Tag Archives: Brazil

Hamilton’s Paradox

I recently finished reading Jonathan Rodden’s 2006 book Hamilton’s Paradox: The Promise and Peril of Fiscal Federalism. The book provides a fascinating analysis of fiscal federalism that combines theory, qualitative and quantitative analysis, and contemporary case studies.

Rodden begins by detailing the potential promises and perils of fiscal federalism. He states that the promise of federalism is straightforward: “decentralized, multitiered systems of government are likely to give citizens more of what they want from government at lower cost than more centralized alternatives.” The perils of federalism, although less examined in the literature, are rooted in the idea that “In decentralized federations, politically fragmented central governments may find it difficult to solve coordination problems and provide federation-wide collective goods. As in the private sector, public institutions only produce desirable outcomes when incentives are properly structured” (p. 5).

In Chapter 3 Rodden provides a very interesting history of federalism and federal bailouts in the U.S. Specifically, he discusses the federal assumption of state debt that took place in 1790, the rapid growth in state borrowing in the early 1800s, the nine states that defaulted in 1841 and 1842 (Maryland, Pennsylvania, Arkansas, Florida, Illinois, Indiana, Louisiana, Michigan, and Mississippi), and the constitutional debt limitations that many states adopted in the 1840s and 1850s.

Most interesting is the game theory model Rodden develops in the second half of Chapter 3. Specifically, it’s a dynamic game of incomplete information that takes place between the central government and a single subnational government. Information is incomplete because subnational governments don’t know exactly how the central government will behave in the event of fiscal crisis. That is, the central government will either allow the subnational government to default (resolute type) or will provide a bailout (irresolute type).

The fist move of the game occurs when a subnational government experiences a fiscal shock with lasting effects (i.e. recession). In response to the fiscal shock it can either adjust immediately or refuse to deal with the shock by borrowing, with the long term hope of receiving a bailout. The path that the subnational government takes is a function of, among other things, the expected probability of the central government being resolute or irresolute (the complete game is much more detailed than the brief description provided here).

Rodden utilizes this game as he develops each of the case studies provided later in the book. The case studies involve comparing and contrasting the events that have taken place in Germany and Brazil. In the 1990’s two states in Germany received formal bailouts by the federal government (the Bund). During the same time, however, bailouts were distributed to virtually every state in Brazil. In Chapters 7 and 8 Rodden carefully details the structures of government in these two countries and outlines the reasons their outcomes were so different.

Two of the many important conclusions that Rodden makes in this book are (1)

when free to borrow, growing transfer dependence is associated with increasing deficits, both among federated units and local governments (p. 116)

and (2)

The central government must not only allow subnational governments significant tax autonomy and disentangle its books from those of the subnational governments, but it must demonstrate through costly action that it will not assume subnational liabilities when times get tough (p. 267)

This brief review of Hamilton’s Paradox only covered a few of the many important topics that the Rodden details in the book. I strongly recommend this book for anyone interested in fiscal federalism.

Experimentation in Drug Policy

Last week Mexico decriminalized possession of small amounts of marijuana, cocaine, heroin, LSD, and methamphetamine, creating one of the most liberal drug policy environments in the world, the Wall Street Journal reported. The new approach comes in the midst of the country’s fight against large drug cartels, and prosecutors suggest that by taking the focus off of small-time users, this policy will allow Mexican law enforcement to focus their efforts against large-scale dealers instead.

This decision comes after the War on Drugs, led by the United States, has failed for decades and some say that Mexican law enforcement is losing the battle with drug cartels. However, the decision to decriminalize drug possession does not necessarily mark a departure from the War on Drugs.  The New York Times reports:

The battle against the drug cartels, which has resulted in more than 11,000 deaths since [Mexican president Felipe] Calderón took office in December 2006, will continue unabated, officials insist. Revising drug possession laws, in fact, will help focus the drug war more effectively, they say.

The article says that some Mexican lawmakers have suggested that instead of merely decriminalizing small quantities, legalizing marijuana would provide a better solution, ending the struggle between law enforcement and the drug cartels that traffic marijuana.

Activist groups in the United States such as the Marijuana Policy Project advocate a similar position. Those who assert that the War on Drugs is an unworkable policy agenda argue that criminalizing drugs will never eliminate the supply or demand of illicit drugs. They believe that by ending the federal attempt to fight drug use, resources could be directed toward helping addicts rather than prosecuting and imprisoning drug users and dealers.

Another argument against the drug war is that it is an unconstitutional abuse of interstate commerce clause of the 10th Amendment. Marijuana became illegal in the United States under the Controlled Substances Act of 1970, marking a departure from the previously upheld notion that a constitutional Amendment would be required to ban drugs, such as the 18th Amendment which marked the prohibition of alcohol. Without such an amendment, some argue that drug law enforcement should be left to the states.

It does not appear that drug decriminalization will be pursued by the current administration; however, President Obama has ended the federal raids of medical marijuana dispensaries that were carried out under the Bush administration. This marks an improvement in the constitutional rights of the citizenry of individual states to determine their own drug policies. Furthermore, Attorney General Eric Holder said that federal efforts to prosecute drug law violators who violate both state and federal laws, giving states an increased incentive to pursue individualized policies.

This week, the Argentinian Supreme Court ruled that prosecuting people for possessing small quantities of marijuana is unconstitutional, and some government officials in Brazil and Ecuador suggest that their countries may liberalize their marijuana policies as well. These institutional shifts offer an opportunity to observe drug decriminalization in action. Will the new legal environment help reduce the country’s drug-related violence, or will it simply increase the number of addicts?

This international experiment offers an opportunity for policy makers to observe the changes in behavior that different policies incentivize, and could lead to results that will suggest appropriate approaches for U.S. lawmakers to take toward drugs. By further decentralizing drug laws domestically, the United States could become a country where people have an option to live in states where policies are in line with their beliefs, potentially reversing the wasteful and unsuccessful War on Drugs.