Risk-sharing with a central authority: Free-riding, lack of commitment, and bail-outs

摘要

Agents with independent risks (regions) often create unions and delegate re-distributive power to a central institution (center) that provides risk-sharing through costly transfers. However, there is the risk that regions free-ride on each other; this risk may be exacerbated when the center cannot commit to future policies. We study a differential game of two regions that make savings decisions and a benevolent center that sets transfers but lacks commitment. We show that this fully dynamic savings game of high complexity can be characterized and computed. One region always ends up bankrupt and the center provides a bail-out: as the poor region enters bankruptcy, there is an upward jump in transfers to the poor region that coincides with a downward jump in the poor region’s consumption. Delegation to a center is Pareto-improving provided that the center’s welfare weights reflect initial wealth differences between regions. However, once regions’ wealth and the center’s welfare weights tilt sufficiently, the dynamics turn unstable, hastening impoverishment and bail-outs.