Weese (2009) Twitter

Political Mergers as Coalition Formation: Evidence from Japanese Municipal Amalgamations
Summary
Political Mergers as Coalition Formation:

Evidence from Japanese Municipal
Amalgamations
Eric Weese
Written by mixingale@twitter for private study
May 27, 2010
1/1
Summary
Summary: Methodological Issue
I How to formalize the political coalition formation?

I describe as a cooperative coalition formation game without
transferable utility
I apply vNM stability as a solution concept
I put restriction on preference or on blocking pattern to ensure the
existence and the uniqueness of the solution
I How to estimate the model primitives?

I simulated maximum likelihood
I some computational issues
2/1
Summary
Summary: Empirical Issue
I What kind of preference do municipality have over coalition?

I prefer high government services and low population
I What kind of rule is optimal?

I rule 1 (the national government forces the commitment to the
transfer): richer municipalities get richer and the poorer gets poorer.
optimality depend on the bargaining power of municipalities and the
social choice function of the social planner
I rule 2 (the central government sets incentives for mergers): sift
upward the utilities of significant number of municipalities
3/1
Theory
Notation
I Hedonic coalition formation game

I the payoff to each player depends only on the coalition to which it
belongs, and not on what other coalitions occur
I N set of players
I S ⊂ N a coalition of these players
I Π the set of all possible coalition structure
I ¹i the preference of i over {S ⊂ N|i ∈ S}
I preferences are extended to those over partitions: let π(i) ≡ S s.t.
i ∈ S, S ∈ π, induce the preference over coalition by
π(i) ¹i π 0 (i) =⇒ π ¹i π 0
I induce the preference by coalition by: π ¹i π, ∀i ∈ S =⇒ π ≺S π 0
4/1
Theory
vNM Stability
I Definition 1: (vNM Stable Set)

I ΠvNM is a stable set with respect to (Π, <) for some binary operator
< if:
I (internal stability) @π, π 0 ∈ ΠvNM where π < π 0
I (external stability) ∀π ∈/ ΠvNM , ∃π 0 ∈ ΠvNM where π < π 0
¤
I How to define binary operator <?
I we need to define < in a way that is intuitively plausible yet at the
same time guarantees that the stable set exists
5/1
Theory
Restriction
I Introduce non-cooperative foundation?

I no choice data
I no information on the actual negotiation process
I Assume that the preferences (including the realizations of
unobservable error terms) are identical across municipalities
I Allow for the preferences to depend on the covariates and the
unobservable error terms of municipalities but restrict the blocking
pattern
6/1
Theory
Restricted Preference Approach
Restricted Preference
I Define the utility of i by:
ui (S) = u(S) + αi
u(S) = v (XS ; θ) + ²S
I v is known up to θ and the distribution of ²S is known

I imply S ≺i S 0 =⇒ ∀j ∈ S, S ≺j S 0
7/1
Theory
Theorem 1 Existence and Uniqueness
I Theorem 1 (Farrell and Scotchmer, 1988)

I If all agents have identical preferences over coalitions, a generically
unique stable partition exists
I Proof:
I 0. Let V 0 be the set of all potential coalitions, start with π 0 = ∅ and
k=0
I 1. Given V k , find Smaxk
s.t. ∀S ∈ V k , u(S) < u(Smax
k
)
I k k
2. Given V and π , set π k+1
= π ∪ {Smax } and
k k
V k+1 = {S|S ∈ V k , S ∩ Smaxk

= ∅}
I 3. If V k+1 6= ∅, repeat from 1
¥
I k
intuition: Smax is never blocked once formed
8/1
Theory
Likelihood Function
I With ²0 ≡ {²S |S ∈ π0 }, perpS 0 = {S|S ∈ π0 , S ∩ S 0 6= ∅}, the

likelihood function can be written as:
Z
L(π0 stable|θ) = I (π0 stable|θ, ²)f² (²)d²
Z²
= P(π0 stable|θ, ²0 )f²0 (²0 )d²0
²0
Y
P(π0 stable|θ, ²0 ) = P(u(S 0 ) < max u(S)|²0 , θ)
S∈perpS 0
S 0 ∈V
I perpS 0 is a set of blocking pairs in π0 to S 0
9/1
Theory
Numerical Likelihood Function
I Given a set of random draws of ²0 , E0 , the numerical likelihood

function is:
1 X Y
L(π0 stable|θ) = P(u(S 0 ) < max u(S)|²0 , θ)
|E0 | 0
S∈perpS 0
²0 ∈E0 S ∈V
10 / 1
Theory
Relaxed Preference Approach
Utility Function
I Define the utility of i by:
ui (S) = v (Xi , XS ; θ) + ²iS
I neither the uniqueness nor the existence of a stable partition can be

guaranteed
11 / 1
Theory
Restriction on Blocking Pattern
I Allow only for the following two blocking patterns:

I refinement: subcoalition of a single existing coalition breaks off to
form a coalition
I coarsening: two or more existing coalitions merger in order to form
a new coalition
I under the current hedonic setting, they can be treated identically
12 / 1
Theory
Notation and Definition
I Let denote:
I π %S π 0 : S unanimously prefers the coarsening π 0
I π &S π 0 : S unanimously prefers the refinement π 0
I Definition 2: π → π 0 (π is blocked by π 0 ) if ∃S s.t. either
π %S π 0 or π &S π 0 , where
S
I π %S π 0 if π 0 \ π = S s.t. π ≺S π 0 , S = Q, ∃Q ∈ π
I π &S π 0 if ∃S ∈ π 0 s.t. π ≺S π 0 and
S
I π \ π 0 = S 0 with S 0 = Q 0 , ∃Q 0 ∈ π 0
I e s.t. Q 0 → Q
@Q e
¤
13 / 1
Theory
Illustration
Coarsening
π ʹ′ S = π ʹ′ − π
π Q1 Q2
€ Refinement
€ €
€ π Sʹ′ = π − π ʹ′
€ π ʹ′ Q1ʹ′ Q2ʹ′
€
€ €
€
€ 14 / 1
Theory
Theorem 2
I Theorem 2 Let 7→ be the transitive closure of →. Then,

I Π∗ = {π|@π 0 s.t. π → π 0 } is a stable set w.r.t. (π, 7→)
I Π∗ is unique
I Π∗ contains a Pareto optimal partition
15 / 1
Theory
Likelihood Function
I Assuming equal-probability equilibrium selection, the likelihood

function is:
Z
I (π0 ∈ Π∗ (θ, ²)
L(π0 |θ) = f² (²)d²
|Π∗ (θ, ²)|
²
Z
1
= P(π0 ∈ Π∗ (θ)) f (²|π0 ∈ Π∗ (θ))d²
∗ (θ, ²)| ²
² |Π
= P(π0 ∈ Π∗ (θ))E²|π0 ∈Π∗ (θ) |Π∗ (θ, ²)|−1
16 / 1
Theory
Expected Cardinality of Stability Set
I It is possible to calculate E²|π0 ∈Π∗ (θ) |Π∗ (θ, ²)|−1 since the
distribution of ² is known but is computationally demanding
I Approximate it by:
E²|π0 ∈Π∗ (θ) |Π∗ |−1 = [E²|π0 ∈Π(θ) |Π∗ |]−1

1 X
= |Π| P(πi ∈ Π∗ |π0 ∈ Π∗ , θ)
|ΠA |
π∈ΠA
I |ΠA | is a random draw of set of partitions
17 / 1
Theory
Probability of π0 being Stable
I Let S0 ↑ and S0 ↓ be the set of all coalitions that could be formed

by mergers and by refinements from π0 , respectively
I With these notations, the probability of π0 being stable is:
Y
P(π0 ∈ Π∗ (θ, ²)|²0 ) = P(π0 ⊀S S|θ, ²0 )
S∈(S0 ↑∪S0 ↓)
I Similarly,
P(πl ∈ Π∗ (θ, ²)|²0 , π0 ∈ Π∗ (θ))

1 X Y
= P(πl ⊀S |θ, ²0 , ²l , π0 ∈ Π∗ (θ))
|El |
²l ∈El S∈(Sl ↑∪Sl ↓)
18 / 1
Theory
Numerical Likelihood Function
I In total, the numerical likelihood function is given by:

1 X Y
L(π0 |θ) ∝ P(π0 ⊀S S|θ, ²0 )
|E0 |
²0 ∈E0 S∈(S0 ↑∪S0 ↓)
Ã !−1
1 X Y
× |ΠA | P(πl ⊀S |θ, ²0 , ²l , π0 ∈ Π∗ (θ))
|El |
²l ∈El S∈(Sl ↑∪Sl ↓)
19 / 1
Theory
Draw of ²S |θ, ²0 , π0 ∈ Π∗ (θ)
I If S is not a potential deviation from π0 :
f (²S |θ, ²0 , π0 ∈ Π∗ (θ)) = f (²S )
I If S is a potential deviation from π0 :
f (²S |θ, ²0 , π0 ⊀S S)
f (²S |θ, ²0 ) − f (²S |θ, ²0 , π0 ≺S S)P(π0 ≺S S|θ, ²0 )
=
P(π0 ⊀S S|θ, ²0 )
I f (²S |θ, ²0 , π ≺S S) is a truncated distribution with ∀i ∈ S,

²i > ui (π0 ) − vi (S)
20 / 1
Theory
Calculation of P(πl ⊀S S|θ, ²0 , ²l , π0 ∈ Π∗ (θ))
I If S is not a potential deviation from π0 , it can be calculated as

done for π0
I If S is a potential deviation from π0 :
P(πl ⊀S S|θ, ²0 , ²l , π0 ⊀S S)
= P(π0 ⊀S S|θ, ²0 , ²l )−1
× (P(πl ⊀S S|θ, ²0 , ²l )
− P(πl ≺S S|θ, ²0 , ²l , π0 ≺S S)P(π0 ≺ S|θ, ²0 , ²l ))
21 / 1
Application
Hedonic Coalition Game without Transferable Utility
I It is plausible to model mergers as a coalition formation game

without transfers
I political Coarse Theorem (Acemoglu, 2003) does not hold
I negotiations regarding compensation seem to be rare
I those in favor for mergers did not promise large transfers to those
opposed
I there will be some problem with contractibility in political mergers
such that transfers are difficult or impossible
22 / 1
Application
Local Allocation Tax
I Before 1990s, the central government have subsidized municipalities

according to a rule called “Lcoal Allocation Tax”:
Tm = max{e cm (g ) − 0.75τ Ym , 0}
e
cm (g ) = g (β0 + β1 POPm ) + vm
I Tm : the transfer to municipality m

I g : the minimum quality of services, the national government sets
I τ : tax rate, the national government sets
I Ym : income of municipality m
I e
cm (·): the standard financial need, the national government sets
I e
cm (·) is well-fitted by the second model
23 / 1
Application
Heisei Amalgamations
I During the financial difficulties of the early 1990s, the national

government implemented a series of reforms designed to reduce the
total transfers: boosted amalgamations among municipalities
I The government reduced transfers to the smallest municipalities by
revising the Local Allocation Tax
I table 2 in the next slide shows that the national government has
substantially reduced the estimates of standard financial need
I Municipalities that merged between 1995 and 2005 were promised to
receive the same amount of transfers as before for at least 10 years
from the date of the merger
I 3232 municipalities in 1995 → 1821 in 2006
24 / 1
Application
Estimated Standard Financial Need Formula
Table: Table 2: Estimated Standard Financial Need Formula
’96-’97 ’06-’07
Intercept 899.9 582.2
(43.9) (59.5)
Population 129.4 131.5
(0.5) (0.6)
Area 4.6 4.6
(0.2) 0.2)
N 1194 1194
25 / 1
Application
Data
I Use 1996-1997 financial data and 2000 population data

I most mergers occurred after 2002
I “Trinity” tax reforms were finalized at 2002
26 / 1
Application
Specification of Utility Function
I For any coalition S, specify the utility of municipality i ∈ S as:
ui (S) = θ1 log((1−τS )yi )+θ2 log gS +θ3 POPS +θ4 log AREAS +φXS +²iS
I XS is a vector of control variables, including a dummy for

non-singleton coalition
I τS = τ
27 / 1
Application
Computational Issues
I Restrict the mergers to those :

I contiguous
I borders less than 15 (actual maximum)
I This reduces the number of potential mergers to 5 million
I ² is drawn using appropriately constructed Markov chains
28 / 1
Application
Estimation Result
Table: Table 2: Estimated Standard Financial Need Formula
Restricted Preference Relaxed Preference

log gS 1.00 1.00
(0.05) (0.001)
log POPS -0.06 -0.12
(0.01) (0.0004)
log AREAS -0.13 0.01
(0.01) (0.0004)
log INCOMES 0.05 1.58
(0.03) (0.001)
IS.MERGERS -0.18 -0.001
(0.01) (0.001)
σ 0.35 0.05
29 / 1
Counterfactual Simulations
Transferrable Utility Model
I Assume that the national government forces municipalities to

commit to their transfers and thus transferrable utility model applies
I Assume that the transfers are small enough to allow the following
approximation:
P
j∈S zij
ui (S, z) = θ1 log((1 − τS )yi + ) + . . . + ²iS
POPi
P
θ1 j∈S zij
(1) ' θ1 log((1 − τS )yi ) + + . . . + ²is
(1 − τS )yi POPi
X
∝ θ1 log((1 − τS )yi ) + zij + . . . + ²is
j∈S
I Use nucleolus as a distribution rule
30 / 1
Figure 7
31 / 1
Incentives To Merge
I Consider a policy that offer a transfer equivalent to 0.3% of income

to richer municipalities
I “richer municipality” is one that had above average per capita
income in in more than half of the potential mergers they could have
participated in
I existence and uniqueness of the solution is preserved
I Two ways:
I ² is drawn from {²|π0 ∈ Π∗ (θ)}: Fig 8 and 9
I ² is drawn randomly: Fig 10
32 / 1
Figure 8
33 / 1
Figure 9
34 / 1
Figigure 10
35 / 1

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Political Mergers as Coalition Formation: Evidence from Japanese Municipal Amalgamations

Political Mergers as Coalition Formation:

Written by mixingale@twitter for private study

May 27, 2010

Summary: Methodological Issue

I How to formalize the political coalition formation?

I How to estimate the model primitives?

Summary: Empirical Issue

I What kind of preference do municipality have over coalition?

I What kind of rule is optimal?

I Hedonic coalition formation game

I Deﬁnition 1: (vNM Stable Set)

I Introduce non-cooperative foundation?

I Deﬁne the utility of i by:

I v is known up to θ and the distribution of ²S is known

Theorem 1 Existence and Uniqueness

I Theorem 1 (Farrell and Scotchmer, 1988)

V k+1 = {S|S ∈ V k , S ∩ Smaxk

I With ²0 ≡ {²S |S ∈ π0 }, perpS 0 = {S|S ∈ π0 , S ∩ S 0 6= ∅}, the

I perpS 0 is a set of blocking pairs in π0 to S 0

Numerical Likelihood Function

I Given a set of random draws of ²0 , E0 , the numerical likelihood

I Deﬁne the utility of i by:

ui (S) = v (Xi , XS ; θ) + ²iS

I neither the uniqueness nor the existence of a stable partition can be

Restriction on Blocking Pattern

I Allow only for the following two blocking patterns:

Notation and Deﬁnition

I Theorem 2 Let 7→ be the transitive closure of →. Then,

I Assuming equal-probability equilibrium selection, the likelihood

Expected Cardinality of Stability Set

E²|π0 ∈Π∗ (θ) |Π∗ |−1 = [E²|π0 ∈Π(θ) |Π∗ |]−1

I |ΠA | is a random draw of set of partitions

Probability of π0 being Stable

I Let S0 ↑ and S0 ↓ be the set of all coalitions that could be formed

P(πl ∈ Π∗ (θ, ²)|²0 , π0 ∈ Π∗ (θ))

Numerical Likelihood Function

I In total, the numerical likelihood function is given by:

Draw of ²S |θ, ²0 , π0 ∈ Π∗ (θ)

I If S is not a potential deviation from π0 :

f (²S |θ, ²0 , π0 ∈ Π∗ (θ)) = f (²S )

I If S is a potential deviation from π0 :

I f (²S |θ, ²0 , π ≺S S) is a truncated distribution with ∀i ∈ S,

Calculation of P(πl ⊀S S|θ, ²0 , ²l , π0 ∈ Π∗ (θ))

I If S is not a potential deviation from π0 , it can be calculated as

Hedonic Coalition Game without Transferable Utility

I It is plausible to model mergers as a coalition formation game

Local Allocation Tax

I Before 1990s, the central government have subsidized municipalities

I Tm : the transfer to municipality m

I During the ﬁnancial diﬃculties of the early 1990s, the national

Estimated Standard Financial Need Formula

Table: Table 2: Estimated Standard Financial Need Formula

I Use 1996-1997 ﬁnancial data and 2000 population data

Speciﬁcation of Utility Function

I For any coalition S, specify the utility of municipality i ∈ S as:

I XS is a vector of control variables, including a dummy for

I Restrict the mergers to those :

Table: Table 2: Estimated Standard Financial Need Formula

Restricted Preference Relaxed Preference

Transferrable Utility Model

I Assume that the national government forces municipalities to

I Use nucleolus as a distribution rule