Regulation in a Political Economy: An explanation of limited commitment of governments in the context of the ratchet effect

Roland Strausz

Departmental Working Papers

Abstract: This paper offers an explanation why governments have limited commitment and are susceptible to the ratchet effect. It analyzes a two period model in which a government with full commitment regulates a firm. Each period is predated by an election. If contracts of previous governments tie newly elected governments, governments end up being unable to resist renegotiation. If previous contracts do not bind new governments and taxation has a crowding-out effect, a ratchet effect occurs which is similar, but not identical to the standard ratchet effect which is due to intertemporal non-commitment. Surprisingly, social welfare may be higher in the latter case.

Keywords: political economy; endogenous limited commitment; renegotiation; short run contracts (search for similar items in EconPapers)
JEL-codes: K20 L51 (search for similar items in EconPapers)
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