Incentive Compatible Reforms : The Political Economy of Public Investments in Mongolia

Abstract

Why do politicians distort public
 investments? And given that public investments are poor
 because presumably that is what is politically rational,
 what types of reforms are likely to be both efficiency
 improving and compatible with the interests of politicians?
 This paper explores these two questions in the context of
 Mongolia. It argues that Mongolian members of parliament
 have an incentive to over-spend on smaller projects that
 bring benefits to specific geographical localities and to
 under-spend on large infrastructure that would bring
 economic benefits to Mongolia on the whole. The incentive
 for the former is that members of parliament internalize the
 political benefits from the provision of particular,
 targeted benefits to specific communities. The disincentive
 for the latter is that large infrastructure carries a
 political risk because the political faction in control of
 that particular ministry would have access to huge rents and
 become politically too powerful. The identity of these
 "winners" is uncertain ex ante, given the
 relatively egalitarian and ethnically homogenous nature of
 Mongolia's society and polity. Anticipating this risk,
 members of parliament are reluctant to fund these projects.
 Since these large infrastructure projects are crucial for
 national growth, neglecting them hurts all members of
 parliament. Members of parliament will therefore support
 reforms that collectively tie their hands by safeguarding
 large, strategic investment projects from political
 interference thereby ensuring that no political faction
 becomes too powerful. This protection of mega-projects would
 need to be part of a bargain that also allows geographical
 targeting of some percentage of the capital budget.