Optimal Provision of a Restricted Public Good under Lobbying and Income Inequality

Abstract

In this chapter we develop a competitive model for a small open economy with a restricted public good to show how income distribution and political-economic considerations have implications for the optimal provision of a restricted public good. The chapter also examines the effect of a change in the international terms of trade on the optimal provision of the public good. We characterise the optimal level of the public good under different scenarios. In the benchmark scenario there is no lobbying and no distributional considerations in the government’s objective function. Here the optimal level of public good provision is given by the Samuelsonian golden rule. We then allow for lobbying by skilled workers and the capitalists for public good provision but do not allow for distributional considerations by the government. Here we derive a necessary and sufficient condition for the optimal level of public good provision to be bigger than the one in the benchmark case. The (necessary and sufficient) condition depends on the sign of the elasticity of the unit cost of production for the public good with respect to the endowment of unskilled labour. In the third scenario, we rule out lobbying but allow for income distributional considerations in the government’s objective function. Here we find sufficient conditions (but not necessary condition) for the optimal level of public good provision to be higher or lower than that under the benchmark case. We also examine how the optimal provision of public good reacts when there is an appreciation of the country’s international terms of trade and derive a sufficient condition for an appreciation of the terms of trade to increase the optimal level of public good provision.