DP3117 The Political Economy of International Unions
We model an international union as a group of countries deciding together the provision of certain public goods and policies because of spillovers. The countries are heterogeneous either in preferences and/or in economic fundamentals. The trade-off between the benefits of coordination and the loss of independent policymaking endogenously determines the size, the composition and the scope of unions. Our model implies that the equilibrium size of the union is inversely related to the degree of heterogeneity between countries and to the spectrum of common policies. Hence, there is a trade-off between enlargement and deepening of coordination: a union involved in too many collateral activities will be favoured by few countries, while a union which focuses on a core of activities will be favoured by many countries. The political equilibrium implies a bias toward excessive centralization and small size of the union, however. This bias can be corrected if there is a constitutional commitment of the union to centralize only certain policies.