Public Investment as Commitment
44 Pages Posted: 7 Feb 2011
Date Written: June 2011
Should public assets such as infrastructure, education, and the environment earn the same return as private investments? We consider if time-inconsistent decision-makers can gain from institutions that enforce cost-benefit rules on large projects that influence the economy as a whole. Long-term public investments provide commitment to current preferences, leading to investment biases in such assets. The institutionalized cost-benefit prudence eliminates such biases but we show that this behavioral rule has no general social value: it implements Pareto efficiency if and only if preferences are time-consistent, and decreases welfare otherwise. We find that the long-term cost-benefit prudence is fundamentally about income transfers to the future, implying that efficient behavioral rules should target savings directly rather than the division of current investment resources.
Keywords: public investments, cost-benefit analysis, inconsistent preferences
JEL Classification: H430, H410, D610, D910, Q540, E210
Suggested Citation: Suggested Citation