On the dynamic inefficiency of governments

When the government must decide not only on road public-policy programs (like investment in infrastructure) but also on the provision of group-specific public goods (like regional transfers or subsidies), dynamic strategic inefficiencies arise. I present a model where the struggle between opposing groups -they disagree on the composition of expenditures and compete for government office- results in governments being endogenously short-sighted. As a result, there is a systematic under-investment in infrastructure and overspending on public goods. This results from resources being more valuable when in power than when out of power. Which group wins government office depends on explicitly modeled election outcomes that are functions of economic as well as (exogenous) political preferences of the citizens. I show how different characteristics of the groups involved in the political conflict affect the economy. In particular, I find that more ideologically homogeneous societies have higher capital accumulation and more efficient allocations since there is a greater incumbency advantage. I also find that when there is an average advantage for one group over the other in the political dimension, this group has incentives to act differently in office, even though both groups have the same basic preferences regarding the size of public spending (though not regarding its composition) and the level of investment. The group that loses the elections more often tends to spend a higher share of output on public goods while investing even less than the other group (when in office). This creates economic cycles -that follow the political cycle- introducing fluctuations in real macroeconomic variables without assuming any exogenous productivity shocksPublic Investment, Commitment, Probabilistic Voting, Markov Equilibrium, Political Cycles, Time-consistency

The political economy of labor subsidies

We explore a political economy model of labor subsidies, extending Meltzer and Richard's median voter model to a dynamic setting. We explore only one source of heterogeneity: initial wealth. As a consequence, given an operative wealth effect, poorer agents work harder, and if the agent with median wealth is poorer than average, a politico-economic equilibrium will feature a subsidy to labor. The dynamic model does not have capital, but it has perfect markets for borrowing and lending. Because tax rates influence interest rates, another channel for redistribution appears, since a decrease in current interest rates favors agents with a negative (below-average) asset position. ; By the same token—and as is typically the case in dynamic politico-economic models with rational agents—the setting features time-inconsistency: the median voter would like to commit to not manipulating interest rates in the future. Under commitment, and under the assumption that preferences admit aggregation, we show that labor subsidies subsist only for one period; after that, subsidies are zero. That is, under commitment, the median voter takes advantage of the voting power once and for all. His wealth moves closer to that of the mean (which is zero), but afterwards he refrains voluntarily from further subsidization. Under lack of commitment, which we analyze formally by looking at the Markov-perfect (time-consistent) equilibrium in a game between successive median voters in the same environment. Instead, subsidies persist—they are constant over time—and are more distortionary than under commitment. Moreover, in the situation without commitment, the median voter does not manage to reduce asset inequality, unlike in the commitment case.

Optimal public investment with and without government commitment

We analyze the problem of optimal public investment when government purchases of productive capital assets are financed through income taxes. Virtually all previous work in this literature has prescribed a share of public investment in GDP that is both constant and time consistent. This paper shows that this straightforward prescription derives from specific assumptions relating to preferences and technology. In a more general framework, the optimal policy is neither constant nor time consistent. With full commitment, a policymaker will typically choose a tax rate, or alternatively a share of public investment, that increases over time. He does not exploit the first-period non-distortionary tax on capital but instead delays taxation in order to generate a "take-off" phase with higher consumption and higher private investment. When optimal policy is constrained to be time consistent, long-run tax rates surprisingly emerge to be lower than under the Ramsey plan. Therefore, the inability to commit to future policy implies too little public investment in the long run. Finally, in contrast to previous work, we find that the efficient share of public investment in GDP depends importantly on the intertemporal elasticity of substitution, capital depreciation rates, and the growth rates of productivity and population.Fiscal policy