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

Author

Listed:
  • Arthur Schram

    (University of Amsterdam)

  • Aljaz Ule

    (University of Amsterdam)

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.

Suggested Citation

  • Arthur Schram & Aljaz Ule, 2013. "Democracy and Regulation: The Effects of Electoral Competition on Infrastructure Investments," Tinbergen Institute Discussion Papers 13-046/I, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20130046
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    References listed on IDEAS

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    9. Ioannis N. Kessides, 2004. "Reforming Infrastructure : Privatization, Regulation, and Competition," World Bank Publications - Books, The World Bank Group, number 13525.
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    More about this item

    Keywords

    Infrastructural investment; regulation; electoral competition; laboratory experiment;
    All these keywords.

    JEL classification:

    • L5 - Industrial Organization - - Regulation and Industrial Policy
    • L43 - Industrial Organization - - Antitrust Issues and Policies - - - Legal Monopolies and Regulation or Deregulation
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • C9 - Mathematical and Quantitative Methods - - Design of Experiments

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