Infrastructure Quality and the Subsidy Trap
I demonstrate how a targeted program of utility subsidies leads to the persistence of low-quality infrastructure in a developing country. First, I estimate a structural model of household demand for electricity, using customer billing data from Colombia matched to household characteristics and network outage data. Using this model, I predict the change in household consumption and firm profits from upgrading low-quality electricity connections. I show that the existing subsidy program, which provides greater transfers in areas with unreliable supply, deters investments to modernize infrastructure. Finally, I analyze less costly programs that provide stronger investment incentives.
This paper was presented at the Financial Systems, Industrial Organization, and Economic Development Workshop in April of 2012. The corresponding presentation is also available.