Competition, entry and the social returns to infrastructure in transition economies

This paper presents a simple model for analysing the contribution of investments in physical and institutional infrastructure to the transition process. In addition to the direct cost savings, infrastructure investment generates important indirect effects, or transition impacts. The model shows that, by reducing transaction costs, infrastructure intensifies product market competition. This leads to more effective weeding out of the existing high‐cost firms in the market. In this model, infrastructure also increases the incentives for low‐cost firms to restructure which generates additional efficiency gains, but exacerbates the existing cost asymmetry in the economy. Finally, infrastructure investment enhances the incentives for relatively low‐cost firms to enter the market, and thus improves the efficiency of the entry process. The importance of these transition impacts of infrastructure is dependent upon features of the economy, such as the degree of cost asymmetry among firms, the proportion of high‐cost firms, the cost of restructuring and entry costs for new firms. JEL classification: L1, O1, P2.