Local public goods, risk sharing, and private information in federal systems

We examine the implications of information asymmetries for the optimal desi gn of interregional insurance schemes and the allocation of local public go ods. We have good and bad news. The good news is that the presence of infor mational asymmetries is not in itself sufficient to deny federations the at tainment of either efficiency or egalitarian goals. The bad news is that no t only the first best may not be incentive compatible but also the incentiv e compatible optimum may violate participation constraints. Federations may have to content themselves with "fourth best" allocations as a result of s trategic manipulation of information by privately informed jurisdictions. ( C) 2000 Academic Press.