Exit and Voice: Yardstick Versus Fiscal Competition Across Governments

Government competition is often invoked as one of the main advantage of decentralization. But competition across governments can take two forms, through tax competition (exit) or yardstick competition (voice). We show these two forms may affect political equilibria in opposite directions. Tax competition increases the disciplining effect of elections on politicians, but it reduces the selection effect. Yardstick competition works in just the opposite direction. However, the two forms of competition may be complementary as expected welfare is concerned.