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THE POLITICAL ECONOMY OF INFRASTRUCTURE INVESTMENT: COMPETITION, COLLUSION AND UNCERTAINTY By Arghya Ghosh and Kieron Meagher ANU Working Papers in Economics and Econometrics # 556 October, 2011 JEL: D43, L13, H4 ISBN: 086831 556 7 THE POLITICAL ECONOMY OF INFRASTRUCTURE INVESTMENT: COMPETITION, COLLUSION AND UNCERTAINTY ARGHYA GHOSH AND KIERON MEAGHER ABSTRACT. Infrastructure, as it impacts transport costs, is crucial in determining equilibrium outcomes in spatial competition; however, infrastructure investment is typically exogenous. Our political economy analysis of infrastructure choice is based upon consumer preferences derived from Salop’s circular city model. In this setting, infrastructure investment has two effects: it directly lowers costs to consumers and indirectly affects market power. We show how political support for infrastructure in- vestments depends crucially on the details of the market. Competition boosts popular support for infrastructure — often excessively so — while collusion leads to underin- vestment. The uncertainty produced by infrastructure induced entry leads to traps and thresholds. Keywords: Spatial Competition, Infrastructure Investment, Salop’s circular city, Vot- ing, Referendum. JEL Codes: D43, L13, H4 1. INTRODUCTION One of the original interpretations of transportation costs in the spatial competi- tion framework is as a reflection of transport infrastructure: “These particular merchants would do well, instead of