Resistance to outside investment: A rational model of surplus - PowerPoint PPT Presentation

Resistance to outside investment: A rational model of surplus destruction Resistance to outside investment: A rational model of surplus destruction Sourav Bhattacharya, University of Pittsburg Tapas Kundu, University of Oslo Prepared for the Nordic Conference on Development Economics 2009 June 17, 2009

Resistance to outside investment: A rational model of surplus destruction Introduction Background Recent trend in policy making in developing economies Encouraging private investment Con‡ict with redistribution?

Resistance to outside investment: A rational model of surplus destruction Introduction Background Private investments are encouraged on the ground of e¢ciency, and creation of higher economic surplus, but most often associated with public resistance Resistance - delaying project …nalization, interruption of production process, blocking production at a public cost Investor-freindliness ! Resistance But is there a reverse causality?

Resistance to outside investment: A rational model of surplus destruction Introduction Questions Questions What explains the apparent puzzle of destructive resistance to productive investment? How does surplus destruction by social groups a¤ect the government’s investor-friendliness? How does resistance a¤ect social welfare through competition between governments ?

Resistance to outside investment: A rational model of surplus destruction Introduction Approach Basic Argument Resistance has informational value, which is important to the government if it is concerned for inequality However, resistance results in a loss of economic surplus The government can be weak in dealing with the outside investor because - loss of economic surplus may lead to suboptimal investment by the investor, and the government’s relative bargaining position changes as it expects a di¤erent utility through informative redistribution when resistance reveals information

Resistance to outside investment: A rational model of surplus destruction Introduction Related Literature Related Literature Resistance to outside investment in India 1) Bardhan 2005, 2006 2) Suri 2004 Signaling through costly public action 1) Theory survey: Ausubel et al. 2002 2) Application: Delaying - Harstad 2007, Heish 2000

Resistance to outside investment: A rational model of surplus destruction The model Framework Framework Players: 2 groups of citizens, A & B The regional government G An outside investor I

Resistance to outside investment: A rational model of surplus destruction The model Framework Nature of investment The investor decides the size of a project x � 0 Investor’s return (prior to any transfer) x � x 2 2 k k denotes the economic strength (of the region) to attract investment. Bene…t to group J 2 f A , B g from investment x : v J x � v with probability ( 1 � p ) v B = v with probability p Assumptions: ( 1 ) v > v , ( 2 ) v A + v > 0.

Resistance to outside investment: A rational model of surplus destruction The model Framework Sequence of events Stage 1: Policy G decides a tax/subsidy τ on the total size of the project x Stage 2: Investment decision I decides the size of x

Resistance to outside investment: A rational model of surplus destruction The model Framework Stage 3: Signaling B can take a costly action to signal its valuation Public cost: If B takes an action with public cost a > 0, the e¤ective size of the project is x ( 1 � a ) Stage 4: Redistribution G distributes/collects tax/subsidy from A and B at some pre-speci…ed rate s τ x and ( 1 � s ) τ x , s 2 [ 0 , 1 ] G decides a transfer of wealth t from group A to group B

Resistance to outside investment: A rational model of surplus destruction The model Framework Timing Timing of the game Policy Signaling Redistribution Investment Making time G offers I decides Valuations B chooses G decides v B realized tax τ to I scale x action a transfer t

Resistance to outside investment: A rational model of surplus destruction The model Payo¤s Payo¤s Investor x ( 1 � a ) � x 2 2 k � τ x

Resistance to outside investment: A rational model of surplus destruction The model Payo¤s Payo¤s Investor x ( 1 � a ) � x 2 2 k � τ x Citizens w A = v A x ( 1 � a ) + s τ x = v B x ( 1 � a ) + ( 1 � s ) τ x w B

Resistance to outside investment: A rational model of surplus destruction The model Payo¤s Government Averse to inequality L ( t ) = [( w A � t ) � ( w B + t )] 2

Resistance to outside investment: A rational model of surplus destruction The model Payo¤s Government Averse to inequality L ( t ) = [( w A � t ) � ( w B + t )] 2 A generalized measure of inequality L λ ( t ) = [ λ ( w A � t ) � ( 1 � λ )( w B + t )] 2

Resistance to outside investment: A rational model of surplus destruction The model Payo¤s Government Averse to inequality L ( t ) = [( w A � t ) � ( w B + t )] 2 A generalized measure of inequality L λ ( t ) = [ λ ( w A � t ) � ( 1 � λ )( w B + t )] 2 G cares about total wealth, but not at the cost of unequal distribution W 2 ( w A , w B , t ) = [( w A � t ) + ( w B + t )] � η [ λ ( w A � t ) � ( 1 � λ )( w B + t )] 2

Resistance to outside investment: A rational model of surplus destruction The model Equilibrium selection Equilibrium selection Sequential equilibria (separating) with beliefs satisfying Cho-Kreps Intuitive Criterion

Resistance to outside investment: A rational model of surplus destruction Underlying assumptions Assumptions Zero cost of redistribution (relaxed later) Positioning of the redistributive stage Informational bene…t

Resistance to outside investment: A rational model of surplus destruction Analysis Benchmarking When information can be obtained at zero cost (e¤ect of uncertainty) If signaling can be banned (e¤ect of costly action)

Resistance to outside investment: A rational model of surplus destruction Analysis First best: Suppose information will be revealed at zero cost

Resistance to outside investment: A rational model of surplus destruction Analysis Costless information (…rst best) Analysis When G can costlessly elicit valuations Proposition Optimal redistribution t o = λ w A � ( 1 � λ ) w B Optimal investment x o = k ( 1 � τ o ) Optimal taxation τ o = 1 � ( v A + Ev B ) 2

Resistance to outside investment: A rational model of surplus destruction Analysis Costless information (…rst best) Proposition G will subsidize investment if and only if its comparative expected valuation (with respect to the investor) is positive i.e., v A + Ev B � 1 > 0 .

Resistance to outside investment: A rational model of surplus destruction Analysis Costless information (…rst best) Two e¤ects if we allow signaling though costly action 1. Better redistribution makes G softer 2. Loss of surplus low surplus for the society: makes G harder low surplus for the investor and so low investment: makes G softer .

Resistance to outside investment: A rational model of surplus destruction Analysis Equilibrium analysis Equilibrium analysis 4) Redistribution stage t e = λ w A � ( 1 � λ ) w B ( 1 � λ ) ( v A + v B ) x ( 1 � a e ) w A � t = λ ( v A + v B ) x ( 1 � a e ) w B + t =

Resistance to outside investment: A rational model of surplus destruction Analysis Equilibrium analysis 3) Signaling stage Observation: - High type will take no action - Condition to ensure that no type misrepresenting its own type λ ( v � v ) λ ( v � v ) (( v A + v ) � λ ( v A + v )) � a � ( 1 � λ ) ( v A + v ) Lemma For the signaling subgame, in the unique separating equilibrium with beliefs satisfying intuitive criterion, the optimal action by B, is given by a ( v ) = 0 λ ( v � v ) (( v A + v ) � λ ( v A + v )) = a e 2 ( 0 , 1 ) a ( v ) =

Resistance to outside investment: A rational model of surplus destruction Analysis Equilibrium analysis 2) Investment stage ( 1 � p ) x + px ( 1 � a e ) � x 2 x e = arg max 2 k � τ x x k ( 1 � τ � pa e ) = 1) Policy stage � � ( 1 � p ) ( v A + v ) x e τ e = arg max + p ( v A + v ) x e ( 1 � a e ) + τ x e τ � � v A + Ev B �� pa e ( v A + v � 1 ) + 1 � = 2

Resistance to outside investment: A rational model of surplus destruction Analysis Equilibrium analysis Equilibrium Outcome Proposition Optimal redistribution t e = λ w A � ( 1 � λ ) w B Optimal investment x e = k ( 1 � τ � pa e ) Optimal taxation � � v A + Ev B �� τ e = pa e ( v A + v � 1 ) + 1 � 2

Resistance to outside investment: A rational model of surplus destruction Analysis Results E¤ect of costly mode of information revealing Proposition Compared to no-informational constraint case, subsidies will be provided over a broader range of parameter values. G will subsidize if and only if its comparative expected valuation (with respect to the investor) under no-informational constraint case is above its expected comparative loss at the low state i.e., ( v A + Ev B � 1 ) > pa e � � v A + v � 1 . Proposition G will be relatively soft (compared to the no-informational constraint case), i.e., τ e < τ o if and only if v A + v < 1 .

Resistance to outside investment: A rational model of surplus destruction Analysis Results Proposition The amount of surplus destroyed, i.e. a e is decreasing in λ , v A and v .