Planning Agreements in the Mezzogiorno: a Principal-Agent Analysis

In this paper we analyse the so-called "planning contracts" which are adopted for the Italian Mezzogiorno from the point of view of the theory of incentives. The Italian Government is the principal who wants to promote economic development in Southern regions of the country. Large firms, both Italian or foreign, are the agents who are keen on locating new plants or restructuring existing ones, provided that expected profits are sufficiently high. Incentives are necessary in order to smooth out any extra-costs encountered when investing and operating in a less favourable environment. We suggest that planning contracts can be interpreted as a case of procurement where Government is the sole buyer of a public good. We refer to a model by Laffont and Tirole (1993) in order to show that under conditions which may be relevant for the Italian experience, firms will enjoy rents that imply allocative inefficiency because of an excess of investment.