The Dutch F-word

Governments use a variety of policies to encourage citizens to make

certain investments. For example, subsidies affect decisions to invest in human

capital, keep livestock, isolate houses, or buy heat pumps. In many cases, the

returns to those investments depend on future policies. Consequently, to make

proper investment decisions, citizens must form expectations about these future

policies. This paper shows theoretically that policies to encourage investments

often depend on their distributional consequences and not on their efficiency

effects. Moreover, we argue that fiscal policies are typically subject to

flexibility problems, not commitment problems. These findings are highly

relevant against the background of governments that, in the wake of climate

change, will use a wide variety of subsidies to encourage citizens and firms to

invest in wind and solar installations, nuclear power plants, or greener cars.