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Procedia Economics and Finance 33 ( 2015 ) 219 – 225

2212-5671 © 2015 The Authors. Published by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).

Peer-review under responsibility of Department of Accountancy and Finance, Eastern Macedonia and Thrace Institute of Technology doi: 10.1016/S2212-5671(15)01707-4

ScienceDirect

The Economies of Balkan and Eastern Europe Countries in the Changed World (EBEEC 2015)

Interregional Cooperation, local welfare and social capital.

Georges Sarafopoulos

a

* Panos Ioannidis

a aDepartment of Economics, Democritus University, Komotini 69100, Greece

Abstract

Cooperation among neighboring local governments determines the final outcome of local economic activity. Every local governmental unity tries to maximize its local welfare in order to improve living standards for population. Respectively, regions seek to adopt strategies by using available resources so that their productive circuit to be competitive.

This paper aims to research the terms of cooperation and competition between two neighboring local governments in order to understand the process of local development. Instruments of Game Theory are employed as methodology tools of interaction among economic and societal regional variables. The strategy of each local government is determined not only by the level of its economic and social activity, but by the respective level of its neighbor, as well. Regional multipliers and social capital are the crucial factors of equilibrium and as a sequence of local development.

Interaction between the two local governmental units determines crucially the cooperative implementation of an investment project. Game’s equilibrium also denotes that interregional bargaining of economic and social resources can support win win strategies. In addition the equilibrium of this model can be perceived as a guideline of good practices for policy makers and bureaucrats.

© 2015 The Authors. Published by Elsevier B.V.

Selection and peer-review under responsibility of Kavala Institute of Technology, Department of Accountancy, Greece.

Keywords: Regional Development; Institutional Reforms of Local Governments; Game Theory

* Corresponding author. Tel.: +302531039819

E-mail address: gsarafop@ierd.duth.gr

© 2015 The Authors. Published by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).

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1. Introduction

Game Theory has a long contribution in regional and urban studies. Games are broadly used by scholars order to study firm’s location (Ellis & Rogers, 2000; Fontini, 2003), investment projects (Wenner, 2003; Sarafopoulos & Ioannidis, 2014) and local governments’ operation (Feiock et al, 2005, Ioannidis, 2014; Hazakis & Ioannidis, 2014; Sarafopoulos &Ioannidis, 2015). Considering that each local economic space has its very characteristics, the research about the strategies of local agents takes receives essential importance.

The use of games in regional and urban research reveals the diverse options of interaction among actors with different interests and therefore shapes the ground for understanding the multiple dimensions of equilibrium (Commedatore et al., 2007; Rosser, 2011). Games are adopted as instruments of understanding the options of cooperation and conflict among local actors, and sequentially of studying the special dimensions of local development (Song & Panayidis, 2012).

Signal games are proper instruments in this field of research as they determine accurately the strategies that maximize the payoffs of actors. The signal which is usually a critical variable, determines not only the possible outcomes of equilibrium, but the dominant strategies of actors, as well (Gibbons, 1994; Skyms, 2010; Fudenberg & Olszewski, 2011). Under this standpoint, the use of signal games broadens the contribution of Game Theory in regional and urban research by integrating the strategies of local actors. Local interests that are transformed into strategies of conflict or cooperation feature the very characteristics of each community and therefore disclose vibrant information about local milieu (Coulson & Ferrario, 2007)

The aim of this paper is to introduce a signal game in the field of local governments’ operation. The notion of the game is to study the influence that social capital exercises on local economic activity. Game’s scenario is based on the potential cooperation of the two local government units that operate in the same region. The signal of the game is the regional multiplier which receives two critical values, high and low.

After introduction, in section 2 the basic elements of the game are studied. According to the sufficient condition of the signal game, social capital is the critical variable of equilibrium. Lastly in section 3 the conclusions of the paper are drawn.

2. The Game

2.1 Basic Elements of the Game

A signal game is introduced in order to understand the investment strategies between two neighboring local governments operating in the same region, namely LGi and LGj. Local government i and local government j are the

only local government units of the region. It is also assumed that LGi is a more prosperous region than LGj is, and

therefore contributes more to the formation of regional multiplier than LGj does.

Local governments have two options to cooperate in the materialization of an investment project and or to adopt a free rider strategy. The investment project gives to local governments a payoff equal to

S

. Game’s signal is the regional multiplier

( )

r

of the regional economy that LGi and LGj belong spatially and administratively. It is also

assumed that LGi is a more prosperous region than LGj is, and therefore contributes more to the formation of

regional multiplier. Regional multiplies receives two values, i.e.

r

hwhich signals regional economies with high values of growth and

r

h which signals regional economies with low values of growth. The first movement in the game belongs to LGi and LGj responses. The game is depicted in figure 1.

(3)

Cooperate

(U

11

, U

21

)

r

h

q

A

M

(U

12

, U

22

)

No Cooperate

(U

13

, U

23

)

Cooperate

1-q

r

l

B

N

No Cooperate

(U

14

, U

24

)

Figure 1: The Game

Where 11 h i j 21 h j i 12 h i 22 h j 13 l i j 23 l j i 14 l i 24 l j

U

r [ ak

( 1

)k ] , U

r [ k

( 1

)k ] ,

U

r k

,U

r k

,

2

2

U

r [ ak

( 1

)k ] , U

r [ k

( 1

)k ] ,

U

r k

, U

r k

,

2

2

E

S

E

D

S

S

S

E

S

E

D

S

S

S

(1)

2.2 Strategies and Payoffs of the Game

Apart from the abovementioned variables the strategies of the two local governments are also determined by

k

i,

k

j,

a

and

E

.Specifically

k

i denotes the social capital in administrative space of LGi and respectively

k

j

represents the level of social capital in LGj. Additionally,

a

and

E

are coefficients that refer to the level of social

capital that stays or/and leaves from a local government unit to other-here from local government i to local government j and vice versa. Note that

D E

,



(0,1)

.

As depicted in figure 1, LGj has two options: to cooperate or not to cooperate. The strategy of the second-and less

prosperous local government (j) is determined by the level of regional multiplier. In the first case, when regional multiplier in high levels LGj has the motive to cooperate in order to receive a part of the more advanced economic

activity of the territory of LGi. This strategy is associated with a trade off in social capital between the two local

government units. In this perspective the payoff for LGj’s cooperative strategy equals to

21 h j i

U

r [ k

E

( 1

D

)k ]

S

(2)

but when the poorer local government chooses the free rider strategy takes

Nature

LG

i

LG

i

LG

j

(4)

22 h j

U

r k

2

S

(3)

The relevant payoffs for the prosperous local government is

11 h i j

U

r [ ak

( 1

E

)k ]

S

(4)

and on the other end of the spectrum LGi receives

12 h i

U

r k

2

S

(5)

respectively.

The second route of the game is signalled by the low level of economic activity inside the region which is expressed by

r

l. The affiliation of local government i in the game is indicated by node A, and in that order, the affiliation of local government j is figured by node by N. Under these circumstances when LGj selects cooperation strategy

receives

23 l j i

U

r [ k

E

( 1

D

)k ]

S

(6)

and when does not cooperate

24 l j

U

r k

2

S

(7)

Local government i takes

13 l i j

U

r [ ak

( 1

E

)k ]

S

(8)

in the cooperation field and

14 l i

U

r k

2

S

(9)

in the free rider option.

The regional multiplier is the critical variable of game’s equilibrium. The critical standpoint is the establishment of sufficient condition for the adoption of cooperative strategy in the materialization of investment project. As LGi is

the more prosperous region, it is logical to suppose that the interaction between the two local government units is determined, except from economic circuit by social variables, as well. This means that the cooperation strategies are affiliated with a trade off social resources, i.e. trust, reciprocity and networking between the two local government units.

(5)

3. The game

2.3. The Sufficient Condition for Cooperation

The investment project will be run cooperatively when the following condition is valid

21

1

23 22

1

24

qU

q U

t

qU

q U

(10)

or

[

(1

) ]

1

[

(1

) ]

(1

)

2

2

h j i l j i h j l j

qr

E

k

D

k

S

q r

E

k

D

k

S

t

qr k

S

q r k

S

(11)

where

q

is the probability of

r

hand

1

q

the probability of

r

l.

After some calculations in (11) we have

[

(1

)

][

(1

)]

[

(1

)]

2

j

a

i

r q

h

r

l

q

j

r q

h

r

l

q

S

S EN

N

t

N

(12)

or

1 2

2 2

i j

k

k

a

E

t

(13)

this means that the sufficient condition for equilibrium stands when

- if

k

i

t

k

jand

1 2

2 2

i j

k

k

a

E

then

1

2

a

t

E

(14)

- if

k

i

d

k

j then

1

2

a

d

E

(15)

- if

k

i

k

jand

1 2

2 2

i j

k

k

a

E

then

1

2

a

E

(16)

(6)

Looking at the conditions that are generated by (14), (15) and (16), it can be stated that when the poorest local government (LGj), has higher levels of social capital than the wealthier region (LGi), then the adoption of

cooperative strategies by the two local governments is more possible.

1 2

2 2

i j

k

k

a

E

This outcome accrues as a consequence to the fact that the difference between

D

and

E

is below 0.5. Taking in to account that

D E

,



(0,1)

, it can be understood that big differences in the values of social capital withhold inside the local units are associated with higher levels of social capital in LGi. Even in the case of (16), whereas the two

local government units are governed by same levels of social capital, cooperation is a bit difficult, as LGi ought to

hold significantly more social capital for her than LGj does.

4. Discussion

In recent years the social variables of regional economies have been integrated in the research as critical determinants local development. Especially the role of social capital attracted the attention of scholars by focusing the role of trust, reciprocity and networking in local economic circuit (Fine, 2001; Kallio et al, 2010). This paper tried to contribute in this research field by portraying the abovementioned interaction into a signal game. Equally important is the advancement of research in signal games in order the diverse interests of local actors to be classified more accurately (Rilley, 2001).

The scenario of the game is based on a potential cooperation between two local that are the only local government units of a region. The cooperation has as desideratum an investment project that can be run by the two local government units. In any other case excluding cooperation, the payoffs of both actors are reduced to the half. In addition, the healthier local government (LGi) contributes more to the regional economic development and as a result signals to the poorest local government (LGj). According to the sufficient condition, the strategy of LGj is determined not only by the level of regional multiplier (high or low), but by the bargaining of social capital between LGi and LGj, as well. The key element of cooperation lies in the values of social capital that each local government unit holds for it. Small deviations between these values favored more the cooperative execution of the investment project, when

k

i is below

k

jand vice versa.

The notion of the game is that cooperation between two neighboring local governments presupposes a mutually beneficiary trade off. In the game presented above, LGi gives to LGj much of its local economic activity. In return, LGi holds more social capital for it, than LGj does. This is the case when (15) is valid and LGj gives proportionally more social capital than receives as it has already takes the payoffs of regional multiplier. In other word, efficient cooperation is an outcome of cognitive swapping.

The basic limitation of the research is that depicts a model case as lacks statistical evidence. However the model tries to summarize the basic options of a local government’ functions by taking into account its economic and social operation. Notwithstanding the findings of the research stand in a theoretical level can be perceived as an alternative base of local and regional planning. Especially, the adoption of social capital in local government strategies can engender improvements in the quality of life for local actors.

Future research should focus on the very special characteristics of each local government unit so that these elements to be included in signal games. Especially in the fields of cooperation among local governments signals can contain not only socioeconomic variables, but also political and spatial variables.

(7)

References

Coulson A., Ferrario, K., (2007), Institutional Thickness’: Local Governance and Economic Development in Birmingham, England, International Journal of Urban and Regional Research, 31, (3), 591-615.

Ellis, S.,Rogers, C., 2000. Local Economic Development as a Prisoners' Dilemma: The Role of Business Climate. Review of Regional Studies 30, 315-330.

Feiock R., Steinacker A., Park, H.J., (2005), Institutional Collective Action and Economic Development Joint Venture, Paper Presented at the Annual Meeting of the

American Public Administration Association, April 2-5, 2005.

Fine B., (2001), Social capital vs. social theory: Political Economy and Social Science at the turn of the Millennium, Routledge, UK. Fontini, F., 2003. A Firms-Government Coordination Game under Strategic Uncertainty. Studi Economici 80, 73-84.

Fudenberg D, Olszewski W., (2011), Repeated Games with Asynchronous Monitoring of an Imperfect Signal. Games and Economic Behavior. (72):86-99.

Gibbons, R.G., 1994. A Primer in Game Theory. Prentice Hall

Ioannidis P.G., (2014), The Impact of Local Government Institutional Reforms on Local Economic Space: from Kapodistrias to Kallikrates, PhD Thesis, Department of Economics, Democritus University (in Greek).

Kallio A., Harmaakorpi V.,Pihkala T., (2010), Absorptive Capacity and Social Capital in Regional Innovation Systems: The Case of the Lahti Region in Finland, Urban Studies, 47, (2) 303–319.

Osborne, M., Rubinstein, A., 1994. A Course in Game Theory, MIT Press.

Rilley, J., 2001. Silver Signals: Twenty-Five Years of Screening and Signaling. Journal of Economic Literature 39, 432-478.

Rosser, J.B. Jr., 2011. Non Linear Dynamics in Urban and Regional Systems, in Puu, T., Panchuck, A., (Ed.), Nonlinear Economic Dynamics, Nova Science Publishers, p.p. 113-126.

Sarafopoulos, G., Ioannidis P.G., (2014), Local Agents’ Cooperation as a Signal Game: Firms, Local Governments and Investment Strategies, Procedia Economics and Finance (Proceedings of The Economies of Balkan and Eastern Europe Countries in the Changed World-EBEEC 2013), 9, 133-141

Sarafopoulos, G., Ioannidis, P.G., (2013), Institutional Reforms and Interaction of Local Governments: A Dynamic Approach, Paper Presented at the 2nd International Conference on Econophysics, 13-14 September, 2013, Kavala, Greece.

Skyrms, B. (2010). Signals Evolution, Learning & Information. New York: Oxford University Press

Song, D.-W., Panayides, P., (2002) A conceptual application of cooperative game theory to liner shipping strategic alliances, Maritime Policy & Management: The flagship journal of international shipping and port research, 29:3, 285-301

Wenner M., (2003), Dealing with Coordination Issues in Rural Development Projects: Game Theory Insights, Working Paper, Washington, DC June 2007-No. RUR-07-06.

References

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