Centralized Fiscal Spending by Supranational Unions

In: Economica, Band 84, Heft 333, S. 78-103

Abstract

We study fiscal spending by supranational unions, where participation is voluntary and countries bargain over contributions to and the allocation of a central budget. Since decisions are made by unanimity, bargaining power over the allocation becomes a function of contributions, which generically causes inefficiency in the presence of income asymmetry between member nations. This link between the budget allocation and contributions explains patterns of inefficient spending in the EU, e.g. why resources are diverted to low‐productivity projects in high‐income countries: the option of veto creates a trade‐off between efficiency on the contributions margin and efficiency on the allocation margin.