Regulation, Remainder Risk, and Public Investment Fund: A Theoretical Analysis

Abstract

In the EU member countries that obey the rule of law principle, the legislative work of the parliament supports the market economy by producing public capital. In many cases, legislation is connected to public investment projects, and sometimes also to socially important private projects. Both include public benefits and costs, but also public risks. Moreover, as the public commitment to major private undertakings may preclude both immaterial and material contributions, there is a noteworthy threat that an accidental actualization of the remainder risk caused by some unforeseen incident would fall heavily on the taxpayers. This paper constructs a club theoretic model for the analysis of representative democracy. In the model, the public commitment to a private project is decided by the simple majority voting rule in the parliament. The analysis shows that strict assessment of the remainder risk may halt the whole undertaking implying that the promised social benefits are also lost. As a solution, we propose a constitutional Investment Fund, which would launch short-maturity public bonds to citizens and pension funds, earmarked to the material part of the public commitment to private projects. The system could partly privatize the public remainder risk so that only the immaterial part remains to common taxpayers thus increasing the probability of a majority vote for the project. At the same time, the government would get equity finance for its investments, and the citizens and pension funds would hold securities with tangible net asset value. The system should increase precision in public debt and risk management and bring democracy, public governance, and the market economy closer to each other.