Planning under Incomplete Information and the Ratchet Effect

Central planning of production is usually performed under asymmetric information which leads to use of an incentive scheme. As the planner revises the scheme over time to take into account information provided by the firm's performance, this induces firms to underproduce to avoid more demanding schedules in the future—the ratchet effect. This paper explores this phenomenon under the realistic assumption that the planner cannot commit himself to a revision procedure. We show that the ratchet effect exists, in the sense that the planner may choose a scheme which is suboptimal from a static viewpoint in order to induce revelation, with the marginal price of output exceeding its optimal static value.