poly: Why interest rates may stay low

Consider a large menu of investment projects competing for funding from
investors. These projects vary in the rate of return on investment (ROI)
investors expect from them if the project were started today. Assume
better technology makes investments more attractive, i.e., increases
their ROI, and consider the two cases, where there are or are not
property rights in such projects.

First let's establish a benchmark "marginal" project, which for
technical reasons is only available today, and whose ROI is just
barely too low for investors to fund it.

When there are property rights, each owner considers whether to start
her project today, or whether to wait longer. Even for high ROI projects,
it may pay to wait because next year the ROI may be much higher. Or if
the ROI is just a bit higher next year it may be better to do it now. The
market price for this property right should reflect the fact that one
can get a better ROI on this investment than is available on the marginal
project defined above. Thus the average ROI on funded projects should
be higher than the marginal ROI, and could be much higher.

Now consider the case of no property rights in projects. In this case
all projects are undertaken by someone as soon as their ROI rises to the
point where it is just above the marginal ROI. Thus in this case the
average ROI isn't much above the marginal ROI. The market value that
the project would have in the property rights case is in this case
burned up in the race to get there first.

To the extent that the supply curve for investment funds is relatively
flat (as it seems to me that the literature suggests), the marginal ROI
will be similar in the two cases. And to the extent that growth rates
are tied more to the average ROI than to the total amount invested,
growth rates may be lower in the no-property-rights case, and may be
relatively insensitive to the real ROI that technology allows.

Robin Hanson
hanson@econ.berkeley.edu http://hanson.berkeley.edu/
RWJF Health Policy Scholar, Sch. of Public Health 510-643-1884
140 Warren Hall, UC Berkeley, CA 94720-7360 FAX: 510-643-8614
Received on Wed Mar 4 00:17:48 1998