Public Investment as Commitment

44 Pages Posted: 7 Feb 2011

See all articles by Reyer Gerlagh

Reyer Gerlagh

Tilburg University - Tilburg University School of Economics and Management

Matti Liski

Aalto University - Department of Economics

Date Written: June 2011

Abstract

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

Gerlagh, Reyer and Liski, Matti, Public Investment as Commitment (June 2011). CESifo Working Paper Series No. 3330. Available at SSRN: https://ssrn.com/abstract=1756669

Reyer Gerlagh (Contact Author)

Tilburg University - Tilburg University School of Economics and Management ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Matti Liski

Aalto University - Department of Economics ( email )

PO Box 1210
FI-00101 Helsinki
Finland
+358-9-43138384 (Phone)
+358-9-43138735 (Fax)

HOME PAGE: http://www.hkkk.fi/~liski

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