Lobbying and Infrastructure Investment in an Open Economy

By

Joy Mazumdar and Ujjayant Chakravorty

Emory University

Abstract

There is a consensus that open economies exhibit faster rates of growth than closed ones. However, the mechanisms through which this takes place are still not very well understood. In this paper we suggest one possible channel via which trade may lead to higher growth. We present a model with two sectors (tradable and non-tradable) to show that the tradable sector will experience higher investment in industry-specific infrastructure. We use the Grossman and Helpman (1994) framework to show that firms in the tradable goods sector will lobby the government for higher levels of investment to gain market share in both the domestic and foreign market. An implication of the paper is that government capital expenditure is likely to be biased in favor of sectors that exhibit a higher degree of openness to international trade.

We assume a fixed number of firms in the two sectors who are engaged in Cournot competition. Infrastructure investments have public good characteristics and are made solely by the government. The benefits from investing in the tradable sector are higher than in the non-tradable sector because domestic firms gain a larger market share both in the domestic and foreign market. This mechanism is similar to the framework of Brander and Spencer (1985). Thus the social planner invests more in the tradable sector. Similar results are obtained in a lobbying framework in which the government maximizes a modified objective function that includes lobbying contributions and aggregate social welfare.

Evidence for this phenomenon can be found in India where government expenditure in the telecommunications sector grew at a significantly higher rate than in other infrastructure sectors. Actual government expenditure in this sector even exceeded five year plan targets unlike in other sectors where expenditures trailed behind target levels substantially. Investments in telecom overshot targets by 3 percentage points while for example, in the critical power sector, investments lagged behind target levels by 22.5 percentage points (Ahluwalia, 1998). Moreover, international telecommunication costs have declined faster than the costs of domestic networks suggesting that export-oriented activities were the biggest beneficiaries of government investment. This is likely due to the lobbying efforts of the highly organized Indian software industry which relies primarily on exports to international markets.

References:

Montek S. Ahluwalia (1998), “Infrastructure Development in India’s Reforms,” in Isher J. Ahluwalia and I.M.D. Little, eds., India’s Economics Reforms and Development: Essays for Manmohan Singh, Oxford University Press, 87-121.

James A. Brander and Barbara J. Spencer (1985), “Export Subsidies and International Market Share Rivalry,” Journal of International Economics (18), 83-100.

Gene M. Grossman and Elhanan Helpman (1994), “Protection for Sale,” American Economic Review 84(4), 833-50.