A Study on Government Commitment, Public Capital, and Trade

Abstract

Purpose – Political populism can leave a negative impact upon social welfare with weakening commitment credibility. It is widely known that public policy plays a role in determining trade gains. The purpose of this paper is to examine how political populism affects the social welfare of an open economy. Design/Methodology/Approach – This paper extends the Brander-Spencer model in which home and foreign firms compete in oligopoly in a third country. In that model, social welfare is defined as the sum of home firm profits. Strategically, home and foreign firms schedule output to maximize firm profits. Firms can make investments privately to reduce the marginal cost. This paper supposes that a government invests in public capital to inspire private investments. The public investment of the home government benefits the home firms. Findings – The project of public capital investment takes time until completion. That is, it will be completed in the future. Thus, commitment credibility matters. Specifically, politicians have incentives to reschedule the on-going project of public capital investment in their best political interest. This is the main reason why many public projects encounter hold-up problems. Political populism lies at the center of the problems. Research Implications – This paper emphasizes that commitment credibility is important as along with the size of the public project. Although the size of a public project is large, the private sector does not respond to the commitment if it lacks credibility. Thus, policymakers should keep in mind that commitment credibility is a necessary condition for the success of a public project.