Design of investment promotion policies

Abstract

Over the last 20years, developing countries have experienced the massive shift of financing and the operation of infrastructure from the public to the private sector. The paper analyzes how the government agency should structure the investment promotion policy. I develop a sequential contracting model between the government, investors and infrastructure providers and derive several properties of the optimal policy. The policy leaves investors uncertain about the project type and prescribes different levels of government support, in the form of tax or price distortions. However, the optimal policy does not change the expectations of investors about distribution of project returns. I characterize how the optimal policy depends on the revenue generation preferences of the government and the profitability of infrastructure projects in the country.