2 NATURE OF THE TRADEOFF
3 EVALUATION OF “TRADEOFF"
4 HOW TRADEOFF PLAYED ITSELF OUT IN EUROPE
5 ADDITIONAL LIGHT ON ASSIGNMENT 1
The recent Nobel Memorial Prize in Economics was given to Oliver Williamson and Elinor Ostrom for their separate work on economic governance. Significant and sustainable economic organizations as well as a period of its wide development first arouse during the early modern period in Europe. The three main elements of economic growth, flow of technology, migration out of traditional agriculture, and external effects in cities (Lucas, 2009) are connected through organizational theory.
The rise of real wages in Europe during the early modern period allows distinction between political and economic structure, although they remain highly related. Another point is geographical and organizational order of power. Whereas the geographical distribution of power didn't change much in Europe from the fall of the Roman Empire until the nation building in the seventeenth century (North, 1981, p. 148), the organizational structure and vertical division of power changed significantly. France is a good example for this. The power of internal rivals was first reduced through their exclusion from taxation (North, 1981, p. 150). But the French enlightenment later reduced the power of the nobility and led to decentralized governance in the long run. In the time of the early modern period, the principle of decentralization spread over Europe and replaced the more traditional centralized structure. The two moving powers to this structural transformation have been a change in population and warfare (North, 1981, p. 126).
Why is it a tradeoff between centralization and decentralization? As we see today, local governments can take decisions much faster than central authorities. Politicians far away often don't really know much about the real needs of local population but local governments are more pragmatic and can adapt more specific because both levels of government care about different things by nature. At an equal level of technology, centralized administration of large populations is naturally slower than the ones of small populations because of communication costs.
The centralization of certain issues proved to be the right way to establish a third party in the framework of the transition from a limited access order to an open access order in the European countries (North/Wallis/Weingast, 2006, p. 52). This third party was powerful enough to unify measures, weights, currency, laws, and the toll system. Centralization does not have to be negative and decentralization does not have to be good by definition. Both have advantages each and in history, the actual needs of the population may have driven the system to polarize on occasion in the one or other direction (North, 1981, p. 143). However, the enforcement of decentralization seems to play the decisive role for England to start industrialization. The key to decentralization in turn, the vertical division of power, seems to be the right of property. Before the Industrial Revolution, in England federalism demonstrated to be a good solution to the dilemma of how to limit the government and to establish a self enforcing decentralized structure of political and mainly economic power around the principle of property rights. Federalism can be described as applied decentralization (Weingast, 1995, p. 1). As it had been in England, this kind of structure proved to be market-preserving, because the subnational governments were able to regulate economical issues, provide common markets, and gained from economic activity in their area (Weingast, 1995, p. 5).
The federal structure in England represented a transition from the natural state to the open access order (North/Wallis/Weingast, 2006, p. 68). Whereas the natural state prevents market prices from reallocation resources, the system in England allowed the price mechanism to work. By this, the prices could reflect scarcity of resources and the latter were able to move and be used in a value maximizing way (North/ Wallis/ Weingast, 2006, p. 45).
Centralization in this context means a ruler at the top of the hierarchy with subordinated lords and clergy directly following his rules. Decentralization in this context means also two levels of hierarchy, but this time the lower level is able to make decisions and laws. That is to act as the lower level were a government itself within a bigger government and both have sovereignty, the bigger government more general and the smaller one more specific. The definition of a bigger and a smaller government in the sense of decentralization seems to depend on population density and technology of bureaucratic tools to administer the related subjects. The bigger government or state is simply said an organization with the comparative advantage in violence in a certain area (North, 1981, p. 21). The efficient size of both levels will be about a point where each gains and costs at the margin are equal (North, 1981, p. 37 / p. 127). This kind of decentralization can be seen today in a lot of economic developed states like Germany, France and the U.S..
Although, the following two examples are simplified, they demonstrate typical organizational systems of the treated time in Europe:
France under Louis XIV is a typical example for centralization. The famous quotation "L'État, c'est moi!" is perhaps not from him but describes the situation pretty well. This structure needed a strong king, who was able to maintain and to control the country. There has only been little room for individual ways of local authorities. All noble and clergy members that wanted to have real political power had to live in Versailles in order to be in favor of the king. He controlled the military, legislative, and jurisdiction. Under this conditions, the economy developed but more traditional than it did in England. It was coined by the fact that in principle the King ruled based on an absolute monarchy.
England in the early modern period would be a typical example for early decentralization of power (Porter, 1977, p. 114). The monarch and the parliament represented a certain central structure, but with the rise of Local Corporations, Parish Vestries, Churchwardens, Commissioners of Roads, Sheriffs, and Justices of the Peace (Porter, 1977, p. 114) the ruler became weaker step by step and gave or was forced to give, whether intended or not, central authority to peripheral governmental institutions.
This way though is a one way street as the modern China shows (Weingast, 1995, p. 23) in a remarkably way. Once a central authority gives power away to local entities, they do of course everything to keep and defend their gained power. It would be far from rational accepting a new contract that leaves one worse off. If the ruler doesn't choose to make use of violent reactions, he has to accept the decentralization. Acceptance is not a bad way as competition among local governments leads to economic prosperity and increased tax revenues (North, 1981, p. 141).
The advantages and disadvantages of centralization and decentralization can be summarized as follows:
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(Prof. Dr. Hagen Lindstädt, 2008)
The tradeoff seems to be evident, except the opportunity costs. The free rider problem is ambivalent because it depends on the opportunity cost. The measure of the value of legitimacy is the additional amount added by the potential free rider on his opportunity cost before he becomes a free rider (North, 1981, p. 11). This kind of problem appeared where subjects escaped their lords into towns or just tried to evade taxation.
As there are disadvantages and advantages, there was and is surely a tradeoff concerning political and economical centralization and decentralization. They have each relative advantages and disadvantages. Furthermore, this tradeoff goes hand in hand with the ones of general craft versus specialization, control versus competition, and strong government versus protection of property rights.
The transition between centralization and decentralization is continuous. I will apply three general efficiency criteria for organizations "incentive compatibility”, "demand compatibility”, and "coordination efficiency” (Prof. Dr. Hagen Lindstädt, 2008). Incentive compatibility means the degree of consistency between the goals of an organization and the goals of its members. Demand compatibility refers to the degree of compatibility of the demands of the organization to its members and the abilities of the members themselves to fulfill the latter. The degree of match between demands to the structure and efficiency of existing structure is measured by the coordination efficiency. Although the decentralized structure diminishes the level of control, it provides a good incentive compatibility and autonomous flexibility for a thriving economy.
While decentralization does increase the tendency towards opportunism and low coordination cost, local governments represent higher demand compatibility and have to compete in order to maximize economic welfare and political influence through attracting as much economic activities as possible. This positive effect offsets the disadvantages.