Policy incentives and economic outcomes : three essays in applied microeconomics

Abstract

This thesis contributes to the understanding of how policy making shapes economic outcomes, and the role of individual decision and incentives in this process. It consists of three chapters, which focus on aspects of this general topic from an applied microeconomic perspective: (i) market mechanisms for environmental policy and their implications for firm investment, (ii) political incentives of pork barrel environmental expenditures, and (iii) strategic interaction in decision making among decentralized levels of government. In the first chapter, entitled Policy Uncertainty and Investment in Low-Carbon Technology, which is joint work with Silvia Albrizio, we investigate how uncertainty over environmental policy affects firms’ investment in low-carbon technology in the context of an emission trading scheme. We develop a three period sequential model combining the industry and electricity sectors and encompassing both irreversible and reversible investment possibilities for firms. Additionally, we explicitly model policy uncertainty in the regulator’s objective function as well as the market interactions giving rise to an endogenous permit price. We find that uncertainty reduces irreversible investment and that the availability of both reversible and irreversible technologies partially eliminates the positive effect of policy uncertainty on reversible technology found in previous literature. In the second chapter, entitled Pork Barrel as a Signaling Tool: The Case of US Environmental Policy, I investigate whether signaling is a driving force of pre-electoral pork barrel policies. I develop a two-period model of electoral competition where politicians use current policies to signal their preferences to rational, forward-looking voters. There exists an equilibrium where incumbents use pork barrel spending for signaling in majoritarian systems. Results show that pork spending is directed towards ideologically homogeneous groups and is mitigated if the incumbent is a "lame duck" or has a high discount rate. The predictions of the model are tested using data on US State level environmental expenditures. The results support the signaling motive as a central mechanism in generating pork barrel towards the environment. In the third chapter, entitled Interaction in Local Governments’ Spending Decisions: Evidence from Portugal, which is joint with Linda Veiga and Miguel Portela, we analyze the sources and the degree of interaction among Portuguese municipalities’ expenditure levels by estimating a dynamic panel model, based on jurisdictional reaction functions. The analysis is performed for all 278 Portuguese mainland municipalities from 1986 to 2006, using alternative ways to measure neighborhood. Results indicate that local governments’ spending decisions are significantly, and positively, influenced by the actions of neighboring municipalities. Attempts to identify the sources of interaction allow us to conclude that they are due to spillovers that require coordination in expenditure items and to mimicking behavior possibly to attract households and firms.