This study has applied some basic principles of economic theory to the history of political institutions in England and America, and has also compared them with some political institutions in the history of China. It is argued in this paper that the relationship between local governments and the national government is vital to the success of great nations. To illustrate this point, the development of four important point institutions in English and American political history has been analyzed：the medieval Court of the Exchequer, the English common law, the English Parliament, and the American system of federal democracy. The Court of Exchequer was an important institution around 1200 in the early development of the English monarchy, which guaranteed that high officials were being appropriately judged for rewards or punishments. Each sheriff, governor of one of the provinces in medieval England, met the treasurer who was the representative of the central government twice a year at the Court of the Exchequer to settle the sheriff's accounts. And a large subset of the most powerful people in England gathered also at the Court of the Exchequer just to watch and verify everything that they did. Everything that the sheriff had been doing was publicly recorded there at the Exchequer. Therefore, local governors were motivated by the promise of large moral-hazard rents. The great common law in England, which had really begun to develop under Henry II around 1170, leaded directly to the legal tradition that we have in America and Britain today. After a long civil war between Henry's mother and his uncle Stephen, Henry who became the king in the end developed a court system that combined elements of centralization with a decentralized dependence on local governments to assure members of rival political elites that their ability to enjoy certain privileges would be protected under a new national leader. The English common law and the Confucian civil service examinations have some similarities both in historical origins and in their functions.A century after Henry II, around 1300, his great-grandson King Edward I developed Parliament as a way of strengthening the state. The early Parliament gave representation to the local officials who exercised the power of the state at its lowest level. Such parliamentary representation strengthened the state by creating decentralized protection for moral hazard rents of thousands of local government officials. The Parliament was just the Court of Exchequer for the local gentry. The fact that towns were represented in Parliament made them particularly effective as engines of economic growth in the early modern era. On the other hand, the fact that rural gentry were represented in England's Parliament was also important in the 1700s for the creation of some companies called turnpike trusts that built toll roads throughout England, giving England the best transportation system of the 18th century, and thus setting the stage for the industrial revolution. When looking for an analogue of Parliament in traditional China, the closest institution is the Confucian system of circulating memorials by scholar-officials. It gave a national political voice to government officials.A successful democracy requires more than just elections; it also requires alternative candidates who have good democratic reputations. Local governments provide the most opportunities for leaders to begin cultivating such reputations. Democratic development in America actually began with decentralized local democracy, and democracy in America has always been federal, in the sense of having separately elected offices at the local, provincial, and national levels. Local democracy can reduce barriers against entry into democratic competition at higher levels of government, and thus local democracy can make elections at higher levels more competitive. On the other hand, elections at higher levels of government can also help to sharpen the competitive incentives for good government in local democracy. Successful democratic development may depend on an interaction between democracy at different levels of government, from local to national.