DP7296 Economic Integration and Investment Incentives in Regulated Industries

Author(s): Emmanuelle Auriol , Sara Biancini

Publication Date: May 2009

Keyword(s): competition , Investment , market integration , regulation

JEL(s): F12 , F15 , L43 , L51 , R53

Programme Areas: Development Economics , Industrial Organization

Link to this Page: www.cepr.org/pubs/dps/DP7296.asp.asp

The paper studies the impact of market integration on investment incentives in non-competitive industries. It distinguishes between investment in transportation and production cost-reducing technologies. Each domestic firm is controlled by a national regulator in a common market made of two countries. When public funds are costly, and production costs in the two countries are not very different, business stealing effect decreases welfare in both countries. Welfare increases in both countries when the difference in production costs is large enough. Market integration tends to increase the level of sustainable investment in cost-reducing technology compared to autarky. This is in contrast with the systematic underinvestment problem arising for transportation facilities. Free-riding reduces the incentives to invest in these public-good components, while business-stealing reduces the capacity for financing new investment.