Democracy and Regulation: The Effects of Electoral Competition on Infrastructure Investments

Tinbergen Institute Discussion Paper 2013-046/I

43 Pages Posted: 20 Mar 2013

See all articles by Arthur J. H. C. Schram

Arthur J. H. C. Schram

University of Amsterdam - Faculty of Economics and Business (FEB); Tinbergen Institute

Aljaz Ule

University of Amsterdam - Center for Research in Experimental Economics and Political Decision-Making (CREED)

Date Written: March 15, 2013

Abstract

This paper investigates infrastructure investment in markets where regulation is subject to varying degrees of manipulation by elected politicians. Based on a model of price regulation in a market with increasing demand and long-term returns on investment we construct a multi-period game between a service provider, consumers with voting rights and elected decision makers. In each period the consumers elect a decision maker who may then regulate the price for service provision. Before an election the service provider chooses whether to increase its capacity. Investment is irreversible and profitable only with a sufficiently high price. We derive the subgame perfect equilibrium for this game and investigate the price and investment dynamics through an experiment with human subjects. The experimental results show that service providers invest when decision-makers' interests align with their own, though prices may rise inefficiently high when the regulatory framework is made independent of future political manipulation. Independency of regulation thus decreases efficiency and consumer surplus. In contrast, when decision-makers' interests do not align with service providers' we find efficiency only when regulation can be made independent from electoral dynamics.

Keywords: Infrastructural investment, regulation, electoral competition, laboratory experiment

JEL Classification: L5, L43, D92, C9

Suggested Citation

Schram, Arthur J. H. C. and Ule, Aljaz, Democracy and Regulation: The Effects of Electoral Competition on Infrastructure Investments (March 15, 2013). Tinbergen Institute Discussion Paper 2013-046/I, Available at SSRN: https://ssrn.com/abstract=2235065 or http://dx.doi.org/10.2139/ssrn.2235065

Arthur J. H. C. Schram (Contact Author)

University of Amsterdam - Faculty of Economics and Business (FEB) ( email )

Roetersstraat 18
CREED
Amsterdam 1018 WB
Netherlands
+31 (0)20 525 4293 (Phone)

HOME PAGE: http://www.fee.uva.nl/creed/PEOPLE/Arthurs.htm

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Aljaz Ule

University of Amsterdam - Center for Research in Experimental Economics and Political Decision-Making (CREED) ( email )

Faculty of Economics and Econometrics
Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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