Handbook of Multilevel Finance
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Handbook of Multilevel Finance

Edited by Ehtisham Ahmad and Giorgio Brosio

This Handbook explores and explains new developments in the “second generation” theory of public finance, in which benevolent rulers and governments have been replaced by personally motivated politicians and the associated institutions. Following a comprehensive introduction by the editors, the renowned contributors present fresh and original perspectives on the key multi-level issues, along with recent developments in theory and practice, as they relate to taxes, budget systems, the management of liabilities and macroeconomic stability. The book also explores special issues concerning the poor and marginalized, structural change and the environment, natural disasters, and the task of overcoming conflicts whilst keeping countries together.
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Chapter 7: Contract federalism

Paul Bernd Spahn


Federal governance structures, dating back to antiquity, were always sensed to be useful in leveraging public welfare, but they were (and are) ill understood from an economic point of view. While welfare is an economic dimension, economists were rarely involved in designing federal constitutions. True, the contribution of the economist would hardly have been helpful for long. The microeconomic foundations of efficient governance and institutions are still shaky. The relevance of information asymmetries and regulatory functions of the state were discovered only recently, and the design of suitable principal–agent models (exploring agency theory, transaction costs economics) for intra-government relationships and the context in which these models are to be understood are still in their infancy. So federal constitutions had been discussed and were drafted mainly by lawyers and political scientists, and intergovernmental relations have often evolved incrementally, responding to different historical and political challenges at a given time. A fundamental reform of existing federal arrangements is especially difficult. Although one could agree that federal constitutions are neither optimal nor forward looking, mainly reflecting past developments and disregarding future challenges, a complete redesign of these arrangements is illusive given that they constitute the very foundation on which the state and intergovernmental relations are built. The constitutional core is de facto ‘cast in stone’, and radical reforms are possible only after catastrophes such as wars. Even then there is need for extensive political compromise and respect for tradition.

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