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Too Much Investment : A Problem Of Coordination Failure

Author

Listed:
  • 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.

Suggested Citation

  • de Meza, David & Lockwood, Ben, 2004. "Too Much Investment : A Problem Of Coordination Failure," The Warwick Economics Research Paper Series (TWERPS) 703, University of Warwick, Department of Economics.
  • Handle: RePEc:wrk:warwec:703
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    File URL: https://www2.warwick.ac.uk/fac/soc/economics/research/workingpapers/2008/twerp703a.pdf
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    References listed on IDEAS

    as
    1. Leonardo Felli & Kevin Roberts, 2016. "Does Competition Solve the Hold-up Problem?," Economica, London School of Economics and Political Science, vol. 83(329), pages 172-200, January.
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    3. 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 477-494, May.
    4. Crawford, Vincent P, 1988. "Long-term Relationships Governed by Short-term Contracts," American Economic Review, American Economic Association, vol. 78(3), pages 485-499, June.
    5. Murphy, Kevin M & Shleifer, Andrei & Vishny, Robert W, 1989. "Industrialization and the Big Push," Journal of Political Economy, University of Chicago Press, vol. 97(5), pages 1003-1026, October.
    6. 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.
    7. Gale, Douglas, 1987. "Limit theorems for markets with sequential bargaining," Journal of Economic Theory, Elsevier, vol. 43(1), pages 20-54, October.
    8. Melvyn G. Coles & Abhinay Muthoo, 1998. "Strategic Bargaining and Competitive Bidding in a Dynamic Market Equilibrium," Review of Economic Studies, Oxford University Press, vol. 65(2), pages 235-260.
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    Cited by:

    1. 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.
    2. Shingo Ishiguro, 2010. "Holdup, search, and inefficiency," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 44(2), pages 307-338, August.
    3. Kurmann, André, 2014. "Holdups and overinvestment in capital markets," Journal of Economic Theory, Elsevier, vol. 151(C), pages 88-113.

    More about this item

    Keywords

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

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials

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