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Too much investment: a problem of coordination failure

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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 (No.703).

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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, 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

Official Date:

March 2004

Dates:

Date	Event
March 2004	Published

Number:

No.703

Number of Pages:

Status:

Not Peer Reviewed

Access rights to Published version:

Open Access

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