On Decentralization

Andrew Batson has a nice post out about an essay in the Palladium magazine. The theme of both the essay and the blog post is decentralization in China.

Dylan Levi King has a nice essay out in Palladium on the history of decentralization in China, opening with the assertion that “the most significant reform carried out in China after 1978 was one of systematic decentralization.” It is difficult to disagree with this. As the best China scholarship of the last few decades has made clear, local initiative played a central role in the country’s growth miracle–see for instance Jean Oi’s book on local state corporatism, or Xu Chenggang’s classic article on “regionally decentralized authoritarianism”.


The essay is a reflection on how decentralization has evolved (and retreated) under the various leaders who have been in charge of the central Chinese government, beginning with Mao, and ending with Xi Jinping. As always, please read the whole thing.

The essay makes the rather unsurprising point that under Xi’s leadership, China is becoming ever more centralized. But the interesting (if not entirely surprising) nugget is that the attempt to increase the degree of centralization began about thirty years ago – Xi is the first leader since then who’s been very successful at it.

Well, so far, at any rate. See this thread, for example:

But the essay helps us think about a question which should be of interest to a student of economics: what is the appropriate level of decentralization? I mean this to be a one-size-fits-all question: for any organization, institution or level of governance, how should we think about the appropriate level of decentralization?

Think about the answer to this question in regard to your own college/school, for example. Who do you need to approach for permission in order to hold an event in your college? Does any prof have the ability to give permission, or are they likely to pass your question up to the head of the department? What about the head of the department? Are they likely to take the decision, or will they pass the question up to the principal or the director? In other words, how much decision-making authority is vested in the lower levels of hierarchy? And how much decision-making authority should be vested in the lower levels of hierarchy?

It is a question with far reaching implications: a centrally driven decision making system retains all the power at the centre, and everybody knows who to go to for getting approval. On the other hand, this is likely to make the system rather inflexible, with very little decision-making authority at lower levels.

Here’s a very simple example: let’s say you’re fifteen minutes late while checking out of a hotel. Should you be charged a fine or not? Should this be up to the clerk who is helping you check out, or should the clerk just blindly follow the “rule” with zero decision-making authority? If you (the guest) then kick up a ruckus, should the clerk call their superior? Should the superior call their superior? And on and on…

Management consultants agonize about this, as do politicians and bureaucrats. But so do government officials, professors in universities and even parents! What is the appropriate level of decentralization is an important question in literally any organization!

So how do we go about building a model in our heads to think about this issue?

Here’s one way to think about it:

Let’s assume that we’re seeking to optimize for the long term growth and stability of the organization in question. That is, to me, an entirely reasonable assumption. Concretely, the management consultant in charge of instituting check-out processes in the hotel is charged with creating a process that will optimize for the long term growth and stability of the hotel chain.

Should the management consultant vest, then, the clerk with the power to waive off the late fee? Under what circumstances? To what extent? With what amount of leeway given for mitigating circumstances? Maybe the clerk can waive off the late fees only for a certain number of times per month? Can HR track which clerks waive off fees the least across the year, and decide bonuses accordingly? Or should clerks be rewarded for building out customer loyalty by waiving off late fees by default for a period of up to an hour beyond the checkout time?

What about re-evaluation requests for semester-end examinations? What about disciplinary committees for deciding upon the punishment for low attendance? The decision to sell land in order to meet revenue requirements by local governments? As you can see, once you start to think of hierarchies and organizations, this can get very complicated very quickly.

And within the field of economics (at least for a specific context), the Oates Theorem is a good starting point to think about this analytically:

Many years ago in Fiscal Federalism (1972), I formalized this idea in a proposition I referred to as “The Decentralization Theorem.” The basic point is that if there are no cost advantages (economies of scale) associated with centralized provision, then a decentralized pattern of public outputs reflecting differences in tastes across jurisdictions will be welfare enhancing as compared to a centralized outcome characterized by a uniform level of output across all jurisdiction

Oates, Wallace E. “On the evolution of fiscal federalism: Theory and institutions.” National tax journal 61.2 (2008): 313-334.

In English, what this means is that so long as centralized provisioning doesn’t have any “bulk” benefits, lower levels of hierarchy will always know more about “local” tastes and preferences, and therefore decision making ought to be as decentralized as possible.

Put another way, a one-size fits all rule won’t be as optimal for the hotel chain as letting the clerk in question decide on a case-by-case basis.

So as a thumb rule, the more one decentralizes, the better. Alas, decentralizing decision-making also has the knock-on effect of decentralizing power, and that tends to not go well with those who, well, have power.

And so while effective decentralization has economic benefits, it also has political consequences. Which is why it makes sense to ask what one is optimizing for. And occasionally, it behooves all of us to ask what one should be optimizing for.

The answers are often wildly different, and more’s the pity.