The author tries to answer the question whether the new institutional economy may be more useful than the neoclassical economy in explaining economic and social relations existing within the institution of the state. The observed disturbances between central and local authorities, notably the attempts to diminish the role of self-government, can negatively affect the provision of public and social goods to the citizens, and consequently, lead to non-effective use of the limited resources and outlays. Based on her analysis of the concept of institution, the essence of the relation between central and local authorities and some concepts and methods of the new institutional economy, such as ‘principal – agent’ relationship, transaction costs, and cost–benefit analysis, the author concludes that the methods of the new institutional economy are useful in the analysis of the mechanism of the functioning of public authorities. Moreover, as in the case of the relationship between the economy and public institutions, there is a need for an institutional equilibrium within the system of public authorities (the state).