Investment complementarities, coordination failure, and the role and effects of public investment policy

Tetsuya Kasahara

No 589, Discussion Paper Series from Institute of Economic Research, Hitotsubashi University

Abstract: This paper analyzes the role and effects of public investment policy when coordination problems among agents can result in individually rational but socially inefficient investment decisions. Developing a coordination investment model in which individuals simultaneously and independently determine whether to undertake a risky but potentially more profitable investment project or an alternative with safe but lower returns, we first show that the risk of coordination failure can in equilibrium result in socially inefficient investment and small consumption. We then investigate the role and effects of a public investment policy designed to help mitigate inefficiency. In our model, the size of a feasible public investment policy is determined endogenously. Our numerical results show that the divisibility of investment projects, the presence of financial constraints, the productivity of public investments, and the relative precision of public and private information, as well as the relative tax rates imposed on risky investments and safe investments, have complex effects on the effectiveness of public investment policy and welfare. In particular, we demonstrate that a public investment policy of a larger size and the availability of more precise information do not necessarily increase welfare.

Keywords: Strategic complementarities; coordination games; information precision; public investment policy; financial constraints (search for similar items in EconPapers)
JEL-codes: C72 D81 H21 H53 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2013-06
New Economics Papers: this item is included in nep-cta, nep-mic, nep-pbe and nep-ppm
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Persistent link: https://EconPapers.repec.org/RePEc:hit:hituec:589

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