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SHORT‐RUN POLICY COMMITMENT WHEN INVESTMENT TIMING IS ENDOGENOUS: ‘MORE HARM THAN GOOD?’
Author(s) -
Dewit Gerda,
Leahy Dermot
Publication year - 2011
Publication title -
bulletin of economic research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.227
H-Index - 29
eISSN - 1467-8586
pISSN - 0307-3378
DOI - 10.1111/j.1467-8586.2009.00332.x
Subject(s) - subsidy , incentive , monopoly , economics , distortion (music) , harm , oligopoly , investment (military) , economic interventionism , intervention (counseling) , commitment device , government (linguistics) , microeconomics , public economics , dynamic inconsistency , market economy , cournot competition , psychology , politics , political science , law , amplifier , linguistics , philosophy , cmos , electronic engineering , psychiatry , engineering
In our model, firms choose when to set cost‐reducing investment and the government, which only has short‐run commitment power, sets an output subsidy. We show that firms that delay investment without government intervention have an incentive to invest early under policy activism, strategically underinvesting or overinvesting to obtain larger subsidies. The policy scheme thus creates a new, potentially more harmful, distortion. Under oligopoly, a firm has a weaker incentive to manipulate policy than under monopoly, which makes policy intervention less harmful. We investigate when the government may do better by adhering to laissez‐faire than by engaging in active policy intervention.