Academic journal article Economic Inquiry

Centralized or Decentralized Information: Which Is Better for Providing Incentives?

Academic journal article Economic Inquiry

Centralized or Decentralized Information: Which Is Better for Providing Incentives?

Article excerpt

I. INTRODUCTION

Consider a country's business environment or the quality of a country's infrastructures. Information about these characteristics may circulate in different ways. Data gathering may be relegated to an international watchdog, which issues publicly available country ratings. This is a case of centralized information. Or, entrepreneurs may hire their own experts, who gather and interpret data for them. This is a case of decentralized information. Which of these two scenarios is more effective for incentivizing a country's ruler to invest in ameliorating his infrastructures?

Suppose that the precision of information available to entrepreneurs is the same under both centralization and decentralization and that the ruler is risk neutral and aims at maximizing aggregate investment. If entrepreneurs make their investment decisions based only on their beliefs on the quality of infrastructure (i.e., independently of the actions of others) then centralization and decentralization are equivalent. For a given quality of infrastructures, they both deliver the same aggregate investment in expectation. The ruler's incentives to invest are therefore independent of the way in which information about the quality of the country's infrastructures is distributed.

Things are less clear if we allow for strategic interactions among the entrepreneurs. With strategic interactions, the entrepreneurs' investment decisions are affected not only by their beliefs about the quality of the country's infrastructure but also by their beliefs about the actions of others. For instance, the entrepreneurs' actions (investments) may be strategic substitutes. Consider a country for which investment by foreign entrepreneurs takes primarily the form of outsourcing of low-skilled manufacturing activities. Investment by other entrepreneurs will drive wages up, making individual investment less profitable. In this case, if an entrepreneur believes that others will invest heavily in the country, he is less inclined to invest, as returns from his investment are smaller. Alternatively, strategic complementarities may exist between the entrepreneurs. This case may emerge if there are knowledge or technology spillovers between different enterprises. Consider a country for which investment by foreign entrepreneurs takes primarily the form of locating research and development (R&D) and technology-intensive production facilities in that country. Although the wage-hiking effect described above is still present, entrepreneurs may now also benefit from investment by other entrepreneurs, through R&D and knowledge spillovers. (1) If this latter effect is sufficiently strong, entrepreneurs will be more inclined to invest in the country if they believe that others are also going to invest in it, as returns from investment are greater.

This article investigates the effect of information structure (centralized/decentralized) on the ruler's incentives. We show that, with strategic interactions among the entrepreneurs, the ruler's incentives under centralization differ from his incentives under decentralization. Essentially, this is because information structure affects the responsiveness of aggregate investment to changes in the quality of the country's infrastructures. In turn, this generates different marginal benefits of investment for the ruler.

Key to the result is the effect of information structure on the distribution of beliefs across the population of entrepreneurs. Consider, for instance, the case in which information is centralized. Each entrepreneur knows that everyone else has received the same information as him (and everybody knows that everybody knows etc. that this is the case). Beliefs over the quality of infrastructure are homogeneous: all entrepreneurs hold the same beliefs. Now consider the case of decentralized information dissemination. Each entrepreneur receives a different piece of information (or individual signal). …

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