TOO MUCH INVESTMENT: A PROBLEM OF COORDINATION FAILURE

David de Meza and Ben Lockwood

The Warwick Economics Research Paper Series (TWERPS) from University of Warwick, Department of Economics

Abstract: This paper shows that coordination failure and contractual incompleteness can lead to socially excessive investment. Firms and workers choose investment levels, then enter a stochastic matching process. If investment levels are discrete, and match frictions are low, high-investing workers (firms) impose a negative pecuniary externality on any worker (firm) who cuts investment. Specifically, an agent cutting investment subsequently bargains with a partner with a binding outside option due to the fact that it can easily match with another high investor. The deviant thus bears the full loss in revenue from its action. However, given enough complementarity in investments, when one agent cuts investment it is efficient that its partner also does so. So, only part of the cost saving accrues to the deviant, with the implication that the net private gain to cutting investment is less than the social gain. A similar argument establishes that over-investment can occur when agents are heterogenous i.e. differ in their cost of investing, even if investments are continuous. Then, over-investment occurs because low-cost investors have a private incentive to invest to shift rent away from high-cost investors. Our model can also explain some recent trends in graduate/non-graduate wage differentials.

Keywords: hold-up; coordination failure; matching; over-investment (search for similar items in EconPapers)
JEL-codes: D23 D62 J31 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2004
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Related works:
Working Paper: Too Much Investment: A Problem of Coordination Failure (2004)
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Persistent link: https://EconPapers.repec.org/RePEc:wrk:warwec:703

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