Raphael Galvao

Political Economy of Transparency

This paper develops a model where short-term reputation concerns guide the public disclosure of information and affect welfare in a coordination environment. Entrepreneurs use public information to make investment decisions, and there is complementarity in their actions. There are and high and low states that determine the productivity in the economy, and the high state is more likely if the government is efficient rather than inefficient. Governments know the state and make public reports with the objective to be perceived as efficient. Entrepreneurs form beliefs about the government based on the public report and the realized productivity, a noisy signal of the state. I find that the inefficient government is never completely truthful in equilibrium. When the efficient government is truthful, the inefficient government sends false reports of a high state with positive probability. This creates uncertainty following the report of a high state: if the true state is high, productivity is underestimated; if the true state is low, productivity is overestimated. This bias reduces welfare in the high state, but there is a tradeoff in the low state: marginal entrepreneurs lose from overestimating productivity; all entrepreneurs gain from a higher aggregate investment. I show that when the trust in the government’s report is low, the inefficient government can improve welfare in the low state by sending false reports that increase investment. However, as the trust in the false reports rises, the bias in entrepreneurs’ beliefs becomes large and welfare decreases (there is too much investment).

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