Efficiency and Stability of National Borders Enrico Spolaore Tufts University NBER and CESIfo

1. Efficiency and Stabilityof National BordersEnrico SpolaoreTufts UniversityNBER and CESIfo Lecture prepared for the opening of a new Center for Regional Economic Studies Katholieke Universiteit Leuven October 15, 2008

2. Introduction • Since 1990 over twenty new sovereign states have been created through secessions and break up of countries • Today there are 193 internationally recognized sovereign states in the world, up from 74 in 1945 (latest UN member: Montenegro in 2006) • Between 1985 and 1999 secessionist movements were present in at least 52 countries (Gurr, 2000) • At the same time, decentralization has become increasingly popular: for example, 63 out of 75 developing countries with pop. greater than 5 million claimed to be transferring fiscal authority from central to local governments during the 1990s (Dillinger, 1994)

4. Questions • What explains existing national borders and their changes? (stability of national borders) • Are national borders and their changes “optimal” or “suboptimal”? (efficiency of national borders) • How are the “efficiency” and “stability” of borders related to economic and political variables such as • international integration • inter-regional redistribution • decentralization and federalism

5. Rest of this talk • An overview of the political economy of national borders: • Costs and benefits of political integration: the basic trade-off between heterogeneity and economies of scale • Stability and optimality of borders in different political and economic regimes • How to measure cultural/historical diversity across populations and its implications • Inter-regional redistribution as a double-edged sword • Inter-regional transfers as a way to keep countries together • Inter-regional redistribution as a reason for breakup • Does decentralization of political power to sub-national governments promote country stability? • Arguments for and against stability • What do the data say?

6. Size of nations addressed by political philosophers • Philosophers interested in a normative question (what is the “optimal” size of nations?) • Plato calculated the “optimal size” of a polity: 5,040 heads of family • Aristotle: “experience has shown that it is difficult, if not impossible, for a populous state to be run by good laws” • Montesquieu: “In a large republic, the common good is sacrificed to a thousand considerations and is subordinated to exceptions; it is vulnerable to whims and accidents.  In a small republic, the public good is more strongly felt, better known, and closer to each citizen” • Madison (Federalist 10): benefits of a large size (with constraints to avoid “tyranny”)

7. Political Economy of National Borders • Traditionally economists have taken national borders themselves as “given” (“exogenous”) • However, borders are not part of the geographical landscape, but “endogenous” human-made institutions, and can be addressed with the tools of modern political economics (costs and benefits, trade-offs,, efficient and inefficient equilibria, etc.)

8. commercial break:

9. Selective references • Alesina, A. and Spolaore, E. 1997. On the number and size of nations .Quarterly Journal of Economics, 112, 1027–56. • Alesina, A. and Spolaore, E. 2005. War, peace, and the size of countries. Journal of Public Economics, 89, 1333-54. • Alesina, A. and Spolaore, E. 2006. Conflict, defense spending, and the number of nations. European Economic Review, • Alesina, A., Spolaore, E. and Wacziarg, R. 2000. Economic integration and political disintegration. American Economic Review 90, 1276–96. • Bolton, P. and Roland, G. 1997. The breakups of nations: a political economy analysis. Quarterly Journal of Economics 112, 1057–89. • Bordignon, M. and Brusco, S. 2001. Optimal secession rules. European Economic Review 45, 1811–34. • Goyal, S. and Staal, K. 2003. The political economy of regionalism. European Economic Review, 48, 563-93. • Le Breton, M. and Weber, S. 2003. The art of making everybody happy: how to prevent a secession? IMF Staff Papers 50, 403-35. • Spolaore, E. 2004. Economic integration, international conflict and political unions. Rivista di Politica Economica, 94, 3-41. • Spolaore, E. 2005. The political economy of national borders. in Oxford Handbook of Political Economy, ed. B. Weingast and D. Wittman. Oxford: Oxford University Press.

10. An Important Trade-Off • The “equilibrium” size of nations and the stability of political borders depend on the trade off between the benefitsfrom a larger size (economies of scale) and the political costs of heterogeneity (diverse preferences for public policies in a larger population)

11. Benefits of Scale • Economies of scale in the provision of public goods • Defense and security • Market size (when there are barriers to international trade) • Insurance against economic shocks or natural calamities • Internalization of externalities(e.g., pollution)

12. Heterogeneity Costs • The costs of heterogeneity emerge because, as size increases, more and more individuals have to share common policies and common public goods. • Average “distance” from public policy increases with size and diversity.

13. How to measure “heterogeneity”? • Language • Religion • Cultural/historical distance Recent research: Spolaore and Wacziarg, “The Diffusion of Development,” forthcoming, Quarterly Journal of Economics, May 2009 Desmet, Le Breton, Ortuño Ortín , Weber, “Nation Formation and Genetic Diversity,” CEPR Working paper

14. Equilibrium Borders • Three types of equilibria: • 1) Nations ruled by Leviathans (rent-maximizing governments) • 2) Democratic equilibria (people vote over policies and borders) • 3) Borders determined by explicit civil and/or international conflicts (wars)

15. The Leviathan EquilibriumLeviathans prefer large nations because they want to maximize the rents (taxes) extracted by their populations, with the minimum amount of public good provision.In a non-democratic world of Leviathans, countries are larger than optimalLeviathans interested in eliminating regional autonomy.

16. Democratic EquilibriumOne person one vote; borders decided by majority voting and by unilateral secessions.Domestic policy decided by majority rule.Democratization leads to secessions

17. Optimality of EquilibriumDoes the democratic equilibrium reproduce the “optimal” configuration of borders?Efficient up to a point, when compared to Leviathan equilibrium (breaking up large dictatorial empires is efficient). But voting on borders - in the absence of efficient side-payments - can lead to “inefficient fragmentation” – that is, voters may reject “efficient” political unions.

18. In actual referenda over European integration, majorities of voters have often rejected proposals for further political unification. • Examples: recent (2008) vote in Ireland, votes in France, the Netherlands, Denmark, Norway (twice), etc.

19. Even in the U.S.: issues about efficiency and stability • “The United States is almost certainly too big to be a meaningful democracy … Sooner or later a profound …decentralization of the federal system may be all but inevitable. A recent study by economists Alberto Alesina of Harvard and Enrico Spolaore of Tufts demonstrates that the bigger the nation, the harder it becomes for the government to meet the needs of its dispersed populations. Regions that don’t feel well served by the government’s distribution of goods and services then have an incentive to take independent action…” Gar Alperovitz, “California Split,” The New York Times, February 10, 2007

20. International economic integration and country breakup • As international economic integration increases, the economic costs of being small are reduced, and hence political disintegration becomes less expensive • In a world of smaller countries, openness is more important • Economic integration and political disintegration go hand in hand

23. Conflict and Defense • National size is more important in a world of high international conflict and weak international alliances • With reduction of international conflict, countries can afford to be smaller • Less conflict, more trade: two reinforcing reasons to be small • However, reduction in global conflict may bring about an increase in local conflict – including more civil conflict

24. In summary, according to recent research on the political economy of national borders: • Large national unions come with substantial costs as well as benefits • Democratization, globalization and reduction in international conflict are associated with the formation of smaller countries • Up to a point, the breakup of countries can be efficient and welfare-improving • However, it may also lead to inefficient fragmentation and costly civil conflict

25. Key questions: Can the inter-regional transfer of resources and/or the decentralization of power provide a “solution” to inefficient political breakups? ..or would such transfers and decentralization make countries even less stable?

26. Interregional redistribution:an important distinction preference-based transfers “side payments” to regions that are “distant” from the central government in terms of preferences over public policies versus income-based transfers transfers from richer regions to poorer regions, based on income differences.

27. Preference-based transfers • In theory, these transfers of resources can be used to “compensate” regions that would otherwise secede, and could therefore ensure efficiency and stability (Alesina and Spolaore, 1997; 2003, chapter 4; LeBreton and Weber, 2001; Haimanko, LeBreton and Weber – and others).

28. Do preference-based transfers work in practice? Three limitations: 1) feasibility (high administrative costs, lack of resources) 2) political credibility (“time-consistency”) - since changing borders is more costly than changing tax/transfer policies, preference-based transfers may not be credible, unless there exists some “commitment technology” (say, enforceable international treaties with third parties) 3) incompatibility with other social goals (for example, with “interpersonal equity”)

29. Income-based Transfers • Empirically, most interregional redistribution is based on income taxation of individuals and firms, and henceforth it transfers resources from richer regions to poorer regions • Under some conditions, such transfers can keep poorer regions (with heterogeneous preferences) “in” • That is, a poorer region that would prefer separation without transfers, may decide to stay in a political union because of the transfers

30. Income-based Transfers: Centrifugal Effects • However, income-based redistribution may also induce richer regions to separate • In some cases, even a poorer region may prefer a political breakup if its preferred tax policy is very different from the one implemented by the central government (Bolton and Roland, 1997) • In general, income-based transfers in economically unequal countries tend to play a centrifugal role, by adding to the political costs of heterogeneity

31. In summary, interregional redistribution is a double-edged sword: • Well-designed interregional transfers can ensure country stability, by compensating regions with higher “heterogeneity costs” – that is, regions that are “far” (politically, culturally, linguistically, religiously etc.) from the national majority, and might otherwise break up. • But these preference-based compensations are difficult to implement both economically and politically. • In contrast, interregional redistribution based on income, while easier to implement, is likely to play a centrifugal role when there is economic inequality across regions as well as political heterogeneity.

32. Interregional redistribution and political decentralization • The effects of interregional redistribution on country stability depend on how centralized political power is within the country • The higher the degree of political centralization, the higher the heterogeneity costs for the periphery, and therefore the higher the pressure to compensate regions with diverse preferences • Is country stability enhanced or hampered when power itself is transferred from the center to sub-national governments?

33. Two opposite effects of power decentralization • More power to the periphery reduces the periphery’s heterogeneity costs from staying in a union, and hence the net benefits from secession (“centripetal effects” of decentralization: more country stability) • But more power to the periphery may also increases the periphery’s ability to secede (“centrifugal effects” of decentralization: less country stability)

34. Political decentralization as a stabilizing force • The idea of federalism as a way to preserve diversity in a democracy has a long pedigree. For example, in 1764 Cesare Beccaria wrote: “ A republic that is too vast cannot save itself from despotism except by subdividing itself and uniting itself into so many federative republics.” Similar ideas in debate over American constitution in 18th century, etc. • More recently, some political scientists have emphasized the positive effects of federalism on country stability and related outcomes: for example, Lijphart (benefits of a “power-sharing approach”), Weingast, Lake and Rothchild, and many others. • Historical examples: Switzerland, India?, Canada? etc.

35. Power decentralization as a destabilizing force • Power decentralization may provide resources and institutions that can be used in actual conflicts between “center” and “periphery” Historical evidence: • The Civil War in the United States • Breakup of Soviet Union and Czechoslovakia, and, much more violently, of Yugoslavia and (see Roeder, Suny, and others) • Failure of “decentralization” in Colombia in the 1990s. • Decentralization in Nigeria (e.g., the case of Warri)

36. How to assess the historical/empirical evidence? Problems: • How to define and measure decentralization? (“decentralization seems often to mean whatever the person using the term wants it to mean,” Bird, 1993) • How to measure “country stability” and other relevant outcomes? • How to identify causality?

37. Causality • Correlation does not mean causation. • On average, less healthy people may use more medicines and doctors, but that’s not because medicine and doctors “cause” diseases! • By the same token, decentralization could be empirically associated with more instability and civil conflict NOT because decentralization per se causes instability, but because decentralization may be an (imperfect) “cure” for instability • countries that are inherently less stable may face more pressure to decentralize. • Did the former Soviet Union or Yugoslavia break up because they had a federal system, or in spite of having a federal system?

38. Economic and political effects of federalism • In a recent study, Robert Inman (“Federalism’s Values and the Value of Federalism,” 2008), compares 73 federal and non-federal countries, and finds positive economic and political effects of federalism in democracies (but not in dictatorships). • Positive effects include: more orderly transfer of executive power, better protection of civil and political rights, and less corruption (see also Fisman and Gatti, 2002) • Are these effects causal? Inman attempts to address this issue by using “instrumental variables” [country land area, number of provinces, and provincial representation to the central government], and by limiting the sample to countries whose current constitutions were established before 1950.

39. Decentralization and ethnic conflict within federations • Bakke and Wibbels (“Diversity, Disparity and Civil Conflict in Federal States,” World Politics, 2006) focus on differences acrossfederal states • They find that fiscal decentralizationincreases the likelihood of ethnic conflict when there are wide disparities in income across regions. • However, the issue of causality remains open.

40. Conclusions I • The literature on the political economy of national borders studies efficiency and stability of borders as a function of different economic and political regimes and environments • In a world of non-democratic Leviathans countries tend to be inefficiently large, while democratization and international economic integration lead to secessions and formation of smaller, more homogeneous countries • However, country breakup itself may lead to inefficiency (i.e., excessive or costly fragmentation) if not accompanied by appropriate political-economic mechanisms and institutions.

41. Conclusions II • This literature points to a potentially positive role for both interregional redistribution and fiscal decentralization. • However, we should be skeptical about the extent to which interregional transfers, by themselves, can reduce regional conflict and potential separatism when there are large “heterogeneity costs” across regions, because of cultural, linguistic and/or economic differences. • Actual income–based regional redistribution, especially when interacting with ethnic and cultural diversity, is likely to increase inter-regional conflict.

42. Conclusion III • Federalism and decentralization raise the periphery’s benefits from political union, but also its ability to secede, with ambiguous effects on country stability • The empirical evidence shows that decentralization in federal states may be associated with more ethnic conflict when economic inequality is high across regions. • But the evidence also shows overall positive effects of federalism, both politically and economically, when accompanied by strong democratic institutions.