Tradeoff between local protection and public sector performance: Lessons from judicial fiscal centralization

Abstract

A fundamental governance challenge facing central authorities is how to mitigate the prevalent local protection against non-local firms. We document that judicial fiscal centralization—transferring local courts’ budgetary power from local governments to provincial finance departments—significantly increases the winning probability of non-local plaintiffs (defendants) against local defendants (plaintiffs) if lawsuits are tried in the defendant's (plaintiff's) jurisdiction. However, such centralization exhausts local governments’ information advantage in keeping local courts accountable. Specifically, the reform shifts local courts’ expenditures from public affairs to private welfare and breeds judge corruption. Interestingly, as gifts in the form of pro-local rulings from courts to governments disappear, governments’ day-to-day support to courts also weakens, deteriorating the courts’ performance. Overall, our paper highlights the depth of the judiciary's political embeddedness and the complexity of fighting against local protection.