Governing like China: The Control of Local Bureaucrats in a Centralized State

Abstract

We develop a model of repeated moral hazard to study the dynamics of local governance in a centralized state (like China). In each period, a principal chooses a mode of governance, deciding whether to delegate local affairs to an agent with better expertise, whether to supervise him, or to take over local affairs. A trilemma arises as the principal cannot overcome the three inefficiencies at the same time: loss of local expertise, rent-seeking behavior, and shirking. The relationship eventually evolves into either recurrent centralization, or recurrent unsupervised delegation, or perpetuated bureaucratic slack. Albeit inefficient ex post, the equilibrium is consistent with ex ante optimal administration. The underpinning of these results is moral hazard in local agency and limited commitment in a centralized state. Our theory sheds light on broader scenarios of agency problems in a centralized state.