Incentives, Protection and Time Consistency

Abstract

Given symmetric information, it is assumed that the optimal policy for a policy maker is to commit to future removal of tariff protection as this provides the form with a greater incentive to undertake cost reducing effort than otherwise. This policy is shown to be time inconsistent and as a result less cost reducing effort is undertaken than in the credible commitment solution. The introduction of asymmetric information weakens this last result as it allows the policy maker to credibly commit to at least some removal of tariff protection. As a consequence, the expected value of the policy maker's objective function may be greater under asymmetric information than symmetric information.