Investment Policy for Time-Inconsistent Discounters

This paper explores how a principal with time-inconsistent preferences invests optimally in technology or capital. If the current principal prefers her future self to save more, she can increase current investments complementary to future savings and decrease investments in the strategic substitutes, for example. To characterize the principal’s choices they are compared to a market equilibrium where the investors are private agents. Each investing agent applies the same discount factors as do the principal and he obtains full property rights to the future returns. With geometric discounting, there would be no need to regulate (subsidize/tax) these agents. With time-inconsistent preferences, however, the current principal benefits from subsidizing investments in “green” capital (complementary to future savings) and tax investments in substitute capital such as “brown” technology and even adaptation technology. The paper can thus compare policies for different types of investments at the same level in the production hierarchy, but investments at different levels are also compared. With quasi-hyperbolic discounting, the optimal subsidy is unrelated to this level. With discount rates that are strictly decreasing in relative time, however, upstream investments (needed for downstream investments) will optimally be subsidized at a higher rate. When applied to environmental policy, the paper provides a new rationale for subsidizing green (and taxing brown) technology unrelated to the traditional motivation emphasizing public good aspects.