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Too Much Investment : A Problem Of Coordination Failure

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Author Info

  • de Meza, David

    (LSE)

  • Lockwood, Ben

    (University of Warwick)

Abstract

This paper shows that coordination failure and contractual incompleteness can lead to socially excessive investment. Firms and workers choose investment levels, then enter a stochastic matching process. If investment levels are discrete, and match frictions are low, high-investing workers (firms) impose a negative pecuniary externality on any worker (firm) who cuts investment. Specifically, an agent cutting investment subsequently bargains with a partner with a binding outside option due to the fact that it can easily match with another high investor. The deviant thus bears the full loss in revenue from its action. However, given enough complementarity in investments, when one agent cuts investment it is efficient that its partner also does so. So, only part of the cost saving accrues to the deviant, with the implication that the net private gain to cutting investment is less than the social gain. A similar argument establishes that over-investment can occur when agents are heterogenous i.e. differ in their cost of investing, even if investments are continuous. Then, over-investment occurs because low-cost investors have a private incentive to invest to shift rent away from high-cost investors. Our model can also explain some recent trends in graduate/non-graduate wage differentials.

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Bibliographic Info

Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 703.

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Length: 41 pages
Date of creation: 2004
Date of revision:
Handle: RePEc:wrk:warwec:703

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Related research

Keywords: hold-up ; coordination failure ; matching ; over-investment;

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References

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  1. Douglas Gale, 2010. "Limit theorems for markets with sequential bargaining," Levine's Working Paper Archive 621, David K. Levine.
  2. Coles, Melvyn G & Muthoo, Abhinay, 1994. "Strategic Bargaining and Competitive Bidding in a Dynamic Market Equilibrium," CEPR Discussion Papers 938, C.E.P.R. Discussion Papers.
  3. Leonardo Felli & Kevin Roberts, 2001. "Does Competition Solve the Hold-up Problem?," STICERD - Theoretical Economics Paper Series 414, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
  4. North, Douglass C. & Weingast, Barry R., 1989. "Constitutions and Commitment: The Evolution of Institutions Governing Public Choice in Seventeenth-Century England," The Journal of Economic History, Cambridge University Press, vol. 49(04), pages 803-832, December.
  5. Crawford, Vincent P, 1988. "Long-term Relationships Governed by Short-term Contracts," American Economic Review, American Economic Association, vol. 78(3), pages 485-99, June.
  6. Maarten Goos & Alan Manning, 2007. "Lousy and Lovely Jobs: The Rising Polarization of Work in Britain," The Review of Economics and Statistics, MIT Press, vol. 89(1), pages 118-133, February.
  7. Murphy, Kevin M. & Shleifer, Andrei & Vishny, Robert W., 1989. "Industrialization and the Big Push," Scholarly Articles 3606235, Harvard University Department of Economics.
  8. Masters, Adrian M, 1998. "Efficiency of Investment in Human and Physical Capital in a Model of Bilateral Search and Bargaining," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(2), pages 477-94, May.
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Cited by:
  1. Shingo Ishiguro, 2007. "Holdup, Search and Inefficiency," Discussion Papers in Economics and Business 07-13, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
  2. Surajeet Chakravarty, 2005. "Resolving Contractual Disputes: Arbitration vs Mediation," The Centre for Market and Public Organisation 05/117, Department of Economics, University of Bristol, UK.

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