Quality of governance and its impact on interjurisdictional competition

The main object of the dissertation’s research is governance, and its role in public finance, in particular in interjurisdictional competition. Three essays on this topic are included in the work as separate chapters (Chapter 2, Chapter 3, Chapter 4). First two of the essays analyze several public finance outcomes when governments - the main actors in the analysis - are different in their efficiency (quality), i.e. they transform tax revenues into public interest at a different rate. This includes both their expertise, integrity (absence of corruption), and exogenous circumstances they face in jurisdictions, they are chosen (or appointed) to administer. The third essay takes purely empirical approach to actually measuring and monitoring the quality of governance in different countries. The main result in the first chapter (essay) is that if the governments of two countries are different in their efficiency (i.e. one of them is able to produce more public good out of the same revenue) then the more efficient government charges the higher corporate income tax rate. It can do so, because besides the high tax rate it offers to the potential investors a qualitative public infrastructure, which reduces the cost of their production. At the same time, less efficient government is not able to compete in the level of public good provision, so it chooses to attract the firms with low taxes. The main result of the paper is, however, contingent on two major assumptions. First is that the profit function of an investor is concave enough in public good. Second is that the countries should be sufficiently different in their efficiency. If at least one of the conditions does not hold then both governments have incentives to deviate, and there are no equilibria in pure strategies. At best, governments are involved in the mixed strategies, and set tax rates in a random manner. The theoretical conclusions of the chapter are in general supported by anecdotal empirical evidence, which I present in the end of it. However, further investigations in this field are needed in order to make robust conclusions. In the Chapter 3 I present new theoretical argument in favor of intergovernmental transfers from a rich (advantaged) jurisdiction to a poor (disadvantaged) one. Namely, if local governments are (at least, partly) malevolent, and the factor productivities in the jurisdictions are different, then subsidizing the jurisdiction with lower productivity intensifies competition for mobile factor between self-interested governments, and leads to an overall higher level of public goods production, thus lower level of corruption. This happens though only in the case of regional subsidies, when budgets of the governments are not affected directly. It is shown in the chapter, that if the difference between jurisdictions is large enough, intergovernmental grant may be beneficial even for the residents of the net-paying jurisdiction. Chapter 4 deals with the empirical measurement of quality of governance on the level of countries. Governance indicators are now widely used as tools for conducting development dialogue, allocating external assistance and influencing foreign direct investment. The chapter argues that available governance indicators are not suitable for these purposes as they do not conceptualize governance and fail to capture how citizens perceive the governance environment and outcomes in their countries. With my co-author A. Shah, I attempt to fill this void by conceptualizing governance and implementing a uniform and consistent framework for measuring governance quality across countries and over time based upon citizens’ evaluations. Citizencentric governance indicators are constructed for 125 countries (over 1994-2005), their comparative analysis is provided as well as some robustness checks.