Political Economy of Transparency

This paper studies the effects of short-term reputation concerns on the public disclosure of information about the state of the economy. There are efficient and inefficient governments, and high productivity states are more likely under the ecient type. Governments know the state and make public reports with the objective to be perceived as ecient. Entrepreneurs use public information to make investment decisions and their actions are strategic complements. In equilibrium, the inecient type is optimistic: it sends false reports high productivity states with positive probability. This creates uncertainty for entrepreneurs: if the true state is high, productivity is underestimated; if the true state is low, productivity is overestimated. This bias reduces welfare in the high state, but there is a tradeo↵ in the low state: marginal entrepreneurs lose from overestimating productivity; all entrepreneurs receive complementarity gains from a higher aggregate investment. I show that when the trust in the government’s report is low, the inecient government can improve welfare in the low state by sending false reports that increase investment (a small economic boom). However, as the trust in the false reports rises, the bias in entrepreneurs’ beliefs becomes large and welfare decreases (there is too much investment).