imperfect, highly politicized world, federalism can provide valuable checks on those with political power. Rather, we isolate situations where marginal moves to increase decentralization will harm a nation's prospects for growth.