Too much investment: a problem of coordination failure
De Meza, David and Lockwood, Ben (2004) Too much investment: a problem of coordination failure. Working Paper. Coventry: University of Warwick, Department of Economics. (Warwick economic research papers).
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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, then if match frictions are low enough, high investing workers (firms) impose a negative pecuniary externality on any worker (firm) who cuts investment, even by one unit. Specifically, if a worker cuts investment, he subsequently bargains with a firm which has a high outside option due to the fact it can easily match with another high investing worker; this lowers the private net benefit to cutting investment below the social net benefit. 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.
|Item Type:||Working or Discussion Paper (Working Paper)|
|Subjects:||H Social Sciences > HD Industries. Land use. Labor > HD28 Management. Industrial Management
Q Science > QA Mathematics
|Divisions:||Faculty of Social Sciences > Economics|
|Library of Congress Subject Headings (LCSH):||Business planning, Investment analysis, Stochastic processes, Matching theory|
|Series Name:||Warwick economic research papers|
|Publisher:||University of Warwick, Department of Economics|
|Place of Publication:||Coventry|
|Number of Pages:||41|
|Status:||Not Peer Reviewed|
|Access rights to Published version:||Open Access|
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