How Disagreement About Social Costs Leads to Inefficient Energy-Productivity Investment

Public energy-productivity investment influences the amount of future energy consumption. If a present government expects its successor to value the social costs of fuel usage differently, this adds a strategic component to its investment considerations. We analyze this governmental time-inconsistency situation as a sequential game. In particular, we show how the expectation of a more conservative party taking over makes a “green” government choose an investment level that is inefficient, in that neither of the parties would prefer it to the investment level of a permanent green government. Under some circumstances, the opposition would even prefer the government definitely to stay in power: The gain from avoiding a strategic investment then outweighs the loss of not being able to regulate energy consumption. We also analyze the welfare gains from binding agreements.