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Description:
In Japan, a formula-based transfer system resulted in local benefits from municipal mergers differing substantially from national benefits. A change in this transfer policy and the mergers that resulted are analyzed using a structural model involving private consumption, public good quality, and geographic distance, along with an asymmetric information problem between the national and local levels of government. The merger process is modeled using a cooperative form coalition formation game. Parameter estimates are obtained using a moment inequalities approach that requires neither an equilibrium selection assumption nor the enumeration of all possible mergers. Estimates suggest that the actual merger incentives the national government offered were weak relative to the optimal incentives, and the post-merger number of municipalities were large relative to the optimal number.