Capital Rigidities, Latent Externalities

Abstract

Capital, one of two fundamental inputs to production, is critical to economic growth. As such, legal rules and institutions generally seek to create more of it, and also seek to protect existing capital. However, capital is often durable, and during the natural life of capital, information may emerge that point to negative externalities, or to superior alternatives. A problem arises because legal rules and institutions tend to over-promote the formation of capital (mostly by subsidizing it), and over-protect existing capital. This has the effect of both creating too much capital and too large capital. Consequently, new regulation or policy change becomes more difficult, as capital owners will have a larger stake to defend, and will expend more resources to resist regulation or policy reform. By enacting legal rules to promote and protect capital, developed societies have unwittingly erected barriers to policy reform. Over time, economies have become less efficient, less nimble, and the source of more litigation. This argument has special application to energy industries and to environmental problems.This article examines rules surrounding the formation and protection of three forms of capital: physical, human, and social. All of these three forms of capital have the potential to be durable, generate a long-lived stream of benefits, and block policy reform. This article sets out a simple model illustrating how legal rules and institutions over-promote and over-protect these forms of capital, and how and when they block policy reform.