A Model Of Market-Enhancing Infrastructure

This paper develops a framework for evaluating the social returns to infrastructure investments that intensify product market competition. We use a circular model with asymmetric production costs both for incumbent firms and potential entrants, where unit transport cost measures the intensity of competition (quality of infrastructure). The static and dynamic welfare effects of infrastructure investment that lowers unit transport cost are analysed, focusing on market selection among asymmetric firms, restructuring, and entry. We show how these welfare effects depend on the initial level of market development, as measured by the distribution of costs in the economy, the number of incumbent firms, the degree of market competition, and restructuring and entry costs. The model generates an endogenous demand for infrastructure investment, and the possibility of a low infrastructure trap that arises from cost heterogeneity rather than from any kind of non-convexities. We simulate the relative welfare effects of reducing transport, restructuring and entry costs, and we evaluate in each case the fraction of social returns which traditional cost-benefit analysis would fail to capture.