Public Input Competition, Stackelberg Equilibrium and Optimality

In this paper we examine the Stackelberg equilibrium in a public input competition model. We demonstrate that the issue of over-provision of public inputs raised in the standard fiscal competition literature may be less strong than predicted, provided that competing jurisdictions are more likely to behave in a Stackelberg fashion than in a non-cooperative one. For the mix of public expenditures, this paper shows that policy coordination contributes to higher welfare. However, the directions of policy coordination through which social welfare can be improved are indeed the opposite for the leading jurisdiction and the follower jurisdiction(s). That is, the changing pattern of decreased public inputs and increased residential public goods, as pioneered by Keen and Marchand [Keen, M., Marchand, M., 1997. Fiscal competition and the pattern of public spending. Journal of Public Economics 66, 33-53.], would only improve the social welfare of the follower jurisdictions. For the leading jurisdiction, improvement of social welfare requires a shift of expenditures from residential public goods to public inputs.