Externality and information asymmetry in the production of local public goods

A traditional argument in public economics says that externality favors centralization (decision-making by the central government) and information asymmetry favors decentralization (decision-making by local governments). In this paper, we find a linkage between externality and information asymmetry with regard to the relative efficiency of centralization and decentralization. In addition, we study the incentives of local governments to reveal their private information. When the uncertainty of private information is sufficiently high, it is possible to improve efficiency by providing a cost incentive for local governments to truthfully reveal their information. Without providing a cost incentive, it is also possible to improve efficiency with the local governments revealing their information partially, but not completely.