Where Tiebout Goes Wrong
The Tiebout model implies that local governments will be redistribution-free and waste-free. If you find these predictions absurd – and you should – local governments must violate one or more assumptions of the Tiebout model. What are the key violations?
1. The lowest-hanging fruit: Tiebout explicitly falsely assumes that local governments are perfect competitors. In the real world, though, local governments face a downward-sloping demand for residency curve. A locality does not lose all its residents simply because it offers a tax-benefit package 1% worse than the district next door.
2. Tiebout implicitly assumes that dissatisfied residents can take their real estate with them. Virtually the opposite is true. So as David Friedman points out, and as one of my papers in Public Choice argues at length, the main effect of unfavorable tax-benefit packages is not to induce migration, but to reduce property values.
Ultimately, though, neither (1) nor (2) get to the heart of the problem with Tiebout. True, local governments aren’t perfect competitors. But imperfectly competitive markets normally work fine: Ponder Amazon, Apple, or the restaurants in your neighborhood. Furthermore, (2) ignores reputation. Market forces may fail to protect current real estate owners in a locality. But local governments that somehow “bind their hands,” that are renowned for their aversion to redistribution and waste, should be far better at attracting labor and capital in the first place.
The fundamental problem with Tiebout, rather, is:
3. Tiebout implicitly assumes that non-profit competition works the same way as for-profit competition. It doesn’t. If a business owner figures out how to produce the same good at a lower cost, he pockets all of the savings. If the CEO of a publicly-held corporation figures out how to produce the same good at a lower cost, he pockets a lot of the savings. But if the mayor of a city figures out how to deliver the same government services for lower taxes, he pockets none of the savings. That’s how non-profits “work.”
With non-profit incentives, neither the number of local governments nor the ease of exit lead to anything resembling perfectly competitive results. The “competitors” simply have little incentive to do a good job, so they all tend to perform poorly.
To use an educational analogy: Think about the difference between competition on a graded exam versus competition on an ungraded exam. In both cases, there are many competitors. But if the exam doesn’t count, the competitors don’t try very hard, so the average outcome is poor.
You could object, of course, that the desire for re-election provides the necessary incentive. But (a) the whole point of the Tiebout model is to show that local government delivers the goods regardless of the quality of the democratic process, and (b) the desire for re-election often gives local politicians perverse incentives to pursue redistributive and/or wasteful policies. In the Tiebout model, a mayor who tried to replace over-educated, overpriced high school gym coaches would see his locality swell with residents and investment. In the real world, however, a mayor who tried to do this would be called a monster and thrown out of office.
If you’re a populist, you should be delighted by this outcome. If you’re an economist, you should be horrified. No matter how you evaluate the outcome, though, one thing is clear: contrary to the Tiebout model, local governments are not analogous to perfectly competitive firms. Not even close.