The Political Economy of Public Investment

35 Pages Posted: 14 May 2008

See all articles by Roel M. W. J. Beetsma

Roel M. W. J. Beetsma

University of Amsterdam - Research Institute in Economics & Econometrics (RESAM); European Commission; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute); Tinbergen Institute; Netspar

Rick van der Ploeg

University of Oxford

Date Written: February 2007

Abstract

The political distortions in public investment projects are investigated within the context of a bipartisan political economy framework. The role of scrapping and modifying projects of previous governments receives special attention. The party in government has an incentive to overspend on large ideological public investment projects in order to bind the hands of its successor. This leads to a bias for excessive debt, especially if the probability of being removed from office is large. These political distortions have implications for the appropriate format of a fiscal rule. A deficit rule, like the Stability and Growth Pact, mitigates the overspending bias in ideological investment projects and improves social welfare. The optimal second-best restriction on public debt exceeds the level of public debt that would prevail under the socially optimal outcome. Social welfare may be boosted even more by appropriate investment restrictions: with a restriction on (future) investment in ideological projects, the current government perceives a large benefit of a debt reduction. However, debt and investment restrictions are not needed if investment projects only have a financial return.

Keywords: Bipartisan, deficit rule, golden rule, ideological projects, investment restriction, market projects, political economy, public investment, scrapping public investment

JEL Classification: E6, H6, H7

Suggested Citation

Beetsma, Roel M. W. J. and van der Ploeg, Frederick, The Political Economy of Public Investment (February 2007). CEPR Discussion Paper No. DP6090, Available at SSRN: https://ssrn.com/abstract=1132227

Roel M. W. J. Beetsma (Contact Author)

University of Amsterdam - Research Institute in Economics & Econometrics (RESAM) ( email )

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Frederick Van der Ploeg

University of Oxford ( email )

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United Kingdom

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