Inefficient Local Regulation of Local Externalities

Since only the residents of a single jurisdiction are affected by local consumption externalities, local regulation might be expected to be inefficient. Yet when production has increasing returns to scale, one jurisdiction's choice of regulatory standard affects the prices and availability of goods in other jurisdictions. These extra-jurisdictional effects can lead to inefficient outcomes with local regulation. Because of commitment failure, jurisdictions may choose divergent standards when an intermediate one is Pareto superior. There may also be coordination failures. The results question the usefulness of "subsidiarity" and "fiscal equivalence" as commonly conceived.