This paper explores the dynamic properties of price based policies in a model of competition between two jurisdictions. Jurisdictions invest over time in infrastructure to increase the quality of the environment, a global public good. They are identical in all respects but one: initial stocks of infrastructure. This is a dynamic type of heterogeneity that disappears in the long run. Therefore, at the steady state, usual institutions from static settings apply: identical jurisdictions unefficiently underinvest, calling for public subsidies. In the short run, however, counterintuitive properties are established: (i) the evolution of capital stocks can be nonmonotonic and (ii) one jurisdiction can be temporarily taxed, even though it should increase its investment, whereas the other is subsidized. It is shown how this phenomena are related to initial conditions and the king of interactions between infrastructure capitals, complementarity or substitutability.
Regulation of investments in infrastructure: the interplay between strategic behaviors and initial endowments
14 January 2014